**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**FOR ANNUAL AND TRANSITIONREPORTS**

**PURSUANTTO SECTIONS 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**
| **x** | ** ** | **Annual report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
|-------|------------|---------------------------------------------------------------------------------------------------------------|

 

**Forthe fiscal year ended JUNE 30, 2006**

**-or-**
| **o** | ** ** | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934.** |
|-------|------------|-----------------------------------------------------------------------------------------------------------|

 

**Forthe transition periodfrom                       to                       **

**CommissionFile Number: 0-49706**

**WILLOW FINANCIAL BANCORP, INC.**

(Exact Name of Registrantas Specified in its Charter)

| **PENNSYLVANIA**                                                 |   | **80-0034942**                      |
|------------------------------------------------------------------|--------|-------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (IRS Employer   Identification No.) |

 

**170 SOUTH WARNER ROADWAYNE, PENNSYLVANIA 19087**

(Address of PrincipalExecutive Offices)

Registrant’s telephonenumber: (including area code) **(610) 995-1700**

Securities registered pursuant to Section 12(b) ofthe Act:

**Common Stock (par value $0.01 per share)**

(Title of Class)

Securities registeredpursuant to Section 12(g) of the Act: **NONE**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. YES o NO x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. YES o NO x

Indicate by check markwhether the Registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. YES x NO o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):

Large Accelerated Filer o Accelerated Filer x Non-Accelerated Filer o

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). YES o NO x

The aggregate market valueof the voting stock held by non-affiliates of the Registrant based on theclosing price of $15.10 on December 31, 2005, the last business day of theRegistrant’s second quarter was $173,708,892 (14,772,913 shares outstandingless 3,269,017 shares held by affiliates at $15.10 per share). Althoughdirectors and executive officers of the Registrant and certain employee benefitplans were assumed to be “affiliates” of the Registrant for purposes of thecalculation, the classification is not to be interpreted as an admission ofsuch status.

As of the close of businesson September 8, 2006 there were 14,970,570 shares of the Registrant’sCommon Stock outstanding.

**DOCUMENTS INCORPORATED BY REFERENCE**

1.                  Portions of the Definitive Proxy Statement for the 2006Annual Meeting of Stockholders are incorporated by reference in Part III.

 

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**WillowFinancial Bancorp, Inc.**

**FORM 10-K**

**Forthe Fiscal Year Ended June 30, 2006**

**INDEX**
| PART I   |   |                                                                                                               |   |   |   |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Item 1.       |   | Business                                                                                                           |   | 1      |   |
| Item 1A.      |   | Risk Factors                                                                                                       |   | 33     |   |
| Item  1B.     |   | Unresolved Staff Comments                                                                                          |   | 36     |   |
| Item 2.       |   | Properties                                                                                                         |   | 37     |   |
| Item 3.       |   | Legal Proceedings                                                                                                  |   | 39     |   |
| Item  4.      |   | Submission of Matters to a  Vote of Security Holders                                                               |   | 40     |   |
| PART II  |   |                                                                                                               |   |   |   |
| Item  5.      |   | Market for Registrant’s  Common Stock, Related Stockholder Matters and Issuer Purchases of Equity  Securities |   | 41     |   |
| Item  6.      |   | Selected Financial Data                                                                                            |   | 41     |   |
| Item  7.      |   | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                        |   | 43     |   |
| Item  7A.     |   | Quantitative and Qualitative  Disclosures about Market Risk                                                        |   | 55     |   |
| Item  8.      |   | Financial Statements and  Supplementary Data                                                                       |   | 62     |   |
| Item  9.      |   | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure                              |   | 102    |   |
| Item  9A.     |   | Controls and Procedures                                                                                            |   | 102    |   |
| Item 9B.      |   | Other Information                                                                                                  |   | 102    |   |
| PART III |   |                                                                                                               |   |   |   |
| Item  10.     |   | Directors and Executive  Officers of the Registrant                                                                |   | 102    |   |
| Item  11.     |   | Executive Compensation                                                                                             |   | 103    |   |
| Item  12.     |   | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                    |   | 103    |   |
| Item  13.     |   | Certain Relationships and  Related Transactions                                                                    |   | 104    |   |
| Item  14.     |   | Principal Accounting Fees  and Services                                                                            |   | 104    |   |
| PART IV  |   |                                                                                                               |   |   |   |
| Item  15.     |   | Exhibits and Financial  Statement Schedules                                                                        |   | 105    |   |
|          |   | Signatures                                                                                                         |   | 108    |   |

 

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**Forward Looking Statements**

*This Annual Report on Form 10-K containscertain forward-looking statements (as defined in the Securities ExchangeAct of 1934 and the regulations hereunder). Forward-looking statementsare not historical facts but instead represent only the beliefs, expectationsor opinions of Willow Financial Bancorp, Inc. and its management regardingfuture events, many of which, by their nature, are inherently uncertain.Forward-looking statements may be identified by the use of such words as:“believe”, “expect”, “anticipate”, “intend”, “plan”, “estimate”, or words ofsimilar meaning, or future or conditional terms such as “will”, “would”, “should”,“could”, “may”, “likely”, “probably”, or “possibly.” Forward-lookingstatements include, but are not limited to, financial projections and estimatesand their underlying assumptions; statements regarding plans, objectives andexpectations with respect to future operations, products and services; andstatements regarding future performance. Such statements are subject to certainrisks, uncertainties and assumption, many of which are difficult to predict andgenerally are beyond the control of Willow Financial Bancorp and itsmanagement, that could cause actual results to differ materially from thoseexpressed in, or implied or projected by, forward-looking statements. Thefollowing factors, among others, could cause actual results to differmaterially from the anticipated results or other expectations expressed in theforward-looking statements: (1) economic and competitive conditionswhich could affect the volume of loan originations, deposit flows and realestate values; (2) the levels of non-interest income and expense and theamount of loan losses; (3) competitive pressure among depositoryinstitutions increasing significantly; (4) changes in the interest rateenvironment causing reduced interest margins; (5) general economicconditions, either nationally or in the markets in which Willow FinancialBancorp is or will be doing business, being less favorable than expected;(6) politicaland social unrest, including acts of war or terrorism; or (7) legislationor changes in regulatory requirements adversely affecting the business in whichWillow Financial Bancorp will be engaged. Willow Financial Bancorp undertakesno obligation to update these forward-looking statements to reflectevents or circumstances that occur after the date on which such statements weremade.*

**PART I**

**Item1.**                        Business

**General.****  **Effective at 11:59 p.m., September 21,2006, Willow Grove Bancorp, Inc. and Willow Grove Bank changed their names to WillowFinancial Bancorp, Inc. and Willow Financial Bank, respectively. As contained  herein, references to the Company includeboth Willow Financial Bancorp, Inc. and Willow Grove Bancorp, Inc. andreferences to the Bank include both Willow Financial Bank and Willow GroveBank. Coincident with the name change, the Company’s trading symbol on theNASDAQ Global Select Market was changed from “WGBC” to “WFBC”.****

Willow Financial Bancorp, Inc. (the “Company”),is a Pennsylvania corporation and parent holding company for Willow FinancialBank (the “Bank”). The Bank, which was originally organized in 1909, is aFederally chartered savings bank and wholly owned subsidiary of the Company.The Bank’s business consists primarily of making commercial business andconsumer loans as well as real estate loans, both commercial and residential,funded primarily by retail and business deposits along with borrowings obtainedfrom the Federal Home Loan Bank (“FHLB”) of Pittsburgh, or borrowings obtainedfrom third parties through repurchase agreements.

After the close ofbusiness on August 31, 2005, the Company completed its acquisition of ChesterValley Bancorp Inc. (“Chester Valley”), a registered bank holding companyheadquartered in Downingtown, Pennsylvania, with over $636 million inassets. Chester Valley had two wholly owned subsidiaries, First Financial Bank,a Pennsylvania chartered commercial bank (“FFB”) with 13 full-service bankingoffices, and Philadelphia Corporation for Investment Services, a registeredinvestment advisor and broker dealer (“PCIS”). The Bank operates a branchbanking network consisting of 28 full-service offices which are located inneighboring Chester County, Montgomery County and Bucks County, Pennsylvania, 

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as wellas Philadelphia. Additionally, the Company relocated to its new Corporate Headquartersand combined operations center in February 2006 and opened a full servicebranch in Wayne, Pennsylvania.

Pursuant to the Agreementand Plan of Merger, dated as of January 20, 2005 (the “Merger Agreement”),Chester Valley was merged with and into the Company, with the Company as thesurviving corporation (the “Merger”), and FFB was merged with and into the Bankwith Willow Financial Bank as the surviving bank (the “Bank Merger”). PCIS nowoperates as a business segment of the Company. As a result of the Merger, eachoutstanding share of Chester Valley common stock, par value $1.00 per share(the “Chester Valley Common Stock”), was converted into the right to receive,at the election of the shareholder, either $27.90 in cash or 1.4823 shares of Companycommon stock, par value $0.01 per share (the “Company Common Stock”), subjectto the allocation and pro ration provisions set forth in the Merger Agreement.The acquisition resulted in the Company’s issuance of an aggregate of 4,977,256 sharesof Company Common Stock and $51.0 million in cash, resulting in a totalmerger consideration paid for Chester Valley Common Stock of$145.3 million. This included capitalized acquisition costs and the valueof Chester Valley vested stock options converted to options of the Company atthe average stock price of the Company on the four days surrounding theannouncement of the acquisition. The Company used general corporate funds topay the aggregate cash consideration of approximately $51.0 million forthe shares of Chester Valley Common Stock acquired in the Merger for cash, aswell as the approximate $3.2 million in acquisition costs.

The Merger has beenaccounted for using the purchase method of accounting, which requires that ourfinancial statements include activity of Chester Valley only subsequent to theacquisition date of August 31, 2005. Accordingly, our consolidatedfinancial statements and the information herein include the combined results of  Chester Valley and its former subsidiaries,FFB and PCIS, since September 1, 2005.

Effective February 28,2006, the Company completed the sale of all outstanding shares of capital stockof PCIS to Uvest BD-A, Inc., a North Carolina Corporation and registeredbroker-dealer (“Uvest”) for consideration of $100 but providing that suchshares may be repurchased for $100 at any time after the closing date of thestock sale. Concurrently with the execution of the sale of PCIS, the Bank andUvest entered into a related Sub-Clearing and Brokerage Services Agreement,which provides that an affiliate of Uvest provides securities clearing andcertain supervisory and compliance services for PCIS, and a Financial ServicesAgreement between PCIS and the Bank which provides that the Bank will beentitled to 92% of the revenue generated by the securities brokerage andinvestment advisory activities conducted at PCIS and will bear substantiallyall operational and overhead expenses. Upon consummation of the sale of PCIS stockto Uvest, PCIS is no longer a subsidiary of the Company. However, under theprovisions of FIN 46R (“Consolidation of Variable Interest Entities”), theresults of PCIS continue to be consolidated in the Company’s financialstatements. The affiliation agreement with Uvest has the primary effect ofrelieving PCIS of direct responsibility for securities clearing and certainback-office and oversight obligations.

References to Companyinclude its consolidated entities, Willow Financial Bank, its subsidiaries, andPCIS, unless the context of the reference indicates otherwise.

In recent years, theCompany’s business plan focused on the following primary goals—changingoperations to a full-service community bank and continued steady growth whilemaintaining a high level of asset quality. Until the acquisition of ChesterValley, the growth was accomplished through internal means. To the extent thatadditional acquisition opportunities present themselves and are deemed prudentby the Company’s Board of Directors and management, additional acquisitions offinancial institutions will be considered to further enhance shareholder value.We also will consider adding additional de novo Bank branch offices to “fill-in”our existing network.

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The Bank’s customerdeposits are insured to the maximum extent provided by law, by the FederalDeposit Insurance Corporation (“FDIC”), through the Savings AssociationInsurance Fund (“SAIF”). The Bank is subject to examination and comprehensiveregulation by the Office of Thrift Supervision (“OTS”) and is also regulated bythe FDIC. The Bank is also subject to reserve requirements established by theBoard of Governors of the Federal Reserve System (the “Federal Reserve Board”or “FRB”), and is a member of the FHLB, one of the regional banks comprisingthe Federal Home Loan Bank System.

Our executive offices arelocated at 170 South Warner Road, Wayne, Pennsylvania, and our telephone numberis (610) 995-1700.

**Available Information**

The Company files annual,quarterly and special reports, proxy statements and other information with theSecurities and Exchange Commission (“SEC”). Our SEC filings are available tothe public at the SEC’s web site at http: //www.sec.gov. Members of the publicmay also read and copy any document we file at the SEC’s Public Reference Room at100 F Street, N.E., Washington, D.C. 20549. You can request copies of thesedocuments by writing to the SEC and paying a fee for the copying cost. Pleasecall the SEC at 1-800-SEC-0330 for more information about theoperation of the public reference room. In addition, our stock is listed fortrading on the Nasdaq Global Select Market and trades under the symbol “WFBC”.You may find additional information regarding Willow Financial Bancorp, Inc.at *www.nasdaq.com*. In addition tothe foregoing, we maintain a web site at *www.wfbonline.com*.We make available on our Internet web site copies of Willow Financial Bancorp’sAnnual Reports on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and any amendments to such documents assoon as reasonably practicable after we file such material with, or furnishsuch documents to, the SEC.

**Market Area and Competition**

The Bank’s primary marketarea includes Bucks, Montgomery, Chester and Philadelphia Counties inPennsylvania. To a lesser extent, the Bank provides services to areas ofDelaware, Berks and Lancaster Counties, Pennsylvania as well as central andsouthern New Jersey and Delaware.

The Bank’s directcompetition for attracting deposits and originating loans has historically comefrom savings associations, other savings banks, commercial banks and creditunions. We face additional competition for deposits from short-term moneymarket funds and other corporate and government securities funds, mutual funds,and other non-financial institutions such as securities brokerage firms andinsurance companies. The Bank competes successfully for loans and depositsthrough competitive interest rates, maturities and fees as well as providingquality service to its customers.

**Employees**

The Company had 312full-time employees and 60 part-time employees at June 30, 2006. None ofthese employees are covered by a collective bargaining agreement and theCompany believes it enjoys good relations with its personnel.

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**Lending Activities**

**Loan Portfolio Composition.****  **The following table sets forth thecomposition of the loan portfolio as of the dates indicated. This data does notinclude single family loans classified as held for sale which amounted to $2.6million, $1.8 million, $1.1 million, $5.3 million, and$1.6 million at June 30, 2006, 2005, 2004, 2003, and 2002,respectively.

|                                         | ** ** | **June 30, 2006**          | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** | **June 30, 2002** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | ** **                           | ** ** | **Percent of**         | ** ** | ** **                  | ** ** | **Percent of**         | ** ** | ** **                  | ** ** | **Percent of** | ** ** | ** ** | ** ** | **Percent of** | ** ** | ** ** | ** ** | **Percent of** | ** ** |
| ** **                              | ** ** | **Amount**                           | ** ** | **total**                   | ** ** | **Amount**                  | ** ** | **total**                   | ** ** | **Amount**                  | ** ** | **total** | ** ** | **Amount** | ** ** | **total** | ** ** | **Amount** | ** ** | **total** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)** | ** ** |
| Mortgage loans:                         |       |                                 |       |                        |       |                        |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Single-family                           |       | $  298,509                 |       |                        | 27.59      | %                           |       | $ 202,942              |       |                        | 34.34      | % |   | $ 181,049 |   |   | 34.15 | % |   | $ 131,821 |   |   | 31.40 | % |   |   | $ 181,454 |   |   |   | 40.40 | % |   |
| Commercial real estate and multi-family |       | 326,268                              |       |                        | 30.16      |                        |       | 174,920                     |       |                        | 29.60      |   |   | 180,881 |   |   | 34.12 |   |   | 155,892 |   |   | 37.14 |   |   |   | 134,294 |   |   |   | 29.90 |   |   |
| Construction                            |       | 112,774                              |       |                        | 10.42      |                        |       | 86,658                      |       |                        | 14.66      |   |   | 57,014 |   |   | 10.75 |   |   | 36,191 |   |   | 8.62 |   |   |   | 29,306 |   |   |   | 6.52 |   |   |
| Home equity                             |       | 259,119                              |       |                        | 23.96      |                        |       | 100,805                     |       |                        | 17.06      |   |   | 91,848 |   |   | 17.32 |   |   | 72,990 |   |   | 17.39 |   |   |   | 75,016 |   |   |   | 16.70 |   |   |
| Total mortgage loans                    |       | 996,670                              |       |                        | 92.13      |                        |       | 565,325                     |       |                        | 95.66      |   |   | 510,792 |   |   | 96.34 |   |   | 396,894 |   |   | 94.55 |   |   |   | 420,070 |   |   |   | 93.52 |   |   |
| Consumer loans                          |       | 4,304                                |       |                        | 0.40       |                        |       | 2,106                       |       |                        | 0.36       |   |   | 1,678 |   |   | 0.32 |   |   | 2,324 |   |   | 0.55 |   |   |   | 10,081 |   |   |   | 2.24 |   |   |
| Commercial business loans               |       | 80,815                               |       |                        | 7.47       |                        |       | 23,492                      |       |                        | 3.98       |   |   | 17,686 |   |   | 3.34 |   |   | 20,549 |   |   | 4.90 |   |   |   | 19,067 |   |   |   | 4.24 |   |   |
| Total loans receivable                  |       | 1,081,789                            |       |                        | 100.00     | %                           |       | 590,923                     |       |                        | 100.00     | % |   | 530,156 |   |   | 100.00 | % |   | 419,767 |   |   | 100.00 | % |   |   | 449,218 |   |   |   | 100.00 | % |   |
| Allowance for loan losses               |       | (16,737                              | )          |                        |       |                        |       | (6,113                      | )          |                        |       |   |   | (5,220 | ) |   |   |   |   | (5,312 | ) |   |   |   |   |   | (4,626 | ) |   |   |   |   |   |
| Deferred loan fees                      |       | (1,170                               | )          |                        |       |                        |       | (623                        | )          |                        |       |   |   | (747 | ) |   |   |   |   | (656 | ) |   |   |   |   |   | (737 | ) |   |   |   |   |   |
| Loans receivable,  net                  |       | $ 1,063,882                     |       |                        |       |                        |       | $ 584,187              |       |                        |       |   |   | $ 524,189 |   |   |   |   |   | $ 413,799 |   |   |   |   |   |   | $ 443,855 |   |   |   |   |   |   |

 

**Contractual PrincipalRepayments and Interest Rates.****  **The following table sets forthscheduled contractual amortization of the loan portfolio at June 30, 2006.Demand loans, loans having no schedule of repayments and no stated maturity andoverdraft loans are reported as due in one year or less.

| ** **                              | ** ** | **At June 30, 2006, the amount due within** | ** **                   | ** **                                            | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------------------|------------------------------|-------------------------------------------------------|------------|
| ** **                              | ** ** | **1 year or  less**                                                  | ** **                   | **more than  1 year to  3 years** | ** ** | **more than  3 years to  5 years** | ** ** | **more than  5 years to  10 years** | ** ** | **more than  10 years to  20 years** | ** ** | **more than  20 years** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)**                                           | ** **                   |
| Mortgage loans:                         |       |                                                                           |                         |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Single-family and home equity           |       |                                                                           | $    882 |                                                  |       |   | $11,012 |   |   |   | $20,807 |   |   |   | $96,307 |   |   |   | $214,051 |   |   |   | $214,569 |   |   | $557,628 |   |
| Commercial real estate and multi-family |       |                                                                           | 12,402                       |                                                  |       |   | 22,523 |   |   |   | 21,273 |   |   |   | 178,165 |   |   |   | 83,457 |   |   |   | 8,448 |   |   | 326,268 |   |
| Construction                            |       |                                                                           | 84,561                       |                                                  |       |   | 23,963 |   |   |   | 4,250 |   |   |   | — |   |   |   | — |   |   |   | — |   |   | 112,774 |   |
| Total mortgage loans                    |       |                                                                           | 97,845                       |                                                  |       |   | 57,498 |   |   |   | 46,330 |   |   |   | 274,472 |   |   |   | 297,508 |   |   |   | 223,017 |   |   | 996,670 |   |
| Consumer                                |       |                                                                           | 478                          |                                                  |       |   | 1,215 |   |   |   | 1,217 |   |   |   | 1,046 |   |   |   | 161 |   |   |   | 187 |   |   | 4,304 |   |
| Commercial business                     |       |                                                                           | 11,614                       |                                                  |       |   | 15,056 |   |   |   | 18,380 |   |   |   | 10,077 |   |   |   | 3,714 |   |   |   | 21,974 |   |   | 80,815 |   |
| Total                                   |       |                                                                           | $109,937                     |                                                  |       |   | $73,769 |   |   |   | $65,927 |   |   |   | $285,595 |   |   |   | $301,383 |   |   |   | $245,178 |   |   | $1,081,789 |   |

 

Of the $971.9 million of loan principal repayments dueafter June 30, 2007, $404.1 million have fixed rates of interest and$567.8 million have adjustable rates of interest.

**LendingActivity and Products.****  **The Bank’s lending activities are subject tounderwriting standards and origination procedures, which have been approved byits Board of Directors.

**Single-FamilyResidential First Mortgage Loans.****  **We process, underwrite and originatesingle-family residential mortgage loans on both a retail and wholesalebasis. We have developed an extensive network of active residential mortgagebrokers and mortgage bankers to support our wholesale production system. Thesecorrespondents identify, process and close loans on our behalf based upon ratesand terms that we provide to them on a regular basis which correlate to ourassessment of our demand for various types of loans. The correspondents forwardcompleted loan applications that are underwritten and approved by Bankpersonnel in accordance with standards previously approved by the Board ofDirectors. Depending upon the various programs we have with the correspondents,loans will be classified as either 

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purchased, where thecorrespondent provides the funds for the loan closing or as originated, wherethe Bank provides the funds for the closing of the loan. In either scenario,the loan could be held in portfolio or sold (on either a servicing released orretained basis) in the secondary market. Retail residential lending activitiesare supplemented by loan originations through the Bank’s internal loanofficers, whereby loan applications are obtained through our branch network andreferrals from local builders, real estate brokers and financial consultants.In order to facilitate sale in the secondary market, single-familyresidential mortgage loans generally are underwritten in accordance withFederal Home Loan Mortgage Corporation (“FHLMC”) and Federal National MortgageAssociation (“FNMA”) guidelines. The Bank will also originate loans that do notconform to the underwriting standards of FHLMC and FNMA that are held in theportfolio. In general, these loans do not conform to their underwritingstandards due to the size of the loan. Upon completion of the Merger with ChesterValley, the Company’s strategy has changed in that loan portfolio growth willbe concentrated in commercial real estate and multi-family, commercialbusiness, construction and consumer lending products. To a lesser extent, theCompany may originate single-family residential loans for its portfolio,primarily with adjustable interest rates.

In addition to originating loans, the Bankperiodically purchases participation interests in larger balance loans,typically multi-family and commercial real estate mortgage loans andconstruction loans from other financial institutions in our market area. We maypurchase these loans to supplement our own originations or sell participationsto manage borrower concentration risks. All purchased participations comply withthe Bank’s approved underwriting standards. During fiscal 2006, in addition tothe loans acquired in the Merger, loan participations purchased aggregated$12.9 million of construction loans. In addition, during fiscal 2006, theBank purchased pools of single-family residential adjustable-rate “jumbo”mortgage loans aggregating $22.8 million. Other than the outstandingbalances, which generally exceed secondary market standards, the loans in thesepools conform to FNMA and FHLMC guidelines. The properties securing the loansin these pools were located across the eastern United States, primarilyconcentrated in the Mid-Atlantic United States. The loan pools were subject toour due diligence review and conformed to the Bank’s internal underwritingstandards. At June 30, 2006, all the loans in pools were current in theirpayment status.

The Bank generally requires a current appraisalprepared by an independent appraiser or an acceptable alternative propertyvaluation on all new single-family residential mortgage loans as well asprivate mortgage insurance on all first mortgage loans with a loan to value inexcess of 80%. Title insurance is required on loans secured by real estate withthe exception of certain single-family residential loans originated under$150 thousand. Hazard insurance is required on all real estate loans. Floodinsurance is also required for all loans secured by properties located in adesignated flood area.

Subsequent to the merger of Chester Valley with andinto the Bank, the Bank’s processing, underwriting and origination of single-familyresidential mortgage loans was streamlined through an in-house origination andprocessing staff as most of the principal balance and servicing rights of theseloans are now originated for re-sale in the secondary market.

At June 30, 2006, residential mortgage loansaggregated $298.5 million as compared to $202.9 million at June 30, 2005.The $95.6 million or 47.1% increase resulted largely from the acquisition ofChester Valley, which had a residential portfolio of $50.4 million at the timeof the acquisition, the above noted purchase of $22.8 million of adjustablerate mortgage loans along with originations through the Bank’s retail andcorrespondent broker networks.

**HomeEquity Loans.****  **Inrecent years, we have increased our emphasis on the origination of home equityloans and lines of credit, due to their shorter maturities (the maximum term ofthe Bank’s home equity loans is 20 years with the exception of purchasemoney second mortgage loans whose maximum term may be up to 30 years) andgenerally have higher interest rates. A home equity loan is a fixed-rate loanwhere the borrower receives the total loan amount at a closing and makesmonthly payments to repay 

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the loan within a specifictime period. Home equity lines of credit are a revolving line of credit with avariable rate and a maximum term of 15 years. The borrower may draw on thisaccount (up to the maximum credit amount) and repay this line at any time. At June 30,2006, home equity loans and lines of credit aggregated $259.1 million or24.0% of the total loan portfolio. Of this amount, $65.6 million were lines ofcredit. The $158.3 million or 157.0% increase over the June 30, 2005balance is largely due to the acquisition of Chester Valley, which had homeequity loans, and lines of credit of $138.7 million at the time of the Merger.

Home equity loans and lines of credit are secured bythe borrower’s residence, on which the Bank generally obtains a second lienposition on the underlying real estate. The Bank’s home equity programs providefinancing in amounts up to 90% of the value of the property securing the loan,when combined with the first mortgage. In addition to originating home equityloans through our branch offices, we rely considerably on purchased loans fromour network of correspondents.

**OtherConsumer Lending Activities.****  **The Bank offers various types of other consumer loansprimarily consisting of loans secured by automobiles and to a much lesserextent deposit account loans, and unsecured personal loans. In addition tooriginating consumer loans, we facilitate the funding of student loans throughour banking offices in conjunction with American Education Services (“AES/PHEAA”).Consumer loans other than home equity loans are originated through our branchnetwork. At June 30, 2006, $4.3 million, or 0.4% of our totalloan portfolio consisted of these types of loans. This compares to$2.1 million of other consumer loans, or 0.4% of the total loan portfolio,at June 30, 2005. At the time of the Merger, Chester Valley’s otherconsumer loans approximated $2.9 million.

**CommercialReal Estate and Multi-Family Residential Real Estate Loans.****  **At June 30, 2006, commercialreal estate and multi-family residential loans amounted to $326.3 millionor 30.2% of the total loan portfolio. This compares to $174.9 million or29.6% at June 30, 2005.

The Bank’s commercial real estate and multi-familyresidential loan portfolio consists primarily of loans secured by officebuildings, retail and industrial buildings, strip shopping centers, residentialproperties with five or more units, non-FNMA eligible single-familyresidential investment properties and other properties used for commercial andmulti-family purposes located within the Bank’s market area. During theyear ended June 30, 2006, the commercial real estate and multi-familyloan portfolio increased by $151.3 million, or 86.5%, due primarily to theMerger. At the time of the Merger, Chester Valley had $165.0 million incommercial real estate loans in its portfolio. During the fiscal year, the Bankhas experienced repayments within this portfolio as borrowers locked inlong-term rates with lenders who offered extended terms without recourse.

The Bank’s underwriting standards for the commercialreal estate and multi-family residential loan portfolio allows for termsup to 25 years with monthly amortization over the life of the loan andloan to value ratios of not more than 80%. Interest rates are generallyadjustable with a maximum interest rate reset period of five years. Prepaymentfees are generally charged on most commercial real estate and multi-familyloans in order to partially protect the Bank in a falling interest rateenvironment. Personal guarantees are generally required as additional securityfor this portfolio of loans.

Commercial real estate and multi-family realestate lending generally involves increased risks as compared to single-familyresidential lending including, but not limited to, larger loans to individualborrowers and loan payments that are dependent upon the successful operation ofthe project or the borrower’s business. The Bank attempts to mitigate theserisks by limiting loans to proven businesses, properties with historicaloperating performance sufficient to service the debt, utilizing conservativedebt coverage ratios in the underwriting, and periodically monitoring theoperation of the business or project and the physical condition of theproperty. Additionally, independent appraisal reports are obtained on each loanto substantiate the property’s market value, and are reviewed by qualified Bankpersonnel or, in some instances, qualified third party consultants, prior tothe closing of the loan.

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**Constructionand Land Acquisition Loans.****  **Construction loans for residential and commercialprojects, which generally are secured by properties in southeasternPennsylvania. are originated within our market area. The Bank generally limitsconstruction loans to builders and developers with whom the Bank has anestablished relationship, or who are otherwise known to officers of the Bank.Additionally, the Bank may acquire participation interests in certainconstruction loans originated by other local financial institutions that havesimilar underwriting standards as the Bank. These participation loans undergo afull underwriting in accordance with the Bank’s established policy.Construction loans outstanding at June 30, 2006 were$112.8 million, or 10.4% of total loans, compared to $86.7 million or14.7% of total loans at June 30, 2005. The $26.1 million or 30.1% increaseresulted primarily from the acquisition of Chester Valley, which had $46.4million in construction loans in its portfolio at the time of the acquisition. Duringthe past year, this portfolio declined as larger residential projects sold at amore rapid pace than anticipated and the demand for new construction financingwas not as robust.

Construction loans generally have variable rates ofinterest, which is a strong tool in managing the interest rate risk exposure ofthe Bank. Generally, they have a maximum term to maturity of three years andloan to value ratios of 80% or less. Residential construction loans todevelopers are made on either a pre-sold or speculative (unsold) basis. Limitsare placed on the number of units that can be built on a speculative basisbased upon the reputation, prior experience and financial position of thebuilder, the location of the property and prior sales in the development andthe surrounding area.

Independent appraisals are obtained for allconstruction loans and are reviewed and analyzed by qualified employees of theBank or, in some instances, qualified third party consultants. Propertyinspections are done at inception as well as prior to advancing additionalproceeds committed under the loan documents. Monthly payment of interest isrequired on all construction loans either through cash or an interest reserveestablished as part of the loan.

Construction loans can also be originated for theacquisition and development of land for sale (i.e. roads or otherimprovements). These loans generally require that the builder have a commitmentfor a construction loan for the units to be built on the site. These loans aresecured by a lien on the property and are generally limited to a loan to valueof 75% or less of the appraised value. The loans have a variable rate ofinterest and require monthly payments of interest. The principal of the loan isrepaid as units are sold and released. Generally, all of these loans are in theBank’s market area and are to developers with whom the Bank has a priorrelationship. Personal guarantees from the borrowers are generally required forthese loans.

Construction and land loans generally carry a higherdegree of risk than single-family residential lending, due to theconcentration of principal in a limited number of loans and borrowers and theeffect of economic conditions on developers, builders and projects. Additionalrisk is also associated with construction lending because of the inherentdifficulty in estimating both a property’s value at completion and theestimated cost (including interest) to complete a project. The nature of theseloans is such that they are more difficult to evaluate and monitor. Inaddition, speculative construction loans to a builder are not pre-sold and thuspose a greater potential risk than construction loans to individuals on theirpersonal residences.

In order to mitigate some of the risks inherent toconstruction lending, inspections are done both prior to origination andthroughout construction prior to advancing funds, limiting the advancement offunds for speculative homes, limiting originations to builders who haveestablished relationships or significant experience, as well as obtainingpersonal guarantees from the principals.

**CommercialBusiness Loans.****  **AtJune 30, 2006, commercial business loans aggregated $80.8 million, or7.5% of total loans, compared to $23.5 million at June 30, 2005, or4.0% of total loans. The $57.3 million or 244.0% increase resulted primarilyfrom the acquisition of Chester Valley, which had $64.2 million of commercialbusiness loans in its portfolio at the time of the Merger. These loans aregenerally originated 

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to small and medium sizedbusinesses in our market area. These types of loans assist in the Bank’sasset/liability management since they generally provide shorter maturitiesand/or adjustable rates of interest in addition to generally having higherrates of return that compensate for the additional credit risk associated withthese loans.

Generally, the Bank provides these loans on a securedbasis and they are collateralized by accounts receivable, inventory, equipment,and/or other general corporate assets of the borrower. Additionally, theprincipals of the borrower guarantee most commercial business loans. Interestrates are adjustable, indexed to a published rate of interest or fixed.

Generally, commercial business loans have beencharacterized as having higher risks associated with them than single-familymortgage loans due to the borrowers’ business operations being more susceptibleto local and national economic conditions as well as collateral being lesstangible than real estate. These risks are mitigated by the Bank employingindividuals experienced in this type of lending and by generally requiring thepersonal guarantees of the business’s principals. Additionally, in someinstances, personal assets of the principals are obtained as additionalsecurity for these loans.

Thefollowing table shows the activity in our loan portfolio during the periodsindicated.

| ** **                                      | ** ** | **Year ended June 30,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                      | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(Dollars in thousands)**   | ** ** |
| Loans held at the  beginning of the period      |       | $  590,923                   |       | $530,156 |   | $419,767 |   |
| Originated and purchased  for portfolio(1)(2):  |       |                                   |       |   |   |   |   |
| Mortgage loans:                                 |       |                                   |       |   |   |   |   |
| Single-family                                   |       | 142,305                                |       | 52,933 |   | 110,707 |   |
| Commercial real estate and multi-family         |       | 20,927                                 |       | 39,879 |   | 64,382 |   |
| Construction                                    |       | 73,573                                 |       | 70,558 |   | 54,396 |   |
| Home equity                                     |       | 96,995                                 |       | 54,782 |   | 73,209 |   |
| Consumer loans                                  |       | 1,088                                  |       | 267 |   | 95 |   |
| Commercial business loans                       |       | 24,578                                 |       | 11,153 |   | 12,431 |   |
| Total originations  and purchases for portfolio |       | 359,466                                |       | 229,572 |   | 315,220 |   |
| Loans acquired  from the Merger                 |       | 467,700                                |       | — |   | — |   |
| Amortization and  curtailments                  |       | (336,167                               | )          | (168,460 | ) | (204,104 | ) |
| Charge-offs                                     |       | (133                                   | )          | (345 | ) | (727 | ) |
| Net increase in  loans                          |       | 490,866                                |       | 60,767 |   | 110,389 |   |
| Total loans held at the  end of the period      |       | $ 1,081,789                       |       | $590,923 |   | $530,156 |   |

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       (1) Excludes loans classified as held for sale at the time oforigination.

       (2) Includes $22.8 million, $21.7 million and $85.6 million inpurchased single-family mortgage loans in fiscal 2006, 2005 and 2004,respectively

**Loans to One Borrower.****  **Under the Financial InstitutionsReform, Recovery, and Enforcement Act of 1989 (“FIRREA”) and pursuant toregulations for Federal Savings Banks, the aggregate loans that the Bank canmake to any one borrower is equal to 15% of the Bank’s unimpaired capital andsurplus (in our case, this amount would be approximately $18.8 million atJune 30, 2006), although there are provisions that would allow us to lendan additional 10% of unimpaired capital and surplus if the loans are secured byreadily marketable securities. At June 30, 2006, our three largest creditrelationships with an individual borrower and related entities amounted to$16.2 million, $11.9 million and $10.5 million; each of whichare in conformity with the current loans to one borrower regulations describedabove.

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**Asset Quality**

**General.****  **As a part of our efforts to maintainasset quality, we have developed and implemented an asset classification systemin conjunction with federal regulations. All of our assets are subject to thisclassification system. Loans are periodically reviewed and the classificationsreviewed at least quarterly by the Loan Committee of the Board of Directors.

When a borrower fails to make a scheduled payment, weattempt to cure the delinquency by making personal contact with the borrower.Initial contacts are generally made 16 days after the date the payment isdue. In most cases, delinquencies are promptly resolved. If the delinquencycontinues, late charges are assessed and additional efforts are made to collectthe deficiency. We generally work with borrowers to resolve such problems,however, when the account becomes 90 days delinquent, we instituteforeclosure or other proceedings, as necessary, to minimize any potential loss.

On loans for which the Bank considers the collectionof principal or interest payments doubtful, we cease the accrual of interestincome (“non-accrual” loans). On loans more than 90 days past due, as toprincipal and interest payments, it is the Bank’s policy to discontinueaccruing additional interest and reverse any interest currently accrued (unlessit is determined that the loan principal and interest are fully secured and inthe process of collection). On occasion, a loan may be placed on non-accrualearlier if the financial condition of the borrower raises significant concernwith regard to his/her ability to service the debt in accordance with the termsof the loan. Interest income is not accrued on these loans until the borrower’sfinancial condition and payment record demonstrate an ability to service thedebt.

Real estate that the Bank acquires as a result offoreclosure or deed-in-lieu of foreclosure is classified as real estate owneduntil sold. Real estate owned is recorded at the lower of cost or fair valueless estimated selling cost. Costs associated with acquiring and improving aforeclosed property are usually capitalized to the extent that the carryingvalue does not exceed fair value less estimated selling costs. Holding costsare charged to expense. Gains and losses on the sale of real estate owned are reflectedin operations, as incurred.

**Delinquent Loans.****  **The following table sets forthinformation concerning delinquent loans at the dates indicated. The amountspresented represent the total outstanding principal balances of the relatedloans rather than the actual payment amounts that are past due.

| ** **                              | ** ** | **At  June 30, 2006**      | ** ** | **At  June 30, 2005** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **30 to  59 days**         | ** ** | **60 to  89 days**    | ** ** | **30 to  59 days** | ** ** | **60 to  89 days** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)** | ** ** |
| Mortgage loans:                         |       |                                 |       |                            |       |   |   |   |   |   |   |
| Single-family                           |       | $1,204                               |       | $    71     |       | $1,635 |   |   | $456 |   |   |
| Commercial real estate and multi-family |       | 519                                  |       | 5,466                           |       | 831 |   |   | — |   |   |
| Construction                            |       | 239                                  |       | 264                             |       | 163 |   |   | — |   |   |
| Home equity                             |       | 587                                  |       | 152                             |       | 96 |   |   | 18 |   |   |
| Consumer loans                          |       | —                               |       | 1                               |       | 2 |   |   | 3 |   |   |
| Commercial  business loans              |       | 51                                   |       | 689                             |       | — |   |   | — |   |   |
| Total delinquent loans  receivable      |       | $2,600                               |       | $6,643                          |       | $2,727 |   |   | $477 |   |   |

 

Loans delinquent 30 to 89 days amounted to$9.2 million at June 30, 2006 compared to $3.2 million at June 30,2005. Management continues to regularly monitor all delinquent loan activity.Management does not consider the current level of delinquencies to be of anysignificant concern as, based upon past experience, most loans, are expected toreturn to fully performing status without going to non-accrual status. In anyevent, management believes that these loans are adequately collateralized orthe allowance is adequate to cover any potential collateral shortfall.

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**Non-Performing Assets.****  **The following table sets forthinformation with respect to non-performing assets we have identified, includingnon-accrual loans and other real estate owned. Total non-performing assetsamounted to $15.8 million, or 1.00% of total assets, at June 30, 2006compared to $3.1 million, or 0.33% of total assets, at June 30, 2005. The$12.7 million increase in the Company’s non-performing assets during fiscal2006 was due primarily to six loan relationships. Five of these relationshipswere non-performing assets acquired in the Merger and had an aggregateprincipal balance of $6.6 million at June 30, 2006. The sixth loan was a$5.3 million commercial real estate loan secured by first mortgages on approximately 100 single-family residentialrental properties located in the Bank’smarket area. Due to the borrower’s cash flow problems, this loan was 60days delinquent at June 30, 2006. Withthe Bank’s consent**,** the borrowerhas commenced a plan to sell the properties securing the loans****with a portionof the proceeds being required to pay down the Bank’s loan. All of these loanswere on non-accrual status at June 30, 2006. The five non-performing loanrelationships acquired in the Merger included a $2.0 million commercial realestate loan which was over 90 days delinquent at June 30, 2006 and issecured by commercial real estatelocated in Virginia. Subsequentto June 30, 2006, the Bank foreclosed on this property and the underlying collateral is nowclassified as real estate owned. The Bank has executed an agreement ofsale for the property and the sale is expected to close****by the end of the quarter ending December 31,2006 at no additional loss. Three additional non-performing loanrelationships acquired in the Merger aggregating approximately $1.1 million arecommercial business loans for which the Bank has been receiving payments;however, the Bank placed the loans on non-accrual as a result of past cash flowproblems experienced by the borrower and a potential deficiency in thecollateral securing the loans. The final non-performing loan relationshipacquired in the Merger includes two loans to a single borrower aggregating $3.5million. Subsequent to the Company’s earnings release on August 14, 2006, management,through additional investigation, became aware that this borrower’s revenueshortfall, while initially expected to be short-term, was long-term in natureand that the value of the collateral securing the loans was significantly belowthe outstanding balance of the loans, thus requiring an increase to theprovision for loan losses of approximately $2.3 million. Prior to theaforementioned earnings release, the loan was classified as substandard;however, the classification has since been downgraded to doubtful.

| ** **                                     | ** ** | **At June 30,**                         | ** ** |
|------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)**              | ** ** |
| Accruing loans 90 or  more days past due       |       |                                              |       |   |   |   |   |   |   |   |   |
| Mortgage loans                                 |       | $       — |       | $  109 |   | $     — |   | $  367 |   | $     — |   |
| Commercial business loans                      |       | —                                            |       | — |   | — |   | 147 |   | 200 |   |
| Other                                          |       | —                                            |       | — |   | 3 |   | — |   | — |   |
| Total accruing  loans 90 or more days past due |       | —                                            |       | 109 |   | 3 |   | 514 |   | 200 |   |
| Non-accrual loans                              |       |                                              |       |   |   |   |   |   |   |   |   |
| Mortgage loans:                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Single-family                                  |       | 1,059                                             |       | 146 |   | 568 |   | 1,064 |   | 1,897 |   |
| Commercial real estate and multi-family        |       | 7,753                                             |       | 315 |   | 48 |   | 48 |   | 1,179 |   |
| Home equity                                    |       | 479                                               |       | 99 |   | 39 |   | 236 |   | 55 |   |
| Consumer                                       |       | 154                                               |       | — |   | 16 |   | 7 |   | 104 |   |
| Commercial business                            |       | 6,036                                             |       | 106 |   | 698 |   | 360 |   | 724 |   |
| Total non-accrual  loans                       |       | 15,481                                            |       | 666 |   | 1,369 |   | 1,715 |   | 3,959 |   |
| Performing  troubled debt restructurings       |       | 256                                               |       | 1,912 |   | 1,404 |   | 1,463 |   | 1,512 |   |
| Total non-performing  loans                    |       | 15,737                                            |       | 2,687 |   | 2,776 |   | 3,692 |   | 5,671 |   |
| Other real estate  owned, net                  |       | 51                                                |       | 439 |   | 403 |   | 391 |   | 85 |   |
| Total non-performing  assets                   |       | $ 15,788                                     |       | $3,126 |   | $3,179 |   | $4,083 |   | $5,756 |   |
| Non-performing  loans to total loans           |       | 1.45                                              | %          | 0.46 | % | 0.52 | % | 0.88 | % | 1.26 | % |
| Non-performing  assets to total assets         |       | 1.00                                              | %          | 0.33 | % | 0.34 | % | 0.48 | % | 0.76 | % |

 

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**Classifiedand Criticized Assets.****  **Federal regulations require that each insuredinstitution classify its assets on a regular basis. Furthermore, in connectionwith examinations of insured institutions, federal examiners have authority toidentify problem assets and, based upon their judgment, classify them. Thereare three classifications for problem assets: “substandard,” “doubtful,” and “loss”.Substandard assets have one or more defined weaknesses and are characterized bythe distinct possibility that the insured institution will sustain some loss ifthe deficiencies are not corrected. Doubtful assets have weaknesses ofsubstandard assets with the additional characteristic that the weaknesses makecollection or liquidation in full on the basis of current existing facts,conditions and values, questionable, and there is a high probability of loss.An asset classified as loss is considered uncollectible and of such littlevalue that continuance as an asset of the institution is not warranted. Federalregulations also require another unclassified category designated “specialmention” to be established and maintained for assets that do not currentlyexpose an insured institution to a sufficient degree of risk to warrantclassification as substandard, doubtful, or loss. At June 30, 2006, theCompany had $6.6 million of assets classified as substandard, consistingof $974 thousand of single-family mortgage loans, $5.1 millionof commercial real estate and business loans and $525 thousand of consumerloans, and $12.4 million classified as doubtful, consisting of $12.3 million ofcommercial real estate and business loans and $86 thousand ofsingle-family mortgage loans. There were no loans classified as loss at June 30,2006. This compares to $1.9 million of assets classified as substandard,consisting of $1.2 million of commercial business and construction loansand $665 thousand of single-family mortgage loans, and $487 thousandclassified as doubtful, consisting entirely of commercial real estate andbusiness loans at June 30, 2005.

**Allowancefor Loan Losses.****  **Theallowance for loan losses is maintained at a level management believes isadequate to cover known and inherent losses in the loan portfolio that are bothprobable and reasonable to estimate at each reporting date. Our determinationof the adequacy of the allowance is based upon an evaluation of the portfolio,loss experience, current economic conditions, volume, growth, composition ofthe portfolio, and other relevant factors. We use historical loss factors foreach loan type and for loans considered to have a higher degree of risk. Additionalcomponents that may be used include, but are not limited to delinquency trends,asset classification trends and current economic conditions. Management thenassesses these conditions and establishes, to the best of its ability, theallowance for loan loss from within the range calculated, based upon the factsknown at that time. The methodology does not imply that any portion of theallowance for loan loss is restricted, but the allowance for loan lossesapplies to the entire loan portfolio.

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Theallowance is increased by a provision for loan losses, which is charged againstincome. As shown in the table below, at June 30, 2006, our allowance forloan losses amounted to $16.7 million or 106.4% and 1.55% of our non-performingloans and total loans receivable less deferred fees, respectively.

| ** **                                                                    | ** ** | **Year ended June 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                    | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                    | ** ** | **(Dollars in thousands)**   | ** ** |
| Balance—beginning  of period                                             |       | $ 6,113                           |       | $ 5,220 |   | $ 5,312 |   | $ 4,626 |   | $4,313 |   |
| Plus: provisions  for loan losses                                             |       | 3,205                                  |       | 1,232 |   | 426 |   | 1,034 |   | 1,212 |   |
| Less: charge-offs  for                                                        |       |                                   |       |   |   |   |   |   |   |   |   |
| Mortgage loans                                                                |       | (24                                    | )          | (7 | ) | (58 | ) | (284 | ) | (12 | ) |
| Consumer loans                                                                |       | (62                                    | )          | (22 | ) | (11 | ) | (4 | ) | (173 | ) |
| Commercial business loans                                                     |       | (47                                    | )          | (316 | ) | (658 | ) | (103 | ) | (769 | ) |
| Total charge-offs                                                             |       | (133                                   | )          | (345 | ) | (727 | ) | (391 | ) | (954 | ) |
| Plus: recoveries for                                                          |       |                                   |       |   |   |   |   |   |   |   |   |
| Mortgage loans                                                                |       | 36                                     |       | 6 |   | 74 |   | — |   | — |   |
| Consumer loans                                                                |       | 44                                     |       | — |   | 1 |   | — |   | 11 |   |
| Commercial business loans                                                     |       | 535                                    |       | — |   | 134 |   | 43 |   | 44 |   |
| Total recoveries                                                              |       | 615                                    |       | 6 |   | 209 |   | 43 |   | 55 |   |
| Allowance acquired from the Merger                                            |       | 6,937                                  |       | — |   | — |   | — |   | — |   |
| Balance—end of  period                                                   |       | $ 16,737                          |       | $ 6,113 |   | $ 5,220 |   | $ 5,312 |   | $4,626 |   |
| Allowance for  loan loss to total end of period non-performing loans          |       | 106.35                                 | %          | 227.50 | % | 188.04 | % | 143.88 | % | 81.57 | % |
| Charge-offs  to average loans                                                 |       | 0.01                                   | %          | 0.06 | % | 0.16 | % | 0.08 | % | 0.21 | % |
| Allowance for loan loss  to end of period total loans less deferred fees |       | 1.55                                   | %          | 1.05 | % | 1.27 | % | 1.27 | % | 1.03 | % |

 

The provision for loan losses for the year ended June 30,2006 was $3.2 million, an increase of $2.0 million from $1.2 million in theprior year. Net recoveries in fiscal 2006 were $482 thousand as compared to netcharge-offs of $339 thousand in fiscal year 2005. The primary reason forthe increase in the allowance for loan losses was the Merger, as Chester Valley’sallowance to total loans on the date of the Merger was greater than that of theCompany due to a higher concentration of loans in the commercial business andconsumer lending areas. The increase in the provision for loan losses in fiscal2006 compared to fiscal 2005 was due primarily to aforementioned increase innon-performing loans and classified loans. Management assesses the allowancefor loan losses at least quarterly, and makes any necessary provision forlosses needed to maintain our allowance for losses at a level deemed adequate.We believe that the allowance for loan losses was adequate at June 30,2006 to cover losses that are both probable and reasonably estimable based uponthe facts and circumstances known to us at that date.

Effective December 21, 1993, the OTS inconjunction with the Comptroller of the Currency, the FDIC and the FederalReserve Board issued a Policy Statement regarding a financial institution’sallowance for loan and lease losses. The Policy Statement, which reflects theposition of the regulatory agencies and does not necessarily constitutegenerally accepted accounting principles, includes guidance (i) on ourresponsibilities for the assessment and establishment of an adequate allowance;and (ii) for the agencies’ examiners to use in evaluating the adequacy ofsuch allowance and the policies used to determine such allowance. The PolicyStatement also sets forth quantitative measures for the allowance with respectto assets classified substandard and doubtful and with respect to the remainingportion of the institution’s portfolio. Specifically, the Policy Statement setsforth the following quantitative measures which examiners may use to determinethe reasonableness of an allowance: (i) 30% to 50% of the portfolio thatis classified doubtful; (ii) 10% to 20% of the portfolio classifiedsubstandard; and (iii) for the portions of the portfolio 

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that have not beenclassified (including loans designated special mention), estimated creditlosses over the upcoming twelve months based on facts and circumstancesavailable as of the evaluation date. While the Policy Statement sets forth thisquantitative measure, such guidance is not intended as a “floor” or “ceiling”.Our policy for establishing loan losses is consistent with the PolicyStatement. In July 2001, the SEC issued Staff Accounting Bulletin (“SAB”) No. 102,“Selected Loan Loss Allowance Methodology And Documentation Issues”. Theguidance in the SAB was effective immediately and focuses on the documentationthe SEC staff normally expects registrants to prepare and maintain in supportof the allowance for loan losses. Concurrent with the SEC’s issuance of SAB No. 102,the federal banking agencies, represented by the FFIEC issued an interagencypolicy statement entitled “Allowance For Loan and Lease Loss Methodologies AndDocumentation For Banks and Savings Institutions” (“FFIEC Policy Statement”).The SAB and FFIEC Policy Statement were the result of an agreement between theSEC and the federal banking agencies in March 1999 to provide guidance onallowance for loan loss methodologies and supporting documentation. Managementbelieves to the best of its knowledge that the Bank’s documentation relating tothe allowance for loan loss is consistent with this guidance.

Theallocation of the allowance for loan losses is shown in the table below. It isbroken down by loan type at June 30, 2006. Through such allocations, we donot intend to imply that actual future charge-offs will necessarily follow thesame pattern or that any portion of the allowance is restricted.

| ** **                                   | ** ** | **June 30, 2006**          | ** **                   | **June 30, 2005**                             | ** ** | **June 30, 2004** | ** ** | **June 30, 2003**                                   | ** ** | **June 30, 2002** | ** **       |
|----------------------------------------------|------------|--------------------------------------|------------------------------|---------------------------------------------------------|------------|-----------------------------|------------|---------------------------------------------------------------|------------|-----------------------------|------------------|
| ** **                                   | ** ** | **Amount**                           | ** **                   | **Percentof  loan type to  total loans** | ** ** | **Amount**                  | ** ** | **Percent of  loan type to  total loans** | ** ** | **Amount**                  | ** **       | **Percent of  loan type to  total loans** | ** ** | **Amount** | ** ** | **Percent of  loan type to  total loans** | ** ** | **Amount** | ** ** | **Percent of  loan type to  total loans** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** **                   |
| Mortgage loans:                              |       |                                 |                         |                                                    |       |                        |       |                                                          |       |                        |             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Single-family                                |       |                                 | $    473 |                                                    |       |                        | 27.59      | %                                                             |       |                        | $  155 |   |   |   | 34.34 | % |   |   | $  155 |   |   |   | 34.15 | % |   |   | $  161 |   |   |   | 31.40 | % |   |   | $  255 |   |   |   | 40.40 | % |   |
| Commercial real estate and multi-family |       |                                 | 7,412                        |                                                    |       |                        | 30.16      |                                                          |       |                        | 2,280            |   |   |   | 29.60 |   |   |   | 2,345 |   |   |   | 34.12 |   |   |   | 2,705 |   |   |   | 37.14 |   |   |   | 2,239 |   |   |   | 29.90 |   |   |
| Construction                                 |       |                                 | 1,979                        |                                                    |       |                        | 10.42      |                                                          |       |                        | 2,169            |   |   |   | 14.66 |   |   |   | 1,598 |   |   |   | 10.75 |   |   |   | 1,156 |   |   |   | 8.62 |   |   |   | 937 |   |   |   | 6.52 |   |   |
| Home equity                                  |       |                                 | 1,351                        |                                                    |       |                        | 23.96      |                                                          |       |                        | 537              |   |   |   | 17.06 |   |   |   | 484 |   |   |   | 17.32 |   |   |   | 430 |   |   |   | 17.39 |   |   |   | 472 |   |   |   | 16.70 |   |   |
| Total mortgage loans                         |       |                                 | 11,215                       |                                                    |       |                        | 92.13      |                                                          |       |                        | 5,141            |   |   |   | 95.66 |   |   |   | 4,582 |   |   |   | 96.34 |   |   |   | 4,452 |   |   |   | 94.55 |   |   |   | 3,903 |   |   |   | 93.52 |   |   |
| Consumer loans                               |       |                                 | 663                          |                                                    |       |                        | 0.40       |                                                          |       |                        | 71               |   |   |   | 0.36 |   |   |   | 53 |   |   |   | 0.32 |   |   |   | 70 |   |   |   | 0.55 |   |   |   | 70 |   |   |   | 2.24 |   |   |
| Commercial business loans                    |       |                                 | 4,859                        |                                                    |       |                        | 7.47       |                                                          |       |                        | 901              |   |   |   | 3.98 |   |   |   | 585 |   |   |   | 3.34 |   |   |   | 790 |   |   |   | 4.90 |   |   |   | 653 |   |   |   | 4.24 |   |   |
| Total                                        |       |                                 | $ 16,737                |                                                    |       |                        | 100.00     | %                                                             |       |                        | $6,113           |   |   |   | 100.00 | % |   |   | $5,220 |   |   |   | 100.00 | % |   |   | $5,312 |   |   |   | 100.00 | % |   |   | $4,626 |   |   |   | 100.00 | % |   |

 

**SecuritiesActivities**

**General.**   TheBank's investment policy is designed, among other things, to provide managementwith an additional tool in implementing its asset/liability strategies. Itemphasizes principal preservation, favorable returns, maintaining liquidity andflexibility, and minimizing credit risk. The policy permits investments in US governmentand agency securities, investment grade corporate bonds and commercial paper,municipal bonds, various types of mortgage-backed securities andcollateralized mortgage obligations, certificates of deposit and federal fundssold to financial institutions approved by our Board of Directors, and certainequity investments and mutual funds.

The Bank will from time to time use hedging programssuch as interest rate swaps, caps, collars or other activities involving theuse of off-balance sheet financial derivatives to assist in its’Asset/Liability management and the mitigation of interest rate risk. The Bankhas not purchased mortgage-backed derivative instruments that would becharacterized “high-risk” under OTS regulations at the time of purchase, norhas it purchased corporate obligations, which are not rated investment grade.

SFAS No. 115 requires the Company to classify asecurity as available for sale (“AFS”), held-to-maturity (“HTM”), or trading,at the time of acquisition. Securities classified as HTM must be purchased withthe intent and ability to hold that security until its final maturity, and canbe sold prior to maturity only under certain rare circumstances. HTM securitiesare accounted for based upon the historical cost of the security. AFSsecurities can be sold at any time based upon our needs or judgment as tomarket 

13

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changes. AFS securitiesare accounted for at fair value with unrealized gains and losses on thesesecurities, net of income tax effects, reflected in the stockholders' equitysection of our Statement of Financial Condition.

Additionally, securities are evaluated periodically todetermine whether a decline in their fair value is other than temporary.Management utilizes criteria such as the magnitude and duration of the decline,in addition to the reasons underlying the decline, to determine whether theloss in value is other than temporary. The term “other than temporary” is notintended to indicate that the decline is permanent, but indicates that theprospects for a near-term recovery of value is not necessarily favorable, orthat there is a lack of evidence to support realizable value equal to orgreater than carrying value of the investment. Once a decline in fair value isdetermined to be other than temporary, the fair value of the security isreduced through a charge to earnings in the consolidated statements of income.

Management does not believe any individual unrealizedloss as of June 30, 2006 represents an other-than-temporary impairment.The temporary impairment is directly related to changes in market interestrates. In general, as interest rates rise, the fair value of fixed-ratesecurities will decrease and, as interest rates fall, the fair value of fixed-ratesecurities will increase. The severity of the impairment as a percent of thetotal investment position is nominal and the duration of the impairment to dateis short. The impairments are deemed temporary based on the direct relationshipof the decline in fair value to movements in interest rates, as well as therelatively short duration of the investments and their high credit quality.Additionally, the Company has the ability and intent to hold these securitiesuntil such time as the value recovers or the securities mature.

At June 30, 2006, investment securities amountedto $303.4 million, or 19.2% of total assets. This includes a$4.1 million unrealized loss, net of income tax, on those investmentsecurities classified as AFS. The portfolio consists of US government andagency securities, many with callable features and agency and non-agencymortgage-backed pass-through securities, collateralized mortgageobligations, municipal bonds, equity investments primarily in mutual funds.

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Thefollowing table sets forth information on the carrying value and the amortizedcost of our securities classified as held to maturity and available for sale atthe dates indicated.

| ** **                      | ** ** | **At June 30,**            | ** ** |
|---------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **Amortized  Cost**                  | ** ** | **Fair  value** | ** ** | **Amortized  Cost** | ** ** | **Fair  value** | ** ** | **Amortized  Cost** | ** ** | **Fair  value** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Held to maturity:               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Municipal bonds                 |       | $                                    | —     |   | $ | — |   | $ | 19,801 |   | $ | 20,230 |   |   | $ | 18,132 |   |   | $ | 18,183 |   |
| US Gov’t agency securities |       | —                               |       | — |   | 15,000 |   | 14,818 |   |   | 16,000 |   |   | 15,717 |   |
| CMOs                            |       | 72,355                               |       | 70,425 |   | 90,449 |   | 90,856 |   |   | 49,018 |   |   | 49,001 |   |
| Mortgage-backed securities      |       | 33,206                               |       | 31,662 |   | 39,201 |   | 39,005 |   |   | 15,363 |   |   | 15,500 |   |
| Total held to maturity          |       | 105,561                              |       | 102,087 |   | 164,451 |   | 164,909 |   |   | 98,513 |   |   | 98,401 |   |
|                                 |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                      | ** ** | **Amortized  Cost** | ** ** | **Carrying  value** | ** ** | **Amortized  Cost** | ** ** | **Carrying  value** | ** ** | **Amortized  Cost** | ** ** | **Carrying  value** | ** ** |
|---------------------------------|------------|---------------------|------------|---------------------|------------|---------------------|------------|---------------------|------------|---------------------|------------|---------------------|------------|
| Available for sale:             |       |                |       |                |       |                |       |                |       |                |       |                |       |
| Interest earning deposits       |       | —              |       | —              |       | 98                  |       | 98                  |       | —              |       | —              |       |
| Corporate debt securities       |       | 14,419              |       | 14,208              |       | —              |       | —              |       | —              |       | —              |       |
| Municipal bonds                 |       | 9,105               |       | 9,127               |       | —              |       | —              |       | —              |       | —              |       |
| Equity securities(1)            |       | 11,642              |       | 11,326              |       | 9,733               |       | 9,502               |       | 9,188               |       | 9,079               |       |
| US Gov’t agency securities |       | 35,473              |       | 34,297              |       | 45,484              |       | 44,867              |       | 75,031              |       | 73,459              |       |
| CMOs                            |       | 29,059              |       | 28,498              |       | 3,786               |       | 3,795               |       | —              |       | —              |       |
| Mortgage-backed securities      |       | 103,523             |       | 99,469              |       | 91,565              |       | 90,255              |       | 141,756             |       | 139,466             |       |
| Total available  for sale       |       | 203,221             |       | 196,925             |       | 150,666             |       | 148,517             |       | 225,975             |       | 222,004             |       |
| Total securities                |       | $                   | 308,782    |                | $          | 299,012             |       | $                   | 315,117    |                | $          | 313,426             |       | $ | 324,488 |   | $ | 320,405 |   |
|                                 |            |                     |            |                     |            |                     |            |                     |            |                     |            |                     |            |  |  |  |  |  |  |

----

       (1) Includes mutual funds with a fair value of approximately$10.3 million at June 30, 2006.

Prior to the effective date of the Merger, the Bankundertook a strategy to de-leverage a portion of its balance sheet by, amongother things, selling certain of its AFS securities. This effort has resultedin the Company selling an aggregate of approximately $95.9 million insecurities which resulted in an aggregate net loss of approximately$912 thousand. Prior to the effective date of the Merger, both Willow FinancialBank and First Financial Bank had taken advantage of market conditions inselling certain securities which did not result in an aggregate loss to eitherCompany, or in the case of First Financial Bank, would potentially reduce anegative mark to market in purchase accounting. The net proceeds received fromthis strategy were utilized to repay higher costing Federal Home Loan Bankborrowings.

**Mortgage-BackedSecurities (“MBS”) and Collateralized Mortgage Obligations (“CMOs”).****  **At June 30, 2006, theinvestment securities portfolio contained MBSs with a carrying value of $33.2million and $99.5 million in HTM and AFS, respectively, and CMOs of$72.4 million and $28.5 million in HTM and AFS, respectively. Thiscompared to $39.2 million and $90.3 million in HTM and AFS MBSs,respectively, and $90.4 million and $3.8 million in HTM and AFS CMOs,respectively, at June 30, 2005. MBSs represent a participation interest ina pool of single-family or multi-family mortgages. Mortgages are soldby various originators to intermediaries (generally agencies of the USGovernment and government sponsored enterprises) that pool and repackage themortgages and sell participation interests in the pools to investors. Theservicer of the mortgage loan collects the principal and interest payments andpasses those payments through to the intermediary who then remits the paymentto the investor. The US Government agencies and government sponsoredenterprises, primarily the Government National Mortgage Association (“GNMA”),FNMA and FHLMC, guarantee the timely payment of principal and interest on thesesecurities. MBSs that are pooled by US Government or government sponsoredenterprises are known as agency mortgage-backed securities. Other privateservicers may pool mortgages 

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into similar pass-throughsecurities and are known as non-agency MBSs. These non-agency MBSs do not havethe guaranteed timely payment of principal and interest that an agency MBS has,and may also include loans that may not qualify to be included in an agencyMBS, for reasons such as, but not limited to, the size of the loan.

MBSs are issued in stated principal amounts and arebacked by mortgage loans within a specific interest rate range, but may havevarying maturity dates. The underlying pool of mortgages may be comprised ofeither fixed-rate or adjustable-rate mortgage loans. Each MBS pool will alsodiffer based upon the actual level of prepayment experienced by the underlyingmortgage loans.

At June 30, 2006, the weighted average life ofour fixed rate and adjustable rate mortgage-backed securities wasapproximately 3.8 years and 5.0 years, respectively, based upon management’sassumptions related to the future prepayments of the underlying mortgages.Prepayments that are greater than those projected will shorten the remainingterm of the security, while a decrease in the amount of prepayments willlengthen the amount of time until the security matures. Prepayments depend onmany factors, including the type of mortgage, the coupon rate, the remainingperiod until the loan matures or the rate is scheduled to reset, the geographicregion, and the general level of market interest rates. During periods ofrising interest rates, if the coupon rates of the underlying mortgages are lessthan prevailing market rates offered on mortgages, refinancing will decreaseand prepayments of the mortgages underlying the security will decline.Conversely, when market interest rates are falling, and the coupon rate on theunderlying mortgage exceeds the prevailing market interest rate for mortgagesoffered, refinancings tend to increase which will increase the amount ofprepayments of the underlying mortgages. 

CMOs are securities that are structured from a pool ofMBSs or whole loans. The structuring results in sectors known as tranches. Eachtranche within a CMO will have different cash flow requirements and interestrates. Although still subject to prepayments, this structuring into tranchesprovides a more predictable cash flow to the bondholder.

**USGovernment and Government Agency Securities and Municipal Bonds.****  **At June 30, 2006, the carryingvalue of US government and US government agency securities within theinvestment securities portfolio was $34.3 million, which includesapproximately $1.2 million in unrealized losses, compared to$59.9 million, which included approximately $799 thousand in unrealizedlosses, at June 30, 2005. This portfolio is comprised primarily ofsecurities issued by the FHLB, FNMA, FHLMC and the Federal Farm Credit Bank.Many of these securities have call features that allow the issuer to redeemthese securities at par value prior to their stated maturity. Generally, if theprevailing market interest rate on new issue callable agency securities withsimilar maturities exceeds the coupon rate of the security with the call feature,the call will not be exercised. Conversely, if the prevailing market interestrate for new issue agency callable securities with similar maturities is belowthe coupon rate of the security with the call feature, the call will beexercised and the bond will be redeemed. When calls are exercised and bondsredeemed prior to their maturity, the Bank faces the risk of re-investing thoseproceeds into other investments with lower yields or longer terms.

Municipal bonds, which were classified as held tomaturity at June 30, 2005, were sold as part of the Company’sde-leveraging strategy referenced above in accordance with the provisions ofFinancial Accounting Standards Board (“FASB”) Statement No. 115, “Accountingfor Certain Investments in Debt and Equity Securities”. The remaining municipalbonds classified as AFS were assumed as a part of the Merger.

Municipal bonds classified as AFS at June 30,2006 are generally issued by local school districts as well as three non-ratedPennsylvania Municipal Authority bonds that are classified as substandard. At June 30,2006, the aggregate book value of these bonds was $3.6 million. Two of thethree bonds, with an aggregate book value of $3.0 million at June 30,2006, are zero coupon bonds with maturities extending up to 2034. Both bondsare secured by the revenue streams of commercial office buildings, which areleased to various 

16

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agencies of theCommonwealth of Pennsylvania under long-term lease arrangements with renewaloptions. A third bond was issued by the Housing Authority of Chester County andhas a book balance of $539 thousand at June 30, 2006, and bearsinterest at rates between 5.60% and 6.00% and matures in June 2019. Thisbond involves low-income scattered housing in Chester County under a program ofthe Office of Housing and Urban Development (“HUD”). HUD has providedadditional funds to build additional houses, which have been donated to thisbond issue. The construction of the homes has been completed and the retirementof the bond issue is dependent upon proceeds from either the rental or sale ofthe homes.

**Other Investments.****  **Other than MBSs, US government andgovernment agency securities and municipal bonds, we have investments invarious equity securities and mutual funds. At June 30, 2006, $1.0 millionwas invested in equity securities and $10.3 million was invested in mutualfunds. The equity securities include stock of several publicly traded companies.The mutual fund investment of $10.3 million is backed primarily byinvestments in adjustable-rate mortgage-backed securities and otherinvestments authorized by our investment policy.

**Sources of Funds**

**General.****  **Deposits are the primary source offunds for the Bank’s lending and investment activities. In addition todeposits, funds are provided from the amortization and prepayments within theloan and mortgage-backed securities portfolios, maturities of investments,and borrowings. Scheduled loan amortization is a relatively stable source offunds. However, competition and the general level of interest rates and marketconditions significantly influences deposit inflows and outflows. Borrowingsmay be used on a short-term basis to compensate for reductions in other fundingsources. On a longer-term basis, borrowings may be used for general businesspurposes.

**Deposits.****  **As shown in the table below, duringthe year ended June 30, 2006, the Bank’s core deposit accounts (which weconsider to be all deposits other than our certificate accounts) increased to69.4% of total deposits from 60.0% of deposits at June 30, 2005.

| ** **                                          | ** ** | **At June 30,**            | ** ** |
|-----------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                          | ** ** | **2006**                             | ** ** | **2005** | ** ** |
| ** **                                          | ** ** | **Amount**                           | ** ** | **Percent of  total** | ** ** | **Amount** | ** ** | **Percent of  total** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)** | ** ** |
| Savings accounts  (passbooks, statements and clubs) |       | $                                    | 101,119    |   |   | 10.3 | % |   | $ | 84,164 |   |   | 14.0 | % |   |
| Money market  accounts                              |       | 305,299                              |       |   | 31.0 | % |   | 133,883 |   |   | 22.2 | % |   |
| Certificates of  deposit                            |       | 301,627                              |       |   | 30.6 | % |   | 240,936 |   |   | 40.0 | % |   |
| Checking accounts:                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing                                    |       | 114,329                              |       |   | 11.6 | % |   | 60,933 |   |   | 10.1 | % |   |
| Non-interest-bearing                                |       | 162,864                              |       |   | 16.5 | % |   | 82,762 |   |   | 13.7 | % |   |
| Total                                               |       | $                                    | 985,238    |   |   | 100.0 | % |   | $ | 602,678 |   |   | 100.0 | % |   |

 

17

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Duringthe year ended June 30, 2006, total deposits increased by $382.6 millionor 63.5% compared to the year ended June 30, 2005. The increase occurredprimarily from the Merger as Chester Valley had total deposits of $437.1million on the acquisition date. Core deposits, as previously defined,increased by $321.9 million also as a result of the Merger, as ChesterValley had total core deposits of $331.3 million on the acquisition date.

| ** **                           | ** ** | **Year ended June 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)**   | ** ** |
| Beginning balance                    |       | $                                      | 602,678    |   | $ | 603,115 |   | $ | 586,643 |   |
| Net (decrease)  increase in deposits |       | (67,594                                | )          | (9,569 | ) | 7,981 |   |
| Deposits assumed  in acquisition     |       | 437,065                                |       | — |   | — |   |
| Interest credited                    |       | 13,089                                 |       | 9,132 |   | 8,491 |   |
| Ending balance                       |       | $                                      | 985,238    |   | $ | 602,678 |   | $ | 603,115 |   |

 

Thefollowing table sets forth by various interest rate ranges, the amount of ourcertificates of deposit at the dates indicated.

| ** **          | ** ** | **At June 30,**            | ** ** |
|---------------------|------------|--------------------------------------|------------|
| ** **          | ** ** | **2006**                             | ** ** | **2005** | ** ** |
| ** **          | ** ** | **(Dollars in thousands)** | ** ** |
| Interest rates:     |       |                                 |       |   |   |
| from 0.00% to 2.99% |       | $                                    | 76,344     |   | $ | 135,015 |   |
| from 3.00% to 3.99% |       | 115,702                              |       | 92,375 |   |
| from 4.00% to 4.99% |       | 96,206                               |       | 12,743 |   |
| from 5.00% to 5.99% |       | 11,211                               |       | 167 |   |
| 6.00% and over      |       | 2,164                                |       | 636 |   |
| Total               |       | $                                    | 301,627    |   | $ | 240,936 |   |

 

Shownbelow are the amount and remaining term to maturity for certificates of depositas of June 30, 2006.

| ** **           | ** ** | **Amounts maturing in** | ** ** |                                              |
|----------------------|------------|-----------------------------------|------------|---------------------------------------------------|
| ** **           | ** ** | **Six months  or less** | ** ** | **Over six  months  through one  year** | ** ** | **Over one  year through  two years** | ** ** | **Over two  years through  three years** | ** ** | **Over three  years** | ** ** |
| **Interest  rates:** | ** ** | ** **                        | ** ** | **(Dollars in thousands)**              | ** ** |   |
| 0.00% to 2.99%       |       |                              | $          | 36,051                                            |   |   |   | $ | 22,065 |   |   |   | $ | 13,001 |   |   |   | $ | 3,241 |   |   |   | $ | 1,986 |   |   |   |
| 3.00% to 3.99%       |       |                              | 65,608     |                                              |   |   | 31,728 |   |   |   | 13,543 |   |   |   | 2,091 |   |   |   | 2,732 |   |   |   |
| 4.00% to 4.99%       |       |                              | 24,440     |                                              |   |   | 30,985 |   |   |   | 16,105 |   |   |   | 8,416 |   |   |   | 16,260 |   |   |   |
| 5.00% to 5.99%       |       |                              | 801        |                                              |   |   | 3,273 |   |   |   | 2,799 |   |   |   | 3,168 |   |   |   | 1,170 |   |   |   |
| 6.00% and over       |       |                              | 401        |                                              |   |   | 793 |   |   |   | 213 |   |   |   | 228 |   |   |   | 529 |   |   |   |
| Total                |       |                              | $          | 127,301                                           |   |   |   | $ | 88,844 |   |   |   | $ | 45,661 |   |   |   | $ | 17,144 |   |   |   | $ | 22,677 |   |   |   |
|                      |            |                                   |            |                                                   |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

18

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At June 30,2006 the total amount of outstanding certificates of deposit in amounts greaterthan or equal to $100 thousand was $63.0 million. The following tableprovides information regarding the maturity of these certificates of deposit.

| **Amounts maturing in**             | ** ** |
|-------------------------------------|------------|
| **Three months  or less** | ** ** | **Over three  months  through six  months** | ** ** | **Over six  months  through one  year** | ** ** | **Over one  year** | ** ** | **Total** | ** ** |
| **(Dollars in thousands)**          | ** ** |
| $8,613                              |       |   | $ | 16,164 |   |   |   | $ | 19,034 |   |   | $ | 19,213 |   | $ | 63,024 |   |
|                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Borrowings.****  **The Bank utilizes outside borrowingsto supplement our funding needs and in the past, under certain instances, asrevenue enhancement programs to take advantage of arbitrage opportunities wheninvestment returns exceeded the cost of borrowings. At June 30, 2006, theCompany had $372.0 million in outstanding borrowings, which were comprisedof $282.7 million in FHLB borrowings, $53.2 million in repurchase agreementsand $36.1 million of trust preferred securities. The investment in FHLB stock,as well as a portion of our residential mortgage loan portfolio and investmentsecurities portfolio, secure advances from the FHLB. The FHLB of Pittsburghprovides an array of borrowing programs which include: fixed or variable rateprograms; various fixed terms ranging from overnight to 20 years; andother programs that have callable or putable features attached to them. TheBank intends to continue to utilize borrowings in the future as an alternativesource of funds. The repurchase agreements are secured by various securitieswithin the Company’s investment securities portfolio. 

As noted previously, the Company initiated ade-leveraging program prior to the August 31, 2005 effective date of theMerger, which continued through December 31, 2005, in which certain securitieswere sold and the proceeds were utilized to fund the cash requirements of theMerger and to repay higher rate borrowings. The program resulted in therepayment of $65.0 million of FHLB borrowings. Additionally, ChesterValley had initiated a de-leveraging program prior to the effective date of theMerger and repaid approximately $20.8 million of its borrowings prior to theMerger. 

Thefollowing table sets forth certain information regarding our borrowings for theperiods indicated.

| ** **                                 | ** ** | **At or for the year ended** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                 | ** ** | **June 30, 2006**                           | ** ** | **June 30, 2005** | ** ** |
| ** **                                 | ** ** | **(Dollars in thousands)**                  | ** ** |
| FHLB advances:                             |       |                                                  |       |   |   |   |   |   |   |
| Average balance outstanding for the period |       |                                                  | $          | 314,920 |   |   |   | $ | 250,299 |   |   |
| Maximum outstanding at any month end       |       |                                                  | 364,572    |   |   |   | 275,035 |   |   |
| Balance outstanding at end of the period   |       |                                                  | 282,717    |   |   |   | 237,400 |   |   |
| Average interest rate for the period       |       |                                                  | 4.02       | % |   |   | 3.52 | % |   |
| Interest rate at the end of the period     |       |                                                  | 4.24       | % |   |   | 3.80 | % |   |
| Repurchase agreements:                     |       |                                                  |       |   |   |   |   |   |   |
| Average balance outstanding for the period |       |                                                  | $          | 26,156 |   |   |   | — |   |   |
| Maximum outstanding at any month end       |       |                                                  | 53,152     |   |   |   | — |   |   |
| Balance outstanding at end of the period   |       |                                                  | 53,152     |   |   |   | — |   |   |
| Average interest rate for the period       |       |                                                  | 4.04       | % |   |   | — |   |   |
| Interest rate at  the end of the period    |       |                                                  | 4.74       | % |   |   | — |   |   |
|                                            |            |                                                       |            |  |  |  |  |  |  |  |  |

 

 

19

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At June 30, 2006 the maturity of our FHLBadvances ranged from July 3, 2006 to October 1, 2018. Certainadvances also require monthly payments of principal. At June 30, 2006,$164.0 million of FHLB advances were callable at the option of the FHLBwithin certain parameters, of which $119.0 million could be called withinone year. Of the FHLB advances that are callable at the discretion of the FHLB,$60.0 million of these advances could be called only if an index exceededa specific pre-determined rate.

**TrustPreferred Securities.****  **Effectivewith the acquisition of Chester Valley, the Company assumed the liability for$10.5 million of Junior Subordinated Debentures to the Chester Valley StatutoryTrust, a Pennsylvania Business Trust, in which the Company owns all of thecommon equity as a result of the acquisition of Chester Valley. The Trustissued $10.0 million of Trust Preferred Securities to investors, which aresecured by the Junior Subordinated Debentures and the guarantee of the Company.The Junior Subordinated Debentures are treated as debt of the Company but theyqualify as Tier I capital, subject to certain limitations under the risk-basedcapital guidelines of the OTS. The Trust Preferred Securities are callable bythe Company on or after March 26, 2007, or at any time in the event thededuction of related interest expense for federal income taxes is prohibited,the treatment as Tier I capital is no longer permitted or under certain othercircumstances. The Trust Preferred Securities must be redeemed by the Companyupon their maturity in the year 2032.

On March 31, 2006,the Company issued $25.8 million of Junior Subordinated Debentures to WillowGrove Statutory Trust I, a Connecticut Statutory Trust, in which the Companyowns all of the common equity. The Trust then issued $25.0 million of TrustPreferred Securities, which pay interest quarterly at three-month Libor plus1.31% to investors, which are secured by the Junior Subordinated Debentures andthe guarantee of the Company. The Junior Subordinated Debentures are treated asdebt of the Company but qualify as Tier I capital of the Bank to the extent ofthe amount of the proceeds, which are invested in the Bank. The Trust PreferredSecurities are callable by the Company on or after June 15, 2011. The TrustPreferred Securities must be redeemed by the Company upon their maturity in theyear 2036.

**Accounting forDerivative Instruments and Hedging**

The Company may from time to time utilize derivativeinstruments such as interest rate swaps, interest rate collars, interest ratefloors, interest rate swaptions or combinations thereof to assist in itsasset/liability management. In accordance with SFAS No. 133, “Accountingfor Derivative Instruments”, the Company formally documents its hedgerelationships, including identification of the hedging instruments and thehedged items, as well as its risk management objectives and strategies forundertaking the hedge. The Company also formally assesses, both at inceptionand at least quarterly thereafter, whether the derivative instruments that areused in hedging transactions are highly effective in offsetting the changes ineither the fair value or cash flows of the hedged item. For fair value hedges,both the effective and ineffective portions of the changes in the fair value ofthe derivative, along with the gain or loss on the hedged item that isattributable to the hedged risk, are recorded in the statement of operationswithin interest income or interest expense. For cash flow hedges, the effectiveportion of the change in the fair value of the derivative is recorded inaccumulated other comprehensive income. When the hedged item impacts thestatement of operations, the gain or loss included in accumulated othercomprehensive income is reported on the same line in the statement ofoperations as the hedged item. In addition, the ineffective portion of thechanges in the fair value of derivatives used as cash flow hedges is reportedin the statement of operations.

As part of the Merger, the Company assumed theresponsibility for a $20 million notional interest rate swap whereby theCompany paid a variable rate and received a fixed rate. The interest rate swaphad been used to hedge certain Federal Home Loan Bank borrowings of the formerChester Valley. On the date of the Merger, the interest rate swap and thehedged borrowings were marked to fair value in purchase accounting. In September 2005,the hedged borrowings were repaid and $10 million notional amount of theinterest rate swap was unwound with the counter-party. After performing theappropriate 

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documentation of thederivative instrument, the Company designated the remaining $10 millionnotional amount interest rate swap as a fair value hedge of certain existingborrowings of Willow Financial Bank. The swap had the effect of converting afixed rate borrowing to an adjustable rate borrowing. During the quarter ended December 31,2005, the derivative instrument ceased to be a highly effective hedge;therefore, the Company discontinued hedge accounting resulting in a pre-taxcharge to the statement of operations of $47 thousand. The interest rate swapwas unwound in February 2006 without resulting in any additional impact tothe statement of operations. The basis adjustment that was previously recordedon the hedged borrowing that is recorded in the statement of financialcondition is amortized as a reduction in interest expense over the remaininglife of the borrowing using the interest method.

Additionally, in August 2003,Chester Valley had purchased a $30.0million notional amount 3.50% Three Month LIBOR interest rate cap whilesimultaneously selling a $30.0 million notional amount 6.00% Three Month LIBORinterest rate cap (“Interest Rate Corridor”) that expires in August 2008. TheCompany paid a net premium, which entitles it to receive the difference betweenThree Month LIBOR from 3.50% up to 6.00% times the $30.0 million notionalamount. The Company performed the appropriate analysis and documentation atinception and designated the interest rate corridor to hedge certain borrowingsof Willow Financial Bank, which were variable in nature and indexed to ThreeMonth LIBOR. The Interest Rate Corridor is being used to hedge the cash flowsof this borrowing. The Interest Rate Corridor could potentially reduce thenegative impact on earnings of the borrowings in a rising interest rateenvironment. The fair market value of the Interest Rate Corridor has twocomponents: the intrinsic value and the time value of the option. The InterestRate Corridor is marked-to-market quarterly, with changes in the intrinsicvalue of the Interest Rate Corridor, net of tax, included as a separatecomponent of other comprehensive income and changes in the time value of theoption included directly as interest expense as required under SFAS 133. Inaddition, the ineffective portion, if any, would have been expensed in theperiod in which ineffectiveness was determined. The fair value of the InterestRate Corridor at June 30, 2006 was $1.2 million.

**REGULATION**

Set forth below is a briefdescription of certain laws and regulations, which are applicable to Willow FinancialBancorp and Willow Financial Bank, including our business segment, PCIS. Thedescription of these laws and regulations, as well as descriptions of laws andregulations contained elsewhere herein, does not purport to be complete and isqualified in its entirety by reference to the applicable laws and regulations.

**General**

Willow Financial Bank, as a federally charteredsavings institution, is subject to federal regulation and oversight by theOffice of Thrift Supervision extending to all aspects of its operations. WillowFinancial Bank also is subject to regulation and examination by the FederalDeposit Insurance Corporation, which insures the deposits of Willow FinancialBankto the maximum extent permitted by law, and requirements established by theFederal Reserve Board. Federally chartered savings institutions are required tofile periodic reports with the Office of Thrift Supervision and are subject toperiodic examinations by the Office of Thrift Supervision and the FederalDeposit Insurance Corporation. Federal laws and regulations determine theinvestment and lending authority of savings institutions, and such institutionsare prohibited from engaging in any activities not permitted by such laws andregulations. Such regulation and supervision primarily is intended for theprotection of depositors and not for the purpose of protecting stockholders.

The Office of ThriftSupervision regularly examines Willow Financial Bank and prepares reports forconsideration by its Board of Directors on any deficiencies that it may find inthe Bank’s operations. The Federal Deposit Insurance Corporation also has theauthority to examine Willow Financial Bank in its role as the administrator ofthe Deposit Insurance Fund. Willow Financial Bank’s relationship with its 

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depositorsand borrowers also is regulated to a great extent by both federal and, to alesser extent, state laws, especially in such matters as the ownership ofsavings accounts and the form and content of Willow Financial Bank’s mortgagerequirements. The Office of Thrift Supervision’s enforcement authority over allsavings institutions and their holding companies includes, among other things,the ability to assess civil money penalties, to issue cease and desist orremoval orders and to initiate injunctive actions. In general, theseenforcement actions may be initiated for violations of laws and regulations andunsafe or unsound practices. Other actions or inactions may provide the basisfor enforcement action, including misleading or untimely reports filed with theOffice of Thrift Supervision. Any change in such laws or regulations, whetherby the Federal Deposit Insurance Corporation, Office of Thrift Supervision orCongress, could have a material adverse impact on us and Willow Financial Bankand our operations.

**Willow FinancialBancorp, Inc.**

Willow Financial Bancorp is a registered savings andloan holding company under Section 10 of the Home Owners’ Loan Act, asamended and subject to Office of Thrift Supervision examination and supervisionas well as certain reporting requirements. In addition, because Willow FinancialBank’s deposits are insured by the Deposit Insurance Fund maintained by theFederal Deposit Insurance Corporation. Willow Financial Bank is subject tocertain restrictions in dealing with Willow Financial Bancorp and with otherpersons affiliated with the Bank.

Generally, the Home Owners’Loan Act prohibits a savings and loan holding company, such as us, directly orindirectly, from (1) acquiring control (as defined) of a savingsinstitution (or holding company thereof) without prior Office of ThriftSupervision approval, (2) acquiring more than 5% of the voting shares of asavings institution (or holding company thereof) which is not a subsidiary,subject to certain exceptions, without prior Office of Thrift Supervisionapproval, or (3) acquiring through a merger, consolidation or purchase ofassets of another savings institution (or holding company thereof) or acquiringall or substantially all of the assets of another savings institution (orholding company thereof) without prior Office of Thrift Supervision approval or(4) acquiring control of an uninsured institution. A savings and loanholding company may not acquire as a separate subsidiary a savings institutionwhich has its principal offices outside of the state where the principaloffices of its subsidiary institution is located, except (a) in the caseof certain emergency acquisitions approved by the Federal Deposit InsuranceCorporation, (b) if the holding company controlled (as defined) suchsavings institution as of March 5, 1987 or (c) when the laws of thestate in which the savings institution to be acquired is located specificallyauthorize such an acquisition. No director or officer of a savings and loanholding company or person owning or controlling more than 25% of such holdingcompany’s voting shares may, except with the prior approval of the Office ofThrift Supervision, acquire control of any savings institution which is not asubsidiary of such holding company.

**Willow FinancialBank**

**Insuranceof Accounts.****  **Thedeposits of Willow Financial Bank are insured to the maximum extent permittedby the Deposit Insurance Fund, which is administered by the Federal DepositInsurance Corporation, and are backed by the full faith and credit of the U.S.Government. As insurer, the Federal Deposit Insurance Corporation is authorizedto conduct examinations of, and to require reporting by, insured institutions.It also may prohibit any insured institution from engaging in any activity theFederal Deposit Insurance Corporation determines by regulation or order to posea serious threat to the Federal Deposit Insurance Corporation. The FederalDeposit Insurance Corporation also has the authority to initiate enforcementactions against savings institutions, after giving the Office of ThriftSupervision an opportunity to take such action.

Under current FederalDeposit Insurance Corporation regulations, insured institutions are assigned toone of three capital groups which are based solely on the level of aninstitution’s capital—“well 

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capitalized,”“adequately capitalized,” and “undercapitalized”—which are defined in the samemanner as the regulations establishing the prompt corrective action systemdiscussed below. These three groups are then divided into three subgroups, whichreflect varying levels of supervisory concern, from those, which are consideredto be healthy to those, which are considered to be of substantial supervisoryconcern. The matrix so created results in nine assessment risk classifications,with rates during the last six months of 2006 ranging from zero for wellcapitalized, healthy institutions, such as Willow Financial Bank, to 27 basispoints for undercapitalized institutions with substantial supervisory concerns.

In addition, allinstitutions with deposits insured by the Federal Deposit Insurance Corporationare required to pay assessments to fund interest payments on bonds issued bythe Financing Corporation, a mixed-ownership government corporationestablished to recapitalize the predecessor to the Savings AssociationInsurance Fund. The assessment rate for the second quarter of 2006 was .00315%of insured deposits and is adjusted quarterly. These assessments will continueuntil the Financing Corporation bonds mature in 2019.

The Federal Deposit InsuranceCorporation may terminate the deposit insurance of any insured depositoryinstitution, including Willow Financial Bank, if it determines after a hearingthat the institution has engaged or is engaging in unsafe or unsound practices,is in an unsafe or unsound condition to continue operations, or has violatedany applicable law, regulation, order or any condition imposed by an agreementwith the Federal Deposit Insurance Corporation. It also may suspend depositinsurance temporarily during the hearing process for the permanent terminationof insurance, if the institution has no tangible capital. If insurance ofaccounts is terminated, the accounts at the institution at the time of thetermination, less subsequent withdrawals, shall continue to be insured for aperiod of six months to two years, as determined by the Federal DepositInsurance Corporation. Management is aware of no existing circumstances, whichwould result in termination of Willow Financial Bank’s deposit insurance.

**Deposit Insurance Reform.**   OnFebruary 8, 2006, President George W. Bush signed into law legislationthat merged the Bank Insurance Fund and the Savings Association Insurance Fundto form the Deposit Insurance Fund, eliminated any disparities in bank andthrift risk-based premium assessments, reduced the administrative burden ofmaintaining and operating two separate funds and established certain newinsurance coverage limits and a mechanism for possible periodic increases. Thelegislation also gave the Federal Deposit Insurance Corporation greaterdiscretion to identify the relative risks all institutions present to theDeposit Insurance Fund and set risk-based premiums.

Majorprovisions in the legislation include:

·       mergingthe Savings Association Insurance Fund and Bank Insurance Fund, which becameeffective March 31, 2006;

·       maintainingbasic deposit and municipal account insurance coverage at $100,000 butproviding for a new basic insurance coverage for retirement accounts of$250,000. Insurance coverage for basic deposit and retirement accounts could beincreased for inflation every five years in $10,000 increments beginningin 2011;

·       providing the FederalDeposit Insurance Corporation with the ability to set the designated reserveratio within a range of between 1.15% and 1.50%, rather than maintaining 1.25%at all times regardless of prevailing economic conditions;

·       providing a one-timeassessment credit of $4.7 billion to banks and savings associations inexistence on December 31, 1996, which may be used to offset futurepremiums with certain limitations; and

·       requiring the payment of dividends of 100% ofthe amount that the insurance fund exceeds 1.5% of the estimated insureddeposits and the payment of 50% of the amount that the insurance fund exceeds1.35% of the estimated insured deposits (when the reserve is greater than 1.35%but no more than 1.5%).

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**Regulatory CapitalRequirements.****  **TheOffice of Thrift Supervision capital requirements consist of a “tangiblecapital requirement,” a “leverage capital requirement” and a “risk-basedcapital requirement.” The Office of Thrift Supervision is authorized to imposecapital requirements in excess of those standards on individual institutions ona case-by-case basis.

Under the tangible capitalrequirement, a savings bank must maintain tangible capital in an amount equalto at least 1.5% of adjusted total assets. Tangible capital is defined as corecapital less all intangible assets (including supervisory goodwill), plus aspecified amount of purchased mortgage-servicing rights.

Under the leverage capitalrequirement adopted by the Office of Thrift Supervision, savings banks mustmaintain “core capital” in an amount equal to at least 3.0% of adjusted totalassets. Core capital is defined as common stockholders’ equity (includingretained earnings), non-cumulative perpetual preferred stock, and minorityinterests in the equity accounts of consolidated subsidiaries, plus purchasedmortgage servicing rights valued at the lower of 90% of fair market value, 90%of original cost or the current amortized book value as determined undergenerally accepted accounting principles, and “qualifying supervisory goodwill,”less non-qualifying intangible assets.

Under the risk-basedcapital requirement, a savings bank must maintain total capital (which isdefined as core capital plus supplementary capital) equal to at least 8.0% ofrisk-weighted assets. A savings bank must calculate its risk-weighted assets bymultiplying each asset and off-balance sheet item by various risk factors,which range from 0% for cash and securities issued by the United StatesGovernment or its agencies to 100% for repossessed assets or loans more than90 days past due. Qualifying one- to-four family residential real estateloans and qualifying multi-family residential real estate loans (not morethan 90 days delinquent and having an 80% or lower loan-to-value ratio)are weighted at a 50% risk factor. Supplementary capital may include, amongother items, cumulative perpetual preferred stock, perpetual subordinated debt,mandatory convertible subordinated debt, intermediate-term preferred stock, andgeneral allowances for loan losses. The allowance for loan losses includable insupplementary capital is limited to 1.25% of risk-weighted assets. The amountof supplementary capital that can be included is limited to 100% of corecapital.

Certain exclusions fromcapital and assets are required for the purpose of calculating total capital,in addition to the adjustments required for calculating core capital. Suchexclusions consist of equity investments (as defined by regulation) and thatportion of land loans and non-residential construction loans in excess of an80% loan-to-value ratio and reciprocal holdings of qualifying capitalinstruments. However, in calculating regulatory capital, institutions mustexclude unrealized losses and gains on securities available for sale, net oftaxes, reported as a separate component of capital calculated according to U.S.generally accepted accounting principles.

In its letter approving themerger of Willow Financial Bank and Chester Valley, the Office of ThriftSupervision, as one of its conditions for approval, indicated that, for theperiods ending December 31, 2005, 2006 and 2007, Willow Financial Bankmust have tier one core capital ratios at least equal to 6.50%, 6.75%, and7.25%, respectively, and total risk-based capital ratios at least equal to11.97%, 12.02% and 12.40%, respectively. Willow Financial Bank also must submitto the Office of Thrift Supervision, quarterly status reports detailing itscompliance with the conditions on regulatory capital outlined in its approvalletter. The Office of Thrift Supervision’s conditions for approval of the BankMerger also indicated that, for the periods ending December 31, 2005, 2006and 2007, Willow Financial Bancorp must have consolidated tangible capitalratios at least equal to 5.14%, 5.59% and 6.12%, respectively. Willow FinancialBancorp also must submit to the Office of Thrift Supervision quarterly statusreports. We are in compliance with these regulatory capital ratios.

Office of ThriftSupervision regulations establish special capitalization requirements forsavings banks that own service corporations and other subsidiaries, includingsubsidiary savings banks. According to these regulations, certain subsidiariesare consolidated for capital purposes and others are excluded from 

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assetsand capital. In determining compliance with the capital requirements, allsubsidiaries engaged solely in activities permissible for national banks,engaged solely in mortgage-banking activities, or engaged in certainother activities solely as agent for its customers are “includable”subsidiaries that are consolidated for capital purposes in proportion to WillowFinancial Bank’s level of ownership, including the assets of includablesubsidiaries in which Willow Financial Bank has a minority interest that is notconsolidated for generally accepted accounting principles purposes. Forexcludable subsidiaries, the debt and equity investments in such subsidiariesare deducted from assets and capital. At June 30, 2006, Willow FinancialBank had no investments subject to a deduction from tangible capital.

Under currently applicableOffice of Thrift Supervision policy, savings institutions must value securitiesavailable for sale at amortized cost for regulatory capital purposes. Thismeans that in computing regulatory capital, savings institutions should addback any unrealized losses and deduct any unrealized gains, net of incometaxes, on debt securities reported as a separate component of capitalcalculated according to U.S. generally accepted accounting principles.

At June 30, 2006,Willow Financial Bank exceeded all of its regulatory capital requirements, withtangible, core and risk-based capital ratios of 7.8%, 7.8% and 13.2%,respectively.

The Office of ThriftSupervision and the Federal Deposit Insurance Corporation generally areauthorized to take enforcement action against a savings bank that fails to meetits capital requirements, which action may include restrictions on operationsand banking activities, the imposition of a capital directive, acease-and-desist order, civil money penalties or harsher measures such as theappointment of a receiver or conservator or a forced merger into anotherinstitution. In addition, under current regulatory policy, a savings bank thatfails to meet its capital requirements is prohibited from paying any dividends.

**Prompt Corrective Action.****  **Under the Federal Deposit InsuranceCorporation Improvement Act of 1991, the federal banking regulators arerequired to take prompt corrective action if an insured depository institutionfails to satisfy certain minimum capital requirements, including a leveragelimit, a risk-based capital requirement, and any other measure of capitaldeemed appropriate by the federal banking regulator for measuring the capitaladequacy of an insured depository institution. All institutions, regardless oftheir capital levels, are restricted from making any capital distribution orpaying management fees if the institution would thereafter fail to satisfy theminimum levels for any of its capital requirements.

Under the Federal DepositInsurance Corporation Improvement Act an institution is deemed to be (a) “wellcapitalized” if it has total risk-based capital of 10.0% or more, has a Tier 1risk-based capital ratio of 6.0% or more, has a Tier 1 leverage capital ratioof 5.0% or more and is not subject to any order or final capital directive tomeet and maintain a specific capital level for any capital measure, (b) “adequatelycapitalized” if it has a total risk-based capital ratio of 8.0% or more, a Tier1 risk-based capital ratio of 4.0% or more and a Tier 1 leverage capital ratioof 4.0% or more (3.0% under certain circumstances) and does not meet thedefinition of “well capitalized,” (c) “undercapitalized” if it has a totalrisk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capitalratio that is less than 4.0% or a Tier 1 leverage capital ratio that is lessthan 4.0% (3.0% under certain circumstances), (d) “significantlyundercapitalized” if it has a total risk-based capital ratio that is less than6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1leverage capital ratio that is less than 3.0%, and (e) “criticallyundercapitalized” if it has a ratio of tangible equity to total assets that isequal to or less than 2.0%. Under specified circumstances, a federal bankingagency may reclassify a well capitalized institution as adequately capitalizedand may require an adequately capitalized institution or an undercapitalizedinstitution to comply with supervisory actions as if it were in the next lowercategory (except that the Federal Deposit Insurance Corporation may notreclassify a significantly undercapitalized institution as critically undercapitalized).

An institution generallymust file a written capital restoration plan which meets specifiedrequirements with its appropriate federal banking agency within 45 days ofthe date that the institution 

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receivesnotice or is deemed to have notice that it is undercapitalized, significantlyundercapitalized or critically undercapitalized. A federal banking agency mustprovide the institution with written notice of approval or disapproval within60 days after receiving a capital restoration plan, subject to extensionsby the agency. An institution that is required to submit a capital restorationplan must concurrently submit a performance guaranty by each company thatcontrols the institution. In addition, undercapitalized institutions aresubject to various regulatory restrictions, and the appropriate federal bankingagency also may take any number of discretionary supervisory actions.

At June 30, 2006,Willow Financial Bank was in the “well capitalized” category for purposes ofthe above regulations.

**Safety and SoundnessGuidelines.****  **TheOffice of Thrift Supervision and the other federal bank regulatory agencieshave established guidelines for safety and soundness, addressing operationaland managerial standards, as well as compensation matters for insured financialinstitutions. Institutions failing to meet these standards may be required tosubmit compliance plans to their appropriate federal regulators. The Office ofThrift Supervision and the other agencies have also established guidelinesregarding asset quality and earnings standards for insured institutions. WillowFinancial Bank believes that it is in compliance with these guidelines andstandards.

**Capital Distributions.****  **Office of Thrift Supervisionregulations govern capital distributions by savings institutions, which includecash dividends, stock repurchases and other transactions charged to the capitalaccount of a savings institution to make capital distributions. A savingsinstitution must file an application for Office of Thrift Supervision approvalof the capital distribution if any of the following occur or would occur as aresult of the capital distribution (1) the total capital distributions forthe applicable calendar year exceed the sum of the institution’s net income forthat year to date plus the institution’s retained net income for the precedingtwo years, (2) the institution would not be at least adequately capitalizedfollowing the distribution, (3) the distribution would violate anyapplicable statute, regulation, agreement or Office of Thrift Supervision-imposedcondition, or (4) the institution is not eligible for expedited treatmentof its filings. If the filing of an application is not required, savingsinstitutions that are a subsidiary of a holding company (as well as certainother institutions) must still file a notice with the Office of ThriftSupervision at least 30 days before the board of directors declares adividend or approves a capital distribution.

**Branching by FederalSavings Institutions.****  **Officeof Thrift Supervision policy permits interstate branching to the full extentpermitted by statute (which is essentially unlimited). Generally, federal lawprohibits federal savings institutions from establishing, retaining oroperating a branch outside the state in which the federal institution has itshome office unless the institution meets the IRS’ domestic building and loantest (generally, 60% of a thrift’s assets must be housing-related) (“IRSTest”). The IRS Test requirement does not apply if: (a) the branch(es)result(s) from an emergency acquisition of a troubled savings institution(however, if the troubled savings institution is acquired by a bank holdingcompany, does not have its home office in the state of the bank holding companybank subsidiary and does not qualify under the IRS Test, its branching islimited to the branching laws for state-chartered banks in the statewhere the savings institution is located); (b) the law of the state wherethe branch would be located would permit the branch to be established if thefederal savings institution were chartered by the state in which its homeoffice is located; or (c) the branch was operated lawfully as a branchunder state law prior to the savings institution’s reorganization to a federalcharter.

Furthermore, the Office ofThrift Supervision will evaluate a branching applicant’s record of compliancewith the Community Reinvestment Act of 1977. An unsatisfactory CommunityReinvestment Act record may be the basis for denial of a branching application.

**Community Reinvestment Actand the Fair Lending Laws.****  **Savings institutions have a responsibility under theCommunity Reinvestment Act and related regulations of the Office of ThriftSupervision to help 

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meet the creditneeds of their communities, including low- and moderate-incomeneighborhoods. In addition, the Equal Credit Opportunity Act and the FairHousing Act prohibit lenders from discriminating in their lending practices onthe basis of characteristics specified in those statutes. An institution’sfailure to comply with the provisions of the Community Reinvestment Act could,at a minimum, result in regulatory restrictions on its activities, and failureto comply with the fair lending laws could result in enforcement actions by theOffice of Thrift Supervision, as well as other federal regulatory agencies andthe Department of Justice.

**Qualified Thrift LenderTest.****  **Allsavings institutions are required to meet a qualified thrift lender test toavoid certain restrictions on their operations. Under Section 2303 of theEconomic Growth and Regulatory Paperwork Reduction Act of 1996, a savingsinstitution can comply with the qualified thrift lender test by eitherqualifying as a domestic building and loan bank as defined in Section 7701(a)(19)of the Internal Revenue Code or by meeting the second prong of the qualifiedthrift lender test set forth in Section 10(m) of the Home Owner’sLoan Act. A savings institution that does not meet the qualified thrift lendertest must either convert to a bank charter or comply with the followingrestrictions on its operations: (a) the institution may not engage in anynew activity or make any new investment, directly or indirectly, unless suchactivity or investment is permissible for a national bank; (b) thebranching powers of the institution shall be restricted to those of a nationalbank; (c) the institution shall not be eligible to obtain any new advancesfrom its Federal Home Loan Bank, other than special liquidity advances with theapproval of the Office of Thrift Supervision; and (d) payment of dividendsby the institution shall be subject to the rules regarding payment ofdividends by a national bank. Upon the expiration of three years from the datethe savings institution ceases to be a qualified thrift lender, it must ceaseany activity and not retain any investment not permissible for a national bankand immediately repay any outstanding Federal Home Loan Bank advances (subjectto safety and soundness considerations).

Currently, the portion ofthe qualified thrift lender test that is based on Section 10(m) ofthe Home Owners’ Loan Act rather than the Internal Revenue Code requires that65% of an institution’s “portfolio assets” (as defined) consist of certainhousing and consumer-related assets on a monthly average basis in nineout of every 12 months. Assets that qualify without limit for inclusion aspart of the 65% requirement are loans made to purchase, refinance, construct,improve or repair domestic residential housing and manufactured housing; homeequity loans; mortgage-backed securities (where the mortgages are securedby domestic residential housing or manufactured housing); stock issued by theFederal Home Loan Bank of Pittsburgh; and direct or indirect obligations of theFederal Deposit Insurance Corporation. Small business loans, credit card loansand student loans are also included without limitation as qualifiedinvestments. In addition, the following assets, among others, may be includedin meeting the test subject to an overall limit of 20% of the savingsinstitution’s portfolio assets: 50% of residential mortgage loans originatedand sold within 90 days of origination; 100% of loans for personal, familyand household purposes (other than credit card loans and educational loans);and stock issued by Fannie Mae or Freddie Mac. Portfolio assets consist oftotal assets minus the sum of (a) goodwill and other intangible assets, (b) propertyused by the savings institution to conduct its business, and (c) liquidassets up to 20% of the institution’s total assets. At June 30, 2006,approximately 71.9% of the portfolio assets of Willow Financial Bank werequalified thrift investments.

**Federal Home Loan BankSystem.****  **WillowFinancial Bank is a member of the Federal Home Loan Bank of Pittsburgh, whichis one of 12 regional Federal Home Loan Banks that administer the homefinancing credit function of savings institutions. Each Federal Home Loan Bankserves as a reserve or central bank for its members within its assigned region.It is funded primarily from proceeds derived from the sale of consolidatedobligations of the Federal Home Loan Bank System. It makes loans to members(i.e., advances) in accordance with policies and procedures established by itsboard of directors. At June 30, 2006, Willow Financial Bank had$282.7 million of Federal Home Loan Bank advances.

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As a member, Willow Financial Bank is required topurchase and maintain stock in the Federal Home Loan Bank of Pittsburgh in anamount equal to at least 1% of its aggregate unpaid residential mortgage loans,home purchase contracts or similar obligations at the beginning of each year or5% of the members’ aggregate amount of outstanding advances and 0.7% of themembers’ unused borrowing capacity. At June 30, 2006, Willow FinancialBank had $16.9 million in stock of the Federal Home Loan Bank of Pittsburgh,which was in compliance with this requirement.

The Federal Home Loan Banks are required to providefunds for the resolution of troubled savings institutions and to contribute toaffordable housing programs through direct loans or interest subsidies onadvances targeted for community investment and low- and moderate-incomehousing projects. These contributions have adversely affected the level ofFederal Home Loan Bank dividends paid and could continue to do so in the futureand could also result in the Federal Home Loan Banks imposing higher interestrates on advances to members. These contributions also could have an adverseeffect on the value of Federal Home Loan Bank stock in the future.

**FederalReserve System.****  **FederalReserve Board regulations require all depository institutions to maintainnon-interest earning reserves against their transaction accounts (primarily NOWand Super NOW checking accounts) and non-personal time deposits. At June 30,2006, Willow Financial Bank was in compliance with these reserve requirements.The balances maintained to meet the reserve requirements imposed by the FederalReserve Board may be used to satisfy liquidity requirements that may be imposedby the Office of Thrift Supervision.

Savings banks are authorized to borrow from a FederalReserve Bank “discount window,” but Federal Reserve Board regulations requiresavings banks to exhaust other reasonable alternative sources of funds,including Federal Home Loan Bank advances, before borrowing from a Federal ReserveBank.

**AffiliateRestrictions.****  **Section 11of the Home Owners’ Loan Act provides that transactions between an insuredsubsidiary of a holding company and an affiliate thereof will be subject to therestrictions that apply to transactions between banks that are members of theFederal Reserve System and their affiliates pursuant to Sections 23A and 23B ofthe Federal Reserve Act.

Generally, Sections 23A and 23B and Office of ThriftSupervision regulations issued in connection therewith limit the extent towhich a savings institution or its subsidiaries may engage in certain “coveredtransactions” with affiliates to an amount equal to 10% of the institution’scapital and surplus, in the case of covered transactions with any oneaffiliate, and to an amount equal to 20% of such capital and surplus, in thecase of covered transactions with all affiliates. Section 23B applies to “coveredtransactions” and certain other transactions and requires that all suchtransactions be on terms and under circumstances that are substantially thesame, or at least as favorable to the savings institution or its subsidiary, asthose prevailing at the time for comparable transactions with nonaffiliatedcompanies. A “covered transaction” is defined to include a loan or extension ofcredit to an affiliate; a purchase of investment securities issued by anaffiliate; a purchase of assets from an affiliate, with certain exceptions; theacceptance of securities issued by an affiliate as collateral for a loan orextension of credit to any party; or the issuance of a guarantee, acceptance orletter of credit on behalf of an affiliate. Section 23B transactions alsoapply to the provision of services and the sale of assets by a savingsassociation to an affiliate.

In addition, under Office of Thrift Supervisionregulations, a savings institution may not make a loan or extension of creditto an affiliate unless the affiliate is engaged only in activities permissiblefor bank holding companies; a savings institution may not purchase or invest insecurities of an affiliate other than shares of a subsidiary; a savingsinstitution and its subsidiaries may not purchase a low-quality asset from anaffiliate; and covered transactions and certain other transactions between asavings institution or its subsidiaries and an affiliate must be on terms andconditions that are consistent with safe and sound banking practices. Withcertain exceptions, each loan or extension of credit by a savings institutionto an 

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affiliate must be securedby collateral with a market value ranging from 100% to 130% (depending on thetype of collateral) of the amount of the loan or extension of credit.

The Office of ThriftSupervision regulation generally excludes all non-bank and non-savingsinstitution subsidiaries of savings institutions from treatment as affiliates,except to the extent that the Office of Thrift Supervision or the FederalReserve Board decides to treat such subsidiaries as affiliates. The regulationalso requires savings institutions to make and retain records that reflectaffiliate transactions in reasonable detail, and provides that certain classesof savings institutions may be required to give the Office of ThriftSupervision prior notice of affiliate transactions.

**Federal SecuritiesLaw**

The Company’s common stockis registered with the SEC under the Securities Exchange Act of 1934, asamended. It is therefore subject to the information, proxy solicitation,insider trading restrictions and other requirements of the Securities ExchangeAct of 1934, as amended.

**Sarbanes-OxleyAct of 2002**

On July 30, 2002, the President signed into lawthe Sarbanes-Oxley Act of 2002 implementing legislative reforms intendedto address corporate and accounting fraud. In addition to the establishment ofa new accounting oversight board which enforces auditing, quality control andindependence standards and is funded by fees from all publicly tradedcompanies, the Sarbanes-Oxley Act restricts provision of both auditingand consulting services by accounting firms. To ensure auditor independence,any non-audit services being provided require pre-approval by the Company’saudit committee. In addition, the audit partners must be rotated. The Sarbanes-OxleyAct requires chief executive officers and chief financial officers, or theirequivalent, to certify to the accuracy of periodic reports filed with the SEC,subject to civil and criminal penalties if they knowingly or willfully violatethis certification requirement. In addition, under the Sarbanes-OxleyAct, counsel will be required to report evidence of a material violation of thesecurities laws or a breach of fiduciary duty by a company to its chiefexecutive officer or its chief legal officer, and, if such officer does notappropriately respond, to report such evidence to the audit committee or othersimilar committee of the board of directors or the board itself.

Longer prison terms will also be applied to corporateexecutives who violate federal securities laws, the period during which certaintypes of suits can be brought against a company or its officers has been extended,and bonuses issued to top executives prior to restatement of a company’sfinancial statements are subject to disgorgement if such restatement was due tocorporate misconduct. Executives are also prohibited from insider tradingduring retirement plan “blackout” periods, and loans to company executives arerestricted. In addition, a provision directs that civil penalties levied by theSEC as a result of any judicial or administrative action under the Act bedeposited to a fund for the benefit of harmed investors. The Federal Accountsfor Investor Restitution (“FAIR”) provision also requires the SEC to developmethods of improving collection rates. The legislation accelerated the timeframe for disclosures by public companies, as they must immediately discloseany material changes in their financial condition or operations. Directors andexecutive officers must also provide information for most changes in ownershipin a company’s securities within two business days of the change.

The Sarbanes-OxleyAct increased the oversight of, and codified certain requirements relating toaudit committees of public companies and how they interact with the Company’s “registeredpublic accounting firm” (“RPAF”). Audit committee members must be independentand are barred from accepting consulting, advisory or other compensatory feesfrom the issuer. In addition, companies must disclose whether at least onemember of the committee is a “financial expert” (as such term is defined by theSEC) and if not, why not. Under the Sarbanes-Oxley Act, a RPAF isprohibited from performing statutorily mandated audit services for a company ifsuch company’s chief executive officer, chief financial 

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officer,comptroller, chief accounting officer or any person serving in equivalentpositions has been employed by such firm and participated in the audit of suchcompany during the one-year period preceding the audit initiation date. TheSarbanes-Oxley Act also prohibits any officer or director of a company orany other person acting under their direction from taking any action tofraudulently influence, coerce, manipulate or mislead any independent public orcertified accountant engaged in the audit of a company’s financial statementsfor the purpose of rendering the financial statement’s materially misleading.The Sarbanes-Oxley Act also required the SEC to prescribe rules requiringinclusion of an internal control report and assessment by management in theannual report to shareholders, which became effective for the Company for thefiscal year ended June 30, 2005. The Sarbanes-Oxley Act requires theRPAF that issues the audit report to attest to and report on management’sassessment of the company’s internal controls. In addition, the Sarbanes-OxleyAct requires that each financial report required to be prepared in accordancewith (or reconciled to) U.S. generally accepted accounting principles and filedwith the SEC reflect all material correcting adjustments that are identified bya RPAF in accordance with U.S. generally accepted accounting principles and therules and regulations of the SEC.

**Regulation of PCIS**

**General**

As noted above, while PCIS is no longer a subsidiaryof the Company, it operates as a business segment of the Company, and itsresults continue to be included in the Company’s consolidated financialstatements. PCIS is subject to regulation by a number of federal regulatoryagencies that are charged with safeguarding the integrity of the securities andother financial markets and with protecting the interests of customers participatingin those markets. The SEC is the federal agency that is primarily responsiblefor the regulation of broker-dealers and investment advisers doingbusiness in the United States. The Federal Reserve Board promulgatesregulations applicable to securities credit transactions involving broker-dealersand certain other institutions. Much of the regulation of broker-dealers,however, has been delegated to self-regulatory organizations (“SROs”),principally the NASD (and its subsidiaries NASD Regulation, Inc.), and theother national securities exchanges. These SROs, which are subject to oversightby the SEC, adopt rules (which are subject to approval by the SEC) thatgovern the industry, monitor daily activity and conduct periodic examinationsof member broker-dealers.

PCIS is also subject to the Uniting and StrengtheningAmerica by Providing Appropriate Tools Required to Intercept and ObstructTerrorism Act of 2001 (the “USA Patriot Act’), signed into law on October 26,2001. The USA Patriot Act requires financial institutions to adopt andimplement policies and procedures designed to prevent and defeat moneylaundering. PCIS believes it is in compliance with the USA Patriot Act.

Securities firms are also subject to regulation bystate securities commissions in the states in which they are required to beregistered. PCIS is registered as a broker-dealer with the SEC and in all50 states and in the District of Columbia, and is a member of, and subject toregulation by, a number of SROs, including the NASD.

As a result of federal and state registration and SROmemberships, PCIS is subject to overlapping schemes of regulation that coverall aspects of its securities business. Such regulations cover mattersincluding capital requirements, uses and safe-keeping of clients’ funds,conduct of directors, officers and employees, record-keeping andreporting requirements, supervisory and organizational procedures intended toassure compliance with securities laws and to prevent improper trading onmaterial nonpublic information, employee-related matters, includingqualification and licensing of supervisory and sales personnel, limitations onextensions of credit in securities transactions, clearance and settlementprocedures, requirements for the registration, underwriting, sale anddistribution of securities, and rules of the SROs designed to promote highstandards of commercial honor and just and equitable principles of 

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trade. A particular focusof the applicable regulations concerns the relationship between broker-dealersand their customers. As a result, the many aspects of the broker-dealercustomer relationship are subject to regulation including, in some instances, “suitability”determinations as to certain customer transactions, limitations on the amountsthat may be charged to customers, timing of proprietary trading in relation tocustomers’ trades and disclosures to customers.

PCIS also is subject to “Risk Assessment Rules”imposed by the SEC which require, among other things, that certain broker-dealersmaintain and preserve certain information, describe risk management policiesand procedures and report on the financial condition of certain affiliateswhose financial and securities activities are reasonably likely to have amaterial impact on the financial and operational condition of the broker-dealers.Certain “Material Associated Persons” (as defined in the Risk Assessment Rules)of the broker-dealers and the activities conducted by such MaterialAssociated Persons may also be subject to regulation by the SEC.

PCIS is registered as an investment adviser with theSEC. As an investment adviser registered with the SEC, it is subject to therequirements of the Investment Advisers Act of 1940 and the SEC’s regulationsthereunder, as well as certain state securities laws and regulations. Suchrequirements relate to, among other things, limitations on the ability of aninvestment adviser to charge performance-based or non-refundable fees toclients, record-keeping and reporting requirements, disclosurerequirements, limitations on principal transactions between an adviser or itsaffiliates and advisory clients, as well as general anti-fraud prohibitions.The state securities law requirements applicable to registered investmentadvisers are in certain cases more comprehensive than those imposed under thefederal securities laws.

In the event ofnon-compliance with an applicable regulation, governmental regulators and theNASD may institute administrative or judicial proceedings that may result incensure, fine, civil penalties (including treble damages in the case of insidertrading violations), the issuance of cease-and-desist orders, thederegistration or suspension of the non-compliant broker-dealer orinvestment adviser, the suspension or disqualification of the broker-dealer’sofficers or employees or other adverse consequences. With the sale of PCIS toUvest, Uvest is now responsible for any such penalties or orders imposed onPCIS subsequent to effective date of the sale, which was February 28,2006.

**TAXATION**

**Federal Taxation**

**General.****  **The Company is subject to federalincome taxation in the same general manner as other corporations with someexceptions listed below. The following discussion of federal taxation is onlyintended to summarize certain pertinent federal income tax matters and is not acomprehensive description of the applicable tax rules. Tax years 2003, 2004 and2005 are open under the statute of limitations and subject to review by theInternal Revenue Service.

The Company files a consolidated federal income taxreturn, which includes the Bank. Accordingly, it is anticipated that any cashdistributions made by it would be treated as cash dividends, and not as a non-taxablereturn of capital to stockholders for federal and state tax purposes.

**Methodof Accounting.****  **Forfederal income tax purposes, income and expenses are reported on the accrualmethod of accounting and the Company files its federal income tax return usinga June 30 fiscal year end.

**BadDebt Reserves.****  **TheSmall Business Job Protection Act of 1996 (the “1996 Act”) eliminated the useof the reserve method of accounting for bad debt reserves by savingsinstitutions, effective for taxable years beginning after 1995. Prior to the1996 Act, the Bank was permitted to establish a reserve for bad debts and to makeadditions to the reserve. These additions could, within specified formulalimits, be deducted in arriving at taxable income. As a result of the 1996 Act,savings associations must use the 

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specific charge-off methodin computing their bad debt deduction beginning with their 1996 federal taxreturn. In addition, federal legislation requires the recapture (over a sixyear period) of the excess of tax bad debt reserves at December 31, 1995over those established as of December 31, 1987. The Bank has no reservesubject to recapture as of June 30, 2006.

**TaxableDistributions and Recapture.****  **Prior to the 1996 Act, bad debt reserves created priorto January 1, 1988 were subject to recapture into taxable income if theBank failed to meet certain thrift asset and definitional tests. New federallegislation eliminated these thrift related recapture rules. However, undercurrent law, pre-1988 reserves remain subject to recapture should the Bank makecertain non-dividend distributions or ceases to maintain a bank charter.

At June 30, 2006, the Bank’s total federalpre-1988 reserve was approximately $8.9 million. The reserve reflects thecumulative effects of federal tax deductions for which no federal income taxprovisions have been made.

**MinimumTax.****  **TheCode imposes an alternative minimum tax (“AMT”) at a rate of 20% on a base ofregular taxable income plus certain tax preferences (“alternative minimumtaxable income” or “AMTI”). The AMT is payable to the extent such AMTI is inexcess of regular income tax. Net operating losses can offset no more than 90%of AMTI. Certain payments of alternative minimum tax may be used as creditsagainst regular tax liabilities in future years. The Company has not beensubject to the AMT nor do we have any such amounts available as credits forcarryover.

**NetOperating Loss Carryovers.****  **Net operating losses may be carried back to the threepreceding taxable years and forward to the succeeding 15 taxable years. Thisprovision applies to losses incurred in taxable years beginning before August 6,1997. For net operating losses in years beginning after August 5, 1997,net operating losses can be carried back to the two preceding taxable years andforward to the succeeding 20 taxable years with some exceptions. At June 30,2006, the Company had $559 thousand in net operating loss carry-forwards forfederal income tax purposes as a result of its acquisition of Chester Valley.The net operating loss carry-forwards will expire in June 2025.

**Corporate Dividends—ReceivedDeduction.****  **TheCompany may exclude from income 100% of dividends received from a member of thesame affiliated group of corporations. The corporate dividends receiveddeduction is 80% in the case of dividends received from corporations, which acorporate recipient owns less than 80%, but at least 20% of the distributioncorporation. Corporations, which own less than 20% of the stock of acorporation distributing a dividend, may deduct only 70% of dividends received.

**State and LocalTaxation**

**PennsylvaniaTaxation.****  **WillowFinancial Bancorp is subject to the Pennsylvania Corporate Net Income Tax andCapital Stock and Franchise Tax. The Corporation Net Income Tax rate for fiscal2006 is 9.99% and is imposed on the Company’s unconsolidated taxable income forfederal purposes with certain adjustments. In general, the Capital Stock Tax isa property tax imposed at the rate of approximately 0.599% of a corporation’scapital stock value, which is determined in accordance with a fixed formulabased upon average net income and net worth.

The Bank is subject to taxunder the Pennsylvania Mutual Thrift Institutions Tax Act (the “MTIT”), asamended to include thrift institutions having capital stock. Pursuant to theMTIT, the tax rate is 11.5%. The MTIT exempts the Bank from other taxes imposedby the Commonwealth of Pennsylvania for state income tax purposes and from alllocal taxation imposed by political subdivisions, except taxes on real estateand real estate transfers. The MTIT is a tax upon net earnings, determined inaccordance with U.S. generally accepted accounting principles (“GAAP”)with certain adjustments. The MTIT, in computing GAAP income, allows for thededuction of interest earned on state and federal obligations, whiledisallowing a percentage of a thrift’s interest expense deduction in theproportion of interest income 

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on thosesecurities to the overall interest income of the Bank. Net operating losses, ifany, thereafter can be carried forward three years for MTIT purposes.

**Subsidiaries**

As of June 30, 2006, the Company’s sole directsubsidiary was Willow Financial Bank. At such date Willow Financial Bank hadfour direct subsidiaries, Willow Grove Investment Corporation, a Delawarecorporation which holds and manages certain securities investments, and WillowGrove Insurance Agency, LLC, a Pennsylvania limited liability company formed toconduct permitted fixed-rate annuity sales. As of June 30, 2006, Willow FinancialBank’s aggregate investment in these subsidiaries was $265.2 million. As aresult of the Merger on August 31, 2005, D&S Service Corporation (“D&SService”) and First Financial Investments (“FFI”), which previously weresubsidiaries of Chester Valley, are now operating as active subsidiaries ofWillow Financial Bank. D&S Service has participated in the development forsale of residential properties, in particular condominium conversions, anddevelopment of commercial properties located in or within close proximity ofChester Valley’s market area and FFI conducts retail investment serviceactivities. D&S Service also operates two wholly owned subsidiaries,Wildman Projects and D&F Projects, Inc. As of June 30, 2006, theBank had $1.7 million invested in D&S Service and its subsidiaries.

Effective February 28,2006, the Company completed the sale of all outstanding shares of capital stockof PCIS to Uvest BD-A, Inc., a North Carolina Corporation and registeredbroker-dealer (“Uvest”), for consideration of $100 but providing that such sharesmay be repurchased for $100 at any time after the closing date of the stocksale. Concurrently with the execution of the sale of PCIS, the Bank and Uvestentered into a related Sub-Clearing and Brokerage Services Agreement, whichprovides that an affiliate of Uvest will provide securities clearing andcertain supervisory and compliance services for the Bank, and a FinancialServices Agreement between PCIS and the Bank which provides that the Bank willbe entitled to 92% of the revenue generated by the securities brokerage andinvestment advisory activities conducted at the PCIS office and will bearsubstantially all operational and overhead expenses. Upon consummation of thesale of PCIS stock to Uvest, PCIS is no longer a subsidiary of the Company. However,under the provisions of FIN 46R, “Consolidation of Variable Interest Entities”,the results of PCIS will continue to be consolidated in the Company’s financialstatements. The affiliation agreement with Uvest has the primary effect ofrelieving PCIS of direct responsibility for securities clearing and certainback-office and oversight obligations.

**Item 1A.**                RiskFactors

***Our operations aresubject to interest rate risk and variations in interest rates may negativelyaffect financial performance.***

Ourearnings and cash flows are largely dependent upon our net interest income. Netinterest income is the difference between interest income earned oninterest-earning assets such as loans and securities and interest expense paidon interest-bearing liabilities such as deposits and borrowed money. Changes inthe general level of interest rates may have an adverse effect on our business,financial condition and result of operations. Interest rates are highlysensitive to many factors that are beyond our control, including generaleconomic conditions and policies of various governmental and regulatoryagencies and, in particular, the Federal Reserve Board. Changes in monetarypolicy, including changes in interest rates, influence the amount of interestincome that we receive on loans and securities and the amount of interest thatwe pay on deposits and borrowings. Changes in monetary policy and interestrates also can adversely affect:

·       ourability to originate loans and obtain deposits;

·       thefair value of our financial assets and liabilities; and

·       theaverage duration of our securities portfolio.

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If the interest rates paidon deposits and other borrowings increase at a faster rate than the interestrates received on loans and other investments, our net interest income, andtherefore earnings, could be adversely affected. Earnings could also be adverselyaffected if the interest rates received on loans and other investments fallmore quickly than the interest rates paid on deposits and other borrowings. Wemeasure interest rate risk under various rate scenarios using specific criteriaand assumptions. A summary of this process, along with the results of our netportfolio value simulations and gap analysis is presented within “Quantitativeand Qualitative Disclosures About Market Risk” in Item 7A of this Annual Reporton Form 10-K.

***We may be unable to successfully implement ourbusiness strategy.***

In recent years, ourbusiness plan has focused on the goals of changing the Bank’s operations to afull-service community bank model, growing our franchise and maintaining a highlevel of asset quality. Our acquisition of Chester Valley Bancorp in August 2005significantly advanced our progress in achieving our goals relative to changingthe Bank to a full-service community bank and growing our franchise. We expectto continue to build and “fill-in” our existing Bank branch network throughacquisitions, if prudently available, and additional de novo branch offices. Noassurance can be given that we will ultimately succeed in our business plan. Ourefforts will depend upon, among other factors, (i) our ability to retainand grow our existing base of deposits in an efficient manner, (ii) maintainingand expanding our commercial and consumer banking relationships in order togrow our loan portfolio, (iii) attracting and retaining experiencedcommercial lenders and managerial employees, (iv) maintaining an efficientcost structure for our operations, (v) maintaining asset quality and (vi) effectivelyexpanding our branch network in southeastern Pennsylvania. The failure toachieve any of these factors could limit the implementations of our businessesstrongly and adversely affect our financial condition and results ofoperations.

***We are subject to lending risk and could suffer lossesin our loan portfolio despite our underwriting practices.***

There are inherent risksassociated with our lending activities. There are risks inherent in making anyloan, including those related to dealing with individual borrowers, nonpayment,uncertainties as to the future value of collateral and changes in economic andindustry conditions. We attempt to closely manage our credit risk through loanunderwriting and application approval procedures, monitoring of large loanrelationship and periodic independent reviews of outstanding loans by ourlending department and third party loan review specialists. We cannot assurethat such approval and monitoring procedures will reduce these credit risks.

***Our loan portfolio includes commercial andmulti-family real estate, commercial business and construction loans, whichgenerally have a higher degree of risk of loss than single-family residentialloans.***

As of June 30, 2006,approximately 40.6% of our total loan portfolio consisted of commercial realestate and multi-family real estate loans and construction loans. In addition,7.5% of our loan portfolio at June 30, 2006 consisted of commercialbusiness loans. We are focused on increasing these types of loans in the future.These types of loans involve increased risks because the borrower’s ability torepay the loan typically depends on the successful operation of the business orthe property securing the loan. Additionally, these loans are made to small ormiddle-market business customers who may be more vulnerable to economicconditions and who may not have experienced a complete business or economic cycle.These types of loans are also typically larger than single-family residentialmortgage loans or consumer loans. Furthermore, since these types of loansfrequently have relatively large balances, the deterioration of one or more ofthese loans could cause a significant increase in non-performing loans and ornon-performing assets. An increase in non-performing loans would result in areduction in interest income recognized on loans. An increase in non-performingloans also could require us to increase the 

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provisionfor losses on loans and increase loan charge-offs, both of which would reduceour net income. All of these could have a material adverse effect on ourfinancial condition and results of operations.

***Adverse economic and business conditions in ourprimary market area could cause an increase in loan delinquencies andnon-performing assets which could adversely affect our financial condition andresults of operations.***

The substantial majorityof our real estate loans are secured by properties located in Bucks, Montgomeryand Chester Counties, Pennsylvania, and Philadelphia and its suburbs insoutheastern Pennsylvania, central and southern New Jersey and Delaware. TheCompany’s results of operations and financial condition may be adverselyaffected by changes in prevailing economic conditions, particularly in thePhiladelphia metropolitan area, including decreases in real estate values,adverse local employment conditions, and other significant local events. Anydeterioration in the local economy could result in borrowers not being able torepay their loans, the value of the collateral securing the Company’s loans toborrowers declining and the quality of the loan portfolio deteriorating. Thiscould result in an increase in delinquencies and non-performing assets orrequire the Company to record loan charge-offs and/or increase the Company’sprovisions for loan losses, which would reduce the Company’s earnings.

***Our allowance for losses on loans may be insufficientto cover actual losses on loans.***

We maintain an allowancefor losses on loans at a level believed adequate by us to absorb credit lossesinherent in the loan portfolio. The allowance for losses on loans is a reserveestablished through a provision for losses on loans charged to expense that representsour estimate of probable incurred losses within the loan portfolio at eachstatement of condition date and is based on the review of available andrelevant information. The level of the allowance for losses on loans reflects,among other things, our consideration of the Company’s historical experience,levels of and trends in delinquencies, the amount of classified assets, thevolume and type of lending, and current and anticipated economic conditions,especially as they relate to the Company’s primary market area. Thedetermination of the appropriate level of the allowance for losses on loansinherently involves a high degree of subjectivity and requires us to makesignificant estimates of current credit risks and future trends. Our allowancefor loan losses may be insufficient to cover actual losses experienced onloans. Changes in economic conditions affecting borrowers, new informationregarding existing loans, identification of additional problem loans and otherfactors, both within and outside of our control, may require an increase in theallowance for losses on loans. In addition, bank regulatory agenciesperiodically review our allowance for losses on loans and may require anincrease in the provision for losses on loans or the recognition of furtherloan charge offs, based on judgments different from ours. Also, if charge offsin future periods exceed the allowance for losses on loans, we will needadditional provisions to increase our allowance for losses on loans. Anyincreases in the allowance for losses on loans will result in a decrease in netincome and possibly capital, and may have a material adverse effect on ourfinancial condition and results of operations.

***We operate in a highly competitive industry and marketarea with other financial institutions offering products and services similarto those we offer.***

We compete with savingsassociations, national banks, regional banks and other community banks inmaking loans, attracting deposits and recruiting and retaining talentedemployees, many of which have greater financial and technical resources than us.We also compete with securities and brokerage companies, mortgage companies,insurance companies, finance companies, money market mutual funds, creditunions and other non-bank financial service providers. Many of thesecompetitors are not subject to the same regulatory restrictions to which we aresubject, yet are able to provide customers with a feasible alternative totraditional banking services. The competition in our market for makingcommercial and construction loans has resulted in more competitive pricing aswell as intense competition for skilled 

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commerciallending officers. These trends could have a material adverse effect on ourability to grow (irrespective of the limitations imposed by the supervisoryagreements) and remain profitable. In addition, if we experience an inabilityto recruit and retain skilled commercial lending officers, includingexperienced construction lenders, it could pose a significant barrier toretaining and growing our customer base. The competition in our market forattracting deposits also has resulted in more competitive pricing.

***We depend on the skills and performance of management.***

We depend heavily on our management team to provideleadership and to implement our strategic plan. Our senior management teamprovides valuable financial expertise and administrative guidance. The loss ofany member of our senior management team could impair our ability to succeed. Wecan give no assurances, however, that these executive officers will continue intheir capacities for any specific periods of time. The loss of services of anymember of our senior management team may make it difficult for us to implementour business strategy and obtain and retain customers. In addition, if any ofour executive officers decides to leave, it may be difficult to replace him orher, and we would lose the benefit of the knowledge he or she gained during hisor her tenure with us.

Our future success dependslargely on our ability to identify, attract, hire, train, retain and motivateother highly skilled technical, managerial, lending and professional personnel.Competition for such employees is intense and there is a risk that we will notbe able to successfully attract, assimilate or retain sufficiently qualifiedpersonnel. If we fail to attract and retain the necessary technical,managerial, sales and marketing, customer service personnel and experiencedprofessionals our ability to successfully implement our business strategy as wellas our results of operations and financial condition could be adverselyaffected.

***We are subject to extensive government regulation andsupervision which could adversely affect our operations.***

We are subject toextensive federal and state regulations and supervision. Banking regulationsare primarily intended to protect depositors’ funds, federal deposit insurancefunds and the banking system as a whole, not stockholders. These regulationsaffect our lending practices, capital structure, investment practices, dividendpolicy and growth, among other things. Congress and federal agenciescontinually review banking laws, regulations and policies for possible changes.Changes to statutes, regulations or regulatory policies, including changes ininterpretation or implementation of statutes, regulations or policies, couldaffect us in substantial and unpredictable ways. Such changes could subject usto additional costs, limit the types of financial services and products we mayoffer and/or increase the ability of non-banks to offer competing financialservices and products, among other things. Failure to comply with law,regulations or policies could result in sanctions by regulatory agencies, civilmoney penalties and/or reputation damage, which could have a material adverseeffect on our business, financial condition and results of operations.

**Item 1B.**               UnresolvedStaff Comments

Not applicable.

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**Item 2.**         Properties

As of June 30, 2006,the Company and the Bank operated from the following locations:

| ** **                                                                 | ** ** | ** **                 | ** ** | ** **                       | ** ** | **At June 30, 2006**  | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **                                                                 | ** ** | **Owned or   Leased** | ** ** | **Lease   expiration date** | ** ** | **Net book   value**            | ** ** | **Deposits** | ** ** |
| ** **                                                                 | ** ** | ** **                 | ** ** | ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| *Executive office and branch  office*:                                     |       |                       |       |                             |       |                                 |       |   |   |   |   |   |   |
| 170 South Warner Road  Wayne, PA 19087                                     |       |                       | Leased     |                             |       | December 2015                   |       |   | $ | 698 |   |   | $ | 319 |   |
| *Former operations center*:                                                |       |                       |       |                             |       |                                 |       |   |   |   |   |   |   |
| 101 Witmer Road  Horsham, PA 19044-2200                                    |       |                       | Leased     |                             |       | December 2008                   |       |   | n/a |   |   | n/a |   |
| *Branch offices*:                                                          |       |                       |       |                             |       |                                 |       |   |   |   |   |   |   |
| Welsh and Norristown  Roads  Maple Glen, PA 19002-8030                     |       |                       | Leased     |                             |       | January 2026                    |       |   | n/a |   |   | 115,336 |   |
| 1555 W. Street Road  Warminster, PA 18974-3103                             |       |                       | Leased     |                             |       | December 2010                   |       |   | n/a |   |   | 36,566 |   |
| 1141 Ivyland Road  Warminster, PA 18974-2048                               |       |                       | Leased     |                             |       | June 2009                       |       |   | n/a |   |   | 24,736 |   |
| 9 Easton Road  Willow Grove, PA 19090-0905                                 |       |                       | Owned      |                             |       | n/a                                  |       |   | 1,749 |   |   | 94,603 |   |
| 701 Twining Road  Dresher, PA 19025-1894                                   |       |                       | Leased     |                             |       | January 2026                    |       |   | n/a |   |   | 59,199 |   |
| 761 Huntingdon Pike  Huntingdon Valley, PA 19006-8399                      |       |                       | Leased     |                             |       | January 2026                    |       |   | n/a |   |   | 52,849 |   |
| 2 N. York Road  Hatboro, PA 19040-3201                                     |       |                       | Leased     |                             |       | May 2007                        |       |   | n/a |   |   | 28,065 |   |
| 1331 Easton Road  Roslyn, PA 19001-2426                                    |       |                       | Leased     |                             |       | December 2008                   |       |   | 17 |   |   | 16,312 |   |
| 11730 Bustleton Avenue  Philadelphia, PA 19116-2516                        |       |                       | Leased     |                             |       | February 2014                   |       |   | 10 |   |   | 39,492 |   |
| 122 N. Main Street  North Wales, PA 19454-3115                             |       |                       | Leased     |                             |       | February 2010                   |       |   | 46 |   |   | 11,410 |   |
| 8200 Castor Avenue  Philadelphia, PA 19152-2719                            |       |                       | Leased     |                             |       | December 2009                   |       |   | 69 |   |   | 21,658 |   |
| 735 Davisville Road  Southampton, PA 18966-3276                            |       |                       | Leased     |                             |       | May 2011                        |       |   | 130 |   |   | 15,479 |   |
| 1452 Buck Road  C-8 Village Shires Center  Holland, PA 18966-2626          |       |                       | Leased     |                             |       | April 2007                      |       |   | 62 |   |   | 9,222 |   |
| 9869 Bustleton Avenue  Belair Shopping Center  Philadelphia, PA 19115-2611 |       |                       | Leased     |                             |       | July 2012                       |       |   | 184 |   |   | 10,067 |   |
|                                                                            |            |                            |            |                                  |            |                                      |            |  |  |  |  |  |  |  |  |

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| 102 Airport Road  Airport Village Shopping Center  Coatesville, PA 19320             |   |   | Owned  |   |   | n/a                |   |   | $      | 224    |   |   | $      | 29,218  |   |
|--------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------------------|--------|--------|--------|--------|--------|--------|--------|---------|--------|
| 119 Pennsylvania Avenue  Avondale, PA 19311                                          |   |   | Owned  |   |   | n/a                |   |   | 576    |   |   | 9,164  |   |
| 82 Quarry Road  Brandywine Square Shopping Center  Downingtown, PA 19335             |   |   | Leased |   |   | August 2011   |   |   | 50     |   |   | 33,454 |   |
| 112 East Lincoln Highway  Coatesville, PA 19320                                      |   |   | Leased |   |   | January 2026  |   |   | n/a    |   |   | 22,379 |   |
| 414 Lancaster Avenue  Devon, PA 19333                                                |   |   | Leased |   |   | January 2026  |   |   | n/a    |   |   | 18,202 |   |
| 100 East Lancaster  Avenue  Downingtown, PA 19335                                    |   |   | Leased |   |   | January 2026  |   |   | 1,197  |   |   | 77,440 |   |
| 300 Simpson Drive  Chester Springs, PA 19425                                         |   |   | Leased |   |   | January 2018  |   |   | 57     |   |   | 9,426  |   |
| 601 North Pottstown Pike  Exton, PA 19341                                            |   |   | Leased |   |   | January 2026  |   |   | n/a    |   |   | 60,437 |   |
| 200 West Lancaster  Avenue  Frazer, PA 19355                                         |   |   | Leased |   |   | January 2026  |   |   | n/a    |   |   | 42,161 |   |
| 838 East Baltimore Pike  Marlborough Square Shopping Center  Kennet Square, PA 19348 |   |   | Owned  |   |   | n/a                |   |   | 544    |   |   | 18,133 |   |
| 3909 Lincoln Highway  Caln Village Shopping Center  Downingtown, PA 19335            |   |   | Leased |   |   | December 2006 |   |   | 27     |   |   | 48,005 |   |
| 16 East Market Street  West Chester, PA 19382                                        |   |   | Leased |   |   | January 2007  |   |   | n/a    |   |   | 18,030 |   |
| 1197 Wilmington Pike  Westtown Village Shopping Center  West Chester, PA 19382       |   |   | Leased |   |   | November 2009 |   |   | 82     |   |   | 63,876 |   |
| *PCIS office*:                                                                       |   |   |   |   |   |               |   |   |   |   |   |   |   |
| One Liberty Place,  Suite 3050  Philadelphia, PA 19103                          |   |   | Leased |   |   | May 2009      |   |   | n/a    |   |   | n/a    |   |
| Total                                                                                |   |   |   |   |   |               |   |   | $      | 5,722  |   |   | $      | 985,238 |   |

 

The Company has executedtwo leases for additional branch locations in Feasterville and Oxford, PA,which are anticipated to open in the third and fourth quarters of fiscal 2007,respectively.

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**Item 3.**                        LegalProceedings

*IrvineConstruction Co. v. Sklaroff, et al.,*(Court of CommonPleas of Montgomery County, Pennsylvania). On September 5, 2003, acomplaint was filed against Willow Financial Bank and eight additionaldefendants by Irvine Construction Co., Inc., alleging thirteen causes ofaction related to an agreement for the construction of an office building.Eleven of such causes include the Bank as a defendant and are: breach ofcontract (two counts), unjust enrichment/equitable restitution (in thealternative), fraud, civil conspiracy (two counts), fraudulent transfer andaiding and abetting fraudulent transfers, constructive trust, abuse of process,and tortuous interference with existing contractual relations (two counts).Four counts against the Bank seek damages in excess of $1.0 million, fivecounts seek damages in excess of $50 thousand, punitive damages and otherrelief, and two counts seek constructive relief. On May 12, 2004, theCourt struck the claim for unjust enrichment and all claims for attorney’sfees. The remaining claims continue to be litigated and discovery is ongoing.Plaintiff and all defendants have propounded and responded to interrogatoriesand document requests. Plaintiff has produced in excess of 11,000 document pages tothe Bank, and the Bank is pursuing additional discovery in the form of morecomplete interrogatory responses and requests to admit. The Bank anticipatesfiling additional motions to compel and partially dispositive motions.Presently, plaintiff and five of the defendants are engaged in motions practiceregarding the lis pendens plaintiff filed on the property at issue, althoughthe Bank is not involved in these proceedings. No depositions are presentlyscheduled. The Bank is vigorously defending the claims and believes that theyare without merit.

As previously described in the company’sprospectus/joint proxy statement dated April 27, 2005 and included in itsregistration statement on Form S-4 (file No. 333-123622)filed in connection with the Merger, FFB previously received a subpoena fromthe Regional Municipal Securities Counsel in the Philadelphia Office of theSecurities and Exchange Commission (the “SEC”). The subpoena arose out of anon-public SEC investigation titled “Hummelstown General Authority,” whichAuthority issued non-rated revenue bonds now in default, underwritten by thefirm of a former director of Chester Valley and FFB. The SEC subpoena requestedthe production of certain documents concerning FFB’s involvement with non-ratedmunicipal securities, including those issued to finance the Whitetail GolfCourse by the Dauphin County General Authority and the Hummelstown GeneralAuthority, through the former director’s firm, and related matters. FFBpreviously produced documents to the SEC and certain officers of FFB providedtestimony to the SEC in response to the SEC’s voluntary request for assistancein this matter. On August 3, 2006, the SEC filed a complaint in federalcourt against the former director, his wife, and the former director’s firm.The Bank is not named as a defendant in the complaint filed by the SEC.

FFB is a party to three civil actions relating to someof the revenue bonds which are the subject of the SEC investigation describedabove. On August 30, 2005, a writ of summons was filed by the BoyertownArea School District in the Court of Common Pleas, Montgomery County, Pennsylvaniacommencing a civil action against, *inter alia,* FFB.*Boyertown Area School District v. First FinancialBank et. al.*, No. 05-21799. A complaint was filed on November 9,2005, asserting the following claims against FFB: Breach of Trust Indenture andFiduciary Duties (Count 1), Breach of Fiduciary Duties (Count 2), CivilConspiracy (Count 3), and Concerted Action (Count 4). Preliminary Objectionshave been filed and are pending. On September 13, 2005, Red Lion AreaSchool District filed a complaint in the Court of Common Pleas, York County,Pennsylvania, against, *inre alia*, FFB.*Red Lion Area School District v. Bradbury et. al.*,No. 2005-SU-1656-Y01; No. 2005-SU-2544-Y01.This case has been transferred to the Court of Common Pleas of MontgomeryCounty, Pennsylvania. The complaint asserts the following claims against FFB:Civil Conspiracy (Count 14), and Breach of Duty as Trustee (Count 15). PreliminaryObjections have been filed and are pending. On March 16, 2006, PerkiomenValley School District filed a complaint in the Court of Common Pleas,Montgomery County, Pennsylvania, against, *inte alia*, FFB *Perkiomen Valley School District v. First Financial Bank et.al.*,No. 06-06533. The complaint asserts the following claims againstFFB: Breach of Trust Indenture (Count 1), Breach of Fiduciary Duties (Count 2),

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Vicarious Liability andRespondeat Superior (Count 3), Civil Conspiracy (Count 4), and Concert ofAction (Count 5).

The actions have been consolidated for discovery andcase management purposes, but not for trial. Preliminary Objections have beenfiled and are pending in each of these actions. No discovery has taken place. Oneof the plaintiffs has filed a motion to stay the proceedings pending theoutcome of the SEC action described above.

Other than the abovereferenced litigation, the Company is involved in various legal proceedingsoccurring in the ordinary course of business. Management of the Company, basedon discussions with litigation counsel, believes that such proceedings will nothave a material adverse effect on the financial condition or operations of theCompany. There can be no assurance that any of the outstanding legalproceedings to which the Company is a party will not be decided adversely tothe Company’s interests and have a material adverse effect on the financialcondition and operations of the Company.

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

**Not applicable**

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**PART II**

**Item 5.**                        Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of EquitySecurities

(a)  Our common stock is traded on the NASDAQGlobal Select Market (NASDAQ) under the symbol WFBC. Local newspaper listingsinclude WillowG and WillGrvBcp. At September 8, 2006 there wereapproximately 2,586 registered shareholders of record, not including the numberof persons or entities whose stock is held in nominee or “street” name throughvarious brokerage firms and banks. The following table shows the quarterly highand low trading prices of our stock and the amount of cash dividends declaredper share for our past two fiscal years.

| ** **               | ** ** | **Stock Price** | ** ** | **Cash dividends** | ** ** |
|--------------------------|------------|----------------------|------------|-------------------------|------------|
| ** **               | ** ** | **High**             | ** ** | **Low**                 | ** ** | **per share** | ** ** |
| Quarter ended:           |       |                 |       |                    |       |   |   |   |   |
| June 30, 2006       |       | $                    | 18.23      |                    | $          | 15.91 |   |   | $ | 0.120 |   |   |
| March 31, 2006      |       | 17.80                |       | 15.22                   |       |   | 0.120 |   |   |
| December 31, 2005   |       | 15.98                |       | 14.70                   |       |   | 0.120 |   |   |
| September 30, 2005  |       | 15.96                |       | 14.79                   |       |   | 0.120 |   |   |
| June 30, 2005       |       | $                    | 16.54      |                    | $          | 14.16 |   |   | $ | 0.120 |   |   |
| March 31, 2005      |       | 19.50                |       | 16.01                   |       |   | 0.120 |   |   |
| December 31, 2004   |       | 19.55                |       | 16.27                   |       |   | 0.110 |   |   |
| September 30,  2004 |       | 17.35                |       | 15.14                   |       |   | 0.110 |   |   |

 

The information for all equity based and individualcompensation arrangements is incorporated by reference from Item 12 hereof.

(b) Notapplicable

(c)  Not applicable.

**Item 6.**                        SelectedFinancial Data

| ** **                       | ** ** | **At June 30,**            | ** ** |
|----------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| Total assets                     |       | $                                    | 1,576,735  |   | $ | 959,255 |   | $ | 921,592 |   | $ | 845,124 |   | $ | 759,806 |   |
| Cash and cash  equivalents       |       | 37,219                               |       | 20,609 |   | 39,445 |   | 98,040 |   | 31,986 |   |
| Securities held  to maturity     |       | 105,561                              |       | 164,451 |   | 98,513 |   | 17,320 |   | 13,973 |   |
| Securities  available for sale   |       | 196,925                              |       | 148,517 |   | 234,207 |   | 291,885 |   | 254,687 |   |
| Loans held for  sale             |       | 2,635                                |       | 1,795 |   | 1,136 |   | 5,293 |   | 1,574 |   |
| Loans receivable,  net           |       | 1,063,882                            |       | 584,187 |   | 524,189 |   | 413,799 |   | 443,855 |   |
| Deposits                         |       | 985,238                              |       | 602,678 |   | 603,115 |   | 586,643 |   | 529,752 |   |
| Borrowings                       |       | 372,018                              |       | 237,400 |   | 206,168 |   | 132,557 |   | 97,824 |   |
| Total stockholders’  equity |       | 203,073                              |       | 107,043 |   | 103,776 |   | 117,130 |   | 124,369 |   |
|                                  |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

41

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| ** **                                           | ** ** | **For the year ended June 30,**                        | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                                                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                           | ** ** | **(Dollars in thousands, except per share data)** | ** ** |
| Interest income                                      |       | $                                                                               | 81,530     |   | $ | 49,679 |   | $ | 40,628 |   | $ | 46,445 |   | $ | 44,818 |   |
| Interest expense                                     |       | 32,238                                                                          |       | 18,749 |   | 15,074 |   | 18,746 |   | 21,463 |   |
| Net interest  income                                 |       | 49,292                                                                          |       | 30,930 |   | 25,554 |   | 27,699 |   | 23,355 |   |
| Provision for  loan losses                           |       | 3,205                                                                           |       | 1,232 |   | 426 |   | 1,034 |   | 1,212 |   |
| Net interest  income after provision for loan losses |       | 46,087                                                                          |       | 29,698 |   | 25,128 |   | 26,665 |   | 22,143 |   |
| Non-interest  income                                 |       | 7,647                                                                           |       | 3,477 |   | 3,983 |   | 3,492 |   | 2,461 |   |
| Non-interest  expense                                |       | 37,402                                                                          |       | 23,397 |   | 20,390 |   | 19,058 |   | 16,319 |   |
| Income before  income taxes                          |       | 16,332                                                                          |       | 9,778 |   | 8,721 |   | 11,099 |   | 8,285 |   |
| Income tax  expense                                  |       | 5,256                                                                           |       | 3,052 |   | 2,610 |   | 3,610 |   | 2,734 |   |
| Net income                                           |       | 11,076                                                                          |       | 6,726 |   | 6,111 |   | 7,489 |   | 5,551 |   |
| Earnings per  share—diluted(1)                  |       | $                                                                               | 0.81       |   | $ | 0.71 |   | $ | 0.62 |   | $ | 0.71 |   | $ | 0.52 |   |
| Earnings per  share—basic(1)                    |       | 0.83                                                                            |       | 0.74 |   | 0.66 |   | 0.75 |   | 0.53 |   |
| Cash dividends  declared per share(1)                |       | 0.48                                                                            |       | 0.46 |   | 0.38 |   | 0.30 |   | 0.24 |   |
| Dividend payout  ratio(2)                            |       | 60.65                                                                           | %          | 62.38 | % | 59.65 | % | 45.02 | % | 45.22 | % |

 

| ** **                                                               | ** ** | **At or for the year ended June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Return on average  assets                                                |       | 0.74                                                                     | %          | 0.70 | % | 0.73 | % | 0.93 | % | 0.82 | % |
| Return on average  equity                                                |       | 5.96                                                                     |       | 6.33 |   | 5.56 |   | 6.10 |   | 7.53 |   |
| Average interest-earning  assets to average interest-bearing liabilities |       | 104.0                                                                    |       | 121.3 |   | 124.2 |   | 127.1 |   | 121.8 |   |
| Interest rate  spread(3)                                                 |       | 3.62                                                                     |       | 3.09 |   | 2.94 |   | 2.91 |   | 2.89 |   |
| Interest rate  margin(4)                                                 |       | 3.72                                                                     |       | 3.30 |   | 3.17 |   | 3.55 |   | 3.61 |   |
| Non-performing  assets to total assets(5)                                |       | 1.00                                                                     |       | 0.33 |   | 0.40 |   | 0.48 |   | 0.76 |   |
| Allowance for  loan losses to:                                           |       |                                                                     |       |   |   |   |   |   |   |   |   |
| Non-performing loans                                                     |       | 106.4                                                                    |       | 227.5 |   | 188.0 |   | 143.9 |   | 81.60 |   |
| Total loans less deferred fees                                           |       | 1.55                                                                     |       | 1.05 |   | 0.99 |   | 1.27 |   | 1.03 |   |
| Average  stockholders’ equity to average assets                     |       | 12.47                                                                    |       | 10.88 |   | 13.10 |   | 15.19 |   | 10.89 |   |
| Tangible  stockholders’ equity to end of period assets              |       | 6.09                                                                     |       | 11.07 |   | 11.43 |   | 13.52 |   | 16.23 |   |
| Total regulatory capital  to risk-weighted assets(6)                     |       | 13.18                                                                    |       | 17.70 |   | 17.72 |   | 19.61 |   | 20.40 |   |

----

       (1) Data prior to April 3, 2002 has been adjusted for the 2.28019exchange ratio in connection with the April 3, 2002 Reorganization andsubscription offering.

       (2) Fiscal year 2002 includes dividends waived by the Mutual HoldingCompany of $1.1 million.

       (3) The weighted average yield on interest-earning assets less theweighted average cost of interest-bearing liabilities.

       (4) This represents net interest income as a percentage of averageinterest-earning assets.

       (5) Non-performing assets equal non-accrual loans, troubled debtrestructurings plus accruing loans 90 or more days past due and real estateowned.

       (6) This ratio relates to the Bank only.

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

The following discussionis intended to assist in understanding our financial condition, and the resultsof operations for Willow Financial Bancorp, Inc., and its subsidiaryWillow Financial Bank, for thefiscal years ended June 30, 2006, 2005 and 2004. The information in thissection should be read in conjunction with the Company’s financial statementsand the accompanying notes included elsewhere herein.

**General**

Net income is largelydriven by net interest income, which is the difference between the incomeearned on interest-earning assets and the interest paid on interest-bearingliabilities and the relative amount of our interest-earning assets tointerest-earning liabilities. Non-interest income and expenses, theprovision for loan losses and income tax expense also affect the Company’sresults of operations.

**Critical AccountingPolicies**

The following discussion and analysis of the Company’sfinancial condition and results of operations is based upon consolidatedfinancial statements, which have been prepared in accordance with U.S.generally accepted accounting principles. The preparation of these financialstatements requires management to make estimates and judgments that affect thereported amounts of assets and liabilities, revenues and expenses and relateddisclosures of contingent assets and liabilities at the date of the financialstatements. Actual results may differ from these estimates under differentassumptions or conditions.

In management’sopinion, the most critical accounting policies affecting the consolidatedfinancial statements are:

1.                *Evaluation of the allowance for loan losses.  *Thedetermination of the allowance for loan losses involves significant judgmentsand assumptions by management which may have a material impact on the carryingvalue of net loans and, potentially, on the amount of net income we recognizefrom period to period. For a description of the methods the Company uses todetermine the adequacy of the allowance for loan losses, see “Results ofOperations—Provision for Loan Losses.”

2.                *Realization of deferred income tax items*.   Includedin other assets is a “net deferred tax asset”, which is an estimate of netdeferred tax assets and deferred tax liabilities. These estimates involvesignificant judgments and assumptions by management, which may have a materialeffect on the carrying value of this asset for financial reporting purposes.For a more detailed description of these items and estimates, see Note 13(Income Taxes) to the audited consolidated financial statements at and for thefiscal year ended June 30, 2006.

*3.**                Goodwill and core deposit intangibles.  *Goodwillrepresents the excess cost over fair value of assets acquired over liabilitiesas a result of the Merger and earlier branch acquisitions. Core depositintangibles are a measure of the value of the checking, savings and moneymarket deposits acquired in the Merger accounted for under the purchase method.The core deposit intangible is being amortized to expense over a twelve-yearlife using a method that approximates a level yield method. The Company followsthe provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,”and performs impairment tests of the intangible assets at least annually andimpairment losses are recognized if the carrying value of the intangibleexceeds its fair value. The Company has not recorded any impairment losses as aresult of this analysis during fiscal years 2006, 2005 and 2004.

The Notes to ConsolidatedFinancial Statements identify other significant accounting policies used in thedevelopment and presentation of the financial statements. This discussion and analysis,the significant accounting policies and other financial statement disclosuresidentify and address key variables and other 

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qualitativeand quantitative factors that are necessary for an understanding and evaluationof the Company and its results of operations.

**Changes inFinancial Condition**

***General.******  ***Total assetsincreased by $617.5 million, or 64.4%, to $1.6 billion at June 30,2006 compared to $959.3 million at June 30, 2005. The net loanportfolio increased $479.7 million or 82.1% while total deposits increasedby $382.6 million or 63.5%. Each of the aforementioned increases resultedprimarily from the Merger of Chester Valley, which was effective after theclose of business on August 31, 2005.

***Cash and CashEquivalents.******  ***Cash and cash equivalents, whichconsist of cash on hand and in other banks in interest-earning andnon-interest earning accounts, amounted to $37.2 million and$20.6 million at June 30, 2006 and 2005, respectively. The increasein cash and cash equivalents of $16.6 million or 80.6% was the result ofthe increased branch network as a result of the Merger as well as increasedliquidity needs of the combined companies.

***SecuritiesAvailable for Sale.******  ***At June 30, 2006, investmentsecurities that were classified as available for sale (“AFS”) totaled$196.9 million, compared to $148.5 million in AFS securities at June 30,2005. The increase in available for sale securities was primarily the result ofthe Merger, Chester Valley had approximately $118.0 million in AFS securitieson the effective date of the Merger. Subsequent to the effective date of theMerger, the portfolio declined by approximately $166.4 million through acombination of sales resulting from a de-leveraging strategy as well asprincipal repayments. The proceeds were utilized to repay higher costingFederal Home Loan Bank (“FHLB”) borrowings. The unrealized loss, net of incometaxes, on AFS securities amounted to approximately $4.1 million at June 30,2006 compared to $1.4 million at June 30, 2005. The increase was theresult of the significant rise in short-term interest rates during the year.

***Securities Held toMaturity.******  ***At June 30, 2006, investmentsecurities classified as held to maturity totaled $105.6 million, comparedto $164.5 million in held to maturity securities at June 30, 2005.Held to maturity securities were comprised primarily of CMOs and mortgage-backedsecurities. The decrease in held to maturity securities was the result of theCompany’s de-leveraging strategy implemented as a result of the Merger. In theaggregate, approximately $34.9 million in HTM securities was liquidated as partof the strategy in accordance with the provisions of SFAS No. 115, whichallows for a sale of held-to-maturity (“HTM”) securities coincident with amerger to allow the Company to maintain its interest rate sensitivityimmediately prior to the merger. The balance of the decline or approximately$24.0 million was the result of principal repayments within the portfolio. Theproceeds were utilized to repay higher costing FHLB borrowings during fiscal2006. Held to maturity investment securities are carried at amortized cost. Inorder to more effectively manage its interest rate risk, the Company planslimited additions to its HTM portfolio.

***Loans.******  ***The net loanportfolio, exclusive of loans held for sale, increased to approximately $1.1billion at June 30, 2006 from $584.2 million at June 30,2005. The $479.7 million, or 82.1%, increase resulted primarily from theMerger. On the effective date of the Merger, Chester Valley’s loan portfolioapproximated $460.0 million. During fiscal 2006, the aggregate combinedportfolio grew by $19.7 million as growth in commercial business and consumerloans were partially offset by paydowns within the Commercial real estate andconstruction loan portfolios. With the inverted yield curve (long term ratesare lower than short rates), a number of loans within the commercial realestate portfolio were refinanced through other lenders who offered extendedterms without recourse. Additionally, the construction loan portfolio includedlarger residential projects, which sold at a more rapid pace than anticipatedand the demand for new construction was not as robust.

Due principally to the Merger, the loan portfolio mixhas become less reliant on single-family mortgages as these loans as apercentage of the total loan portfolio have been reduced from 34.3% to 

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27.6%. Conversely, thecommercial and home equity loan portfolios as a percentage of total loans haveincreased to 7.5% and 24.0%, respectively, compared to 4.0% and 17.1%,respectively, at June 30, 2005. These latter loan types typically haveshorter terms or are variable rate. The Company plans to focus its growth inthe commercial lending with a focus on small businesses, commercial real estatelending as well as consumer lending.

The allowance for loan losses increased to$16.7 million at June 30, 2006 compared to $6.1 million at June 30,2005, due largely to the acquisition of the Chester Valley allowance of $6.9million. The current fiscal year provision for loan losses was increased fromthat which was expensed in fiscal 2005 by approximately $2.0 million. Theincrease in fiscal 2006 was due largely to an increase in non-performing loansof $12.7 million. During the current fiscal year, the Company received netrecoveries of $482 thousand due largely to an approximate $434 thousandrecovery on a previously charged-off commercial business loan.

***Loans Held for Sale.******  ***Mortgage loansoriginated or purchased with the intention of being sold into the secondarymarket are classified as held for sale and are carried at the lower ofaggregate cost or market value with any unrealized loss reflected in theconsolidated statements of income. At June 30, 2006, $2.6 million offixed-rate, single-family residential mortgages were classified as heldfor sale compared to $1.8 million in loans classified as held for sale at June 30,2005. The increase of $840 thousand resulted primarily from the timing ofthe origination of the loans and the ultimate delivery to the purchaser of theloans. In order to mitigate the risk of loss on the sale of these loans, theCompany generally commits these loans for sale, on a best efforts basis, to a thirdparty at the time that the borrower locks the loan with the Company.

***Intangible Assets.******  ***At June 30,2006, intangible assets aggregated $107.0 million as compared to$881 thousand at June 30, 2005. Intangible assets include a coredeposit intangible of $13.0 million, which resulted from the acquisition ofChester Valley. The core deposit intangible is being amortized using anaccelerated method over a 12-year life. Intangible assets also includegoodwill, which primarily represents the excess cost over fair value of assetsacquired over liabilities as a result of the Chester Valley acquisition. Thegoodwill that resulted from the Chester Valley acquisition is approximately $93.2million while the balance of the goodwill, which related to a branch acquisitionin 1994 approximated $848 thousand at June 30, 2006. Goodwill isperiodically measured for impairment. The Company has not recorded anyimpairment losses as a result of this analysis.

***Deposits.******  ***During theyear ended June 30, 2006, total deposits increased by $382.6 million or63.5%. The increase occurred primarily from the Merger, which had totaldeposits of $437.1 million on the acquisition date. Core deposits, which wedefine as savings, checking, NOW and money market accounts, increased by $321.9 millionalso as a result of the Merger. Chester Valley had total core deposits of$331.3 million on the acquisition date. The acquisition has resulted in theinterest sensitive certificate of deposit balances being reduced from 40.0% oftotal deposits at June 30, 2005 to 30.6% at June 30, 2006. Checkingaccounts increased to $277.2 million or 28.1% of total deposits at June 30,2006 compared to $143.7 million, or 23.8% of total deposits at June 30,2005.

The Company will continue to deploy a strategy toincrease core deposit accounts and balances through targeted marketing,cross-selling of our existing customer base and expansion of our commercialbusiness lending, which typically results in the opening of a checking account.During fiscal 2006, the Company experienced an outflow of deposits as themarket has become increasingly competitive, reflected in, among other things,the opening of thirteen de-novo banks in our markets. The decline was largelyin certificates of deposits as the Company redeemed $40 million in certificatesunder the FHLB’s Pennsylvania Local Government Investment Trust program andallowed certain retail certificates to mature without aggressively trying torenew such accounts if that was the sole relationship with the Company.

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***Federal Home LoanBank Advances.******  ***Advances from the FHLB provide theCompany with an additional source of funds to fund interest earning assetgrowth and are a tool in meeting the Company’s asset/liability strategies. At June 30,2006, the total amount of these borrowings was $282.7 million, an increaseof $45.3 million or a 19.1% increase from the $237.4 millionoutstanding at June 30, 2005. However, immediately following the Merger,FHLB advances reached a high of $364.6 million and, subsequently, approximately$81.9 million in advances were repaid during fiscal 2006, primarily through thepreviously described de-leveraging strategy.

***Trust PreferredSecurities.***   Effective with the acquisitionof Chester Valley, the Company assumed the liability for $10.5 million ofJunior Subordinated Debentures to the Chester Valley Statutory Trust, aPennsylvania Business Trust, in which the Company owns all of the common equityas a result of the acquisition of Chester Valley. The Trust issued $10.0million of Trust Preferred Securities to investors, which are secured by theJunior Subordinated Debentures and the guarantee of the Company. The JuniorSubordinated Debentures are treated as debt of the Company but they qualify asTier I capital, subject to certain limitations under the risk-based capitalguidelines of the Office of ThriftSupervision (“OTS”). The Trust Preferred Securities are callable by theCompany on or after March 26, 2007, or at any time in the event thededuction of related interest expense for federal income taxes is prohibited,the treatment as Tier I capital is no longer permitted or under certain othercircumstances. The Trust Preferred Securities must be redeemed by the Companyupon their maturity in the year 2032.

On March 31, 2006, the Company issued $25.8million of Junior Subordinated Debentures to Willow Grove Statutory Trust I, aConnecticut Statutory Trust, in which the Company owns all of the common equity.The Trust then issued $25.0 million of Trust Preferred Securities, which payinterest quarterly at three-month Libor plus 1.31% to investors, which aresecured by the Junior Subordinated Debentures and the guarantee of the Company.The Junior Subordinated Debentures are treated as debt of the Company butqualify as Tier I capital of the Bank to the extent of the amount of theproceeds, which are invested in the Bank. The Trust Preferred Securities arecallable at par by the Company on or after June 15, 2011. The TrustPreferred Securities must be redeemed by the Company upon their maturity in theyear 2036.

***Accounting forDerivative Instruments and Hedging.***   TheCompany may from time to time utilize derivative instruments such as interestrate swaps, interest rate collars, interest rate floors, interest rateswaptions or combinations thereof to assist in its asset/liability management. Inaccordance with SFAS No. 133, Accounting for Derivative Instruments, theCompany formally documents its hedge relationships, including identification ofthe hedging instruments and the hedged items, as well as its risk managementobjectives and strategies for undertaking the hedge. The Company also formallyassesses, both at inception and at least quarterly thereafter, whether thederivative instruments that are used in hedging transactions are highlyeffective in offsetting the changes in either the fair value or cash flows ofthe hedged item. For fair value hedges, both the effective and ineffectiveportions of the changes in the fair value of the derivative, along with thegain or loss on the hedged item that is attributable to the hedged risk, arerecorded in the statement of operations within interest income or interestexpense. For cash flow hedges, the effective portion of the change in the fairvalue of the derivative is recorded in accumulated other comprehensive income.When the hedged item impacts the statement of operations, the gain or lossincluded in accumulated other comprehensive income is reported on the same linein the statement of operations as the hedged item. In addition, the ineffectiveportion of the changes in the fair value of derivatives used as cash flowhedges is reported in the statement of operations.

As part of the Merger, the Company assumed theresponsibility for a $20 million notional interest rate swap whereby theCompany pays a variable rate and receives a fixed rate. The interest rate swaphad been used to hedge certain Federal Home Loan Bank borrowings of the former Chester Valley. On the date of the Merger,the interest rate swap and the hedged borrowings were marked to fair value inpurchase accounting. In September 2005, the hedged borrowings were repaidand $10 million notional amount of the interest rate swap was unwound with thecounter-party. After performing the appropriate 

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documentation of thederivative instrument, the Company designated the remaining $10 millionnotional amount interest rate swap as a fair value hedge of certain existingborrowings of Willow Financial Bank. The swap had the effect of converting afixed rate borrowing to an adjustable rate borrowing. During the quarter ended December 31,2005, the derivative instrument ceased to be a highly effective hedge and,therefore, the Company discontinued hedge accounting resulting in a pre-taxcharge to the statement of operations of $47 thousand. The interest rate swapwas unwound in February 2006 without resulting in any additional impact tothe statement of operations. The basis adjustment that was previously recordedon the hedged borrowing that is recorded in the statement of financialcondition is amortized as a reduction in interest expense over the remaininglife of the borrowing using the interest method.

Additionally, in August 2003, Chester Valley had purchased a $30.0million notional amount 3.50% Three Month LIBOR interest rate cap whilesimultaneously selling a $30.0 million notional amount 6.00% Three Month LIBORinterest rate cap (“Interest Rate Corridor”) that expires in August 2008. Chester Valley paid a net premium, whichentitles it to receive the difference between Three Month LIBOR from 3.50% upto 6.00% times, the $30.0 million notional amount. The Company performed theappropriate analysis and documentation on the acquisition date and designatedthe interest rate corridor to hedge certain borrowings of Willow FinancialBank, which were variable in nature and indexed to the Three Month LIBOR. TheInterest Rate Corridor is being used to hedge the cash flows of this borrowing.The Interest Rate Corridor could potentially reduce the negative impact onearnings of the borrowings in a rising interest rate environment. The fairmarket value of the Interest Rate Corridor has two components: the intrinsicvalue and the time value of the option. The Interest Rate Corridor ismarked-to-market quarterly, with changes in the intrinsic value of the InterestRate Corridor, net of tax, included as a separate component of othercomprehensive income and change in the time value of the option included directlyas interest expense as required under SFAS 133. In addition, the ineffectiveportion, if any, would have been expensed in the period in whichineffectiveness was determined. The Interest Rate Corridor was effectivethroughout fiscal 2006. The fair value of the Interest Rate Corridor at June 30,2006 was $1.2 million.

***Stockholders’ Equity.******  ***At June 30,2006, total stockholders’ equity amounted to $203.1 million or 12.9% oftotal assets compared to $107.0 million or 11.2% of assets at June 30,2005. The increase of $96.0 million, or 89.7% was primarily due to theshares issued for the Merger with an aggregate value of $91.0 million, netincome of $11.1 million, which was partially offset by the payment ofaggregate cash dividends of $6.7 million and a decrease of $2.3 million incomprehensive income as a result of an increase in the unrealized loss inmarket value of AFS securities. Additional paid-in capital increased $92.8million due to the aforementioned share issuance, director and employee stockoption exercises of $1.3 million, and $198 thousand in tax benefits on stockoption exercises.

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**Average Balances,Net Interest Income, Yields Earned and Rates Paid**

The following tablepresents the average daily balances for various categories of assets andliabilities, and income and expense related to those assets and liabilities forthe years ended June 30, 2006, 2005 and 2004. The table also shows theaverage yields and costs on interest-earning assets and interest-bearingliabilities for each of those years. Loans receivable include non-accrualloans. To adjust nontaxable loans and securities to a taxable equivalent, a35.0%, 31.2% and 29.9% effective rate has been used for the fiscal years endingJune 30, 2006, 2005, and 2004, respectively. The adjustment of tax-exemptloans and securities to a tax equivalent yield in the table below may beconsidered to include non-GAAP financial information. Management believes thatit is a standard practice in the banking industry to present net interestmargin, net interest rate spread and net interest income on a fully taxequivalent basis. Therefore, management believes, these measures provide usefulinformation to investors by allowing them to make peer comparisons. A GAAPreconciliation also is included below.

| ** **                                                                             | ** ** | **At June 30,**            | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                             | ** ** | **Average  Balance**                 | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** |
| ** **                                                                             | ** ** | **(Dollars in thousands)** | ** ** |
| Interest-earning assets:                                                               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans receivable—taxable                                                          |       | $984,603                             |       |   | $64,946 |   |   |   | 6.60 | % |   | $567,677 |   |   | $34,536 |   |   |   | 6.08 | % |   | $458,032 |   |   | $29,123 |   |   |   | 6.36 | % |   |
| Loans receivable—tax free                                                         |       | 11,910                               |       |   | 808 |   |   |   | 6.78 |   |   | — |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   |   | — |   |   |
| Securities—taxable                                                                |       | 316,811                              |       |   | 14,983 |   |   |   | 4.73 |   |   | 341,346 |   |   | 13,878 |   |   |   | 4.07 |   |   | 290,705 |   |   | 10,307 |   |   |   | 3.55 |   |   |
| Securities—tax free                                                               |       | 11,477                               |       |   | 1,041 |   |   |   | 9.07 |   |   | 19,783 |   |   | 1,286 |   |   |   | 6.50 |   |   | 18,024 |   |   | 1,143 |   |   |   | 6.34 |   |   |
| Interest-bearing deposits                                                              |       | 14,122                               |       |   | 304 |   |   |   | 2.15 |   |   | 19,502 |   |   | 363 |   |   |   | 1.86 |   |   | 48,430 |   |   | 372 |   |   |   | 0.77 |   |   |
| Total interest-earning  assets                                                         |       | 1,338,923                            |       |   | 82,083 |   |   |   | 6.13 |   |   | 948,308 |   |   | 50,063 |   |   |   | 5.28 |   |   | 815,191 |   |   | 40,945 |   |   |   | 5.02 |   |   |
| Non-interest-earning  assets                                                           |       | 151,835                              |       |   |   |   |   |   |   |   |   | 21,500 |   |   |   |   |   |   |   |   |   | 23,968 |   |   |   |   |   |   |   |   |   |
| Total assets                                                                           |       | $1,490,757                           |       |   |   |   |   |   |   |   |   | $969,808 |   |   |   |   |   |   |   |   |   | $839,159 |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                                               |       | $926,092                             |       |   | 17,648 |   |   |   | 1.91 |   |   | $607,724 |   |   | $9,933 |   |   |   | 1.63 |   |   | $577,111 |   |   | $9,283 |   |   |   | 1.61 |   |   |
| FHLB borrowings                                                                        |       | 314,920                              |       |   | 12,659 |   |   |   | 4.02 |   |   | 250,299 |   |   | 8,816 |   |   |   | 3.52 |   |   | 147,842 |   |   | 5,791 |   |   |   | 3.92 |   |   |
| Repurchase agreements                                                                  |       | 26,156                               |       |   | 1,056 |   |   |   | 4.04 |   |   | — |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   |   | — |   |   |
| Trust preferred  securities                                                            |       | 15,589                               |       |   | 875 |   |   |   | 5.61 |   |   | — |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   |   | — |   |   |
| Total interest-bearing  liabilities                                                    |       | 1,282,757                            |       |   | 32,238 |   |   |   | 2.51 |   |   | 858,023 |   |   | 18,749 |   |   |   | 2.19 |   |   | 724,953 |   |   | 15,074 |   |   |   | 2.08 |   |   |
| Non-interest-bearing  liabilities:                                                     |       | 22,056                               |       |   |   |   |   |   |   |   |   | 5,936 |   |   |   |   |   |   |   |   |   | 4,282 |   |   |   |   |   |   |   |   |   |
| Total  stockholders’ equity                                                       |       | 185,944                              |       |   |   |   |   |   |   |   |   | 105,849 |   |   |   |   |   |   |   |   |   | 109,924 |   |   |   |   |   |   |   |   |   |
| Total liabilities  and equity                                                          |       | $1,490,757                           |       |   |   |   |   |   |   |   |   | $969,808 |   |   |   |   |   |   |   |   |   | $839,159 |   |   |   |   |   |   |   |   |   |
| Net interest-earning  assets                                                           |       | $  56,166                  |       |   |   |   |   |   |   |   |   | $166,305 |   |   |   |   |   |   |   |   |   | $159,021 |   |   |   |   |   |   |   |   |   |
| Net interest  income                                                                   |       |                                 |       |   | $49,845 |   |   |   |   |   |   |   |   |   | $31,314 |   |   |   |   |   |   |   |   |   | $25,871 |   |   |   |   |   |   |
| Net interest rate  spread                                                              |       |                                 |       |   |   |   |   |   | 3.62 | % |   |   |   |   |   |   |   |   | 3.09 | % |   |   |   |   |   |   |   |   | 2.94 | % |   |
| Net interest  margin                                                                   |       |                                 |       |   |   |   |   |   | 3.72 | % |   |   |   |   |   |   |   |   | 3.30 | % |   |   |   |   |   |   |   |   | 3.17 | % |   |
| Ratio of average  interest-earning assets to average interest-bearing liabilities |       |                                 |       |   |   |   |   |   | 104 | % |   |   |   |   |   |   |   |   | 111 | % |   |   |   |   |   |   |   |   | 112 | % |   |

 

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Although managementbelieves that the above non-GAAP financial measures enhance investors’understanding of the Company’s business and performance, these non-GAAPfinancial measures should not be considered an alternative to GAAP. Thereconciliation of these non-GAAP financial measures to GAAP is presented below.

| ** **  | ** ** | **Year Ended June 30,** | ** ** |
|-------------|------------|----------------------------------------|------------|
| ** **  | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **  | ** ** | **Interest  Income**                   | ** ** | **Tax  Adjustment** | ** ** | **Adjusted  Income** | ** ** | **Interest  Income** | ** ** | **Tax  Adjustment** | ** ** | **Adjusted  Income** | ** ** | **Interest  Income** | ** ** | **Tax  Adjustment** | ** ** | **Adjusted  Income** | ** ** |
| ** **  | ** ** | **(Dollars in Thousands)**   | ** ** |
| Loans(a)    |       | $  526                       |       |   | $282 |   |   |   | $  808 |   |   |   | $ — |   |   |   | $ — |   |   |   | $     — |   |   |   | $ — |   |   |   | $ — |   |   |   | $     — |   |   |
| Investments |       | 771                                    |       |   | 270 |   |   |   | 1,041 |   |   |   | 902 |   |   |   | 384 |   |   |   | 1,286 |   |   |   | 764 |   |   |   | 326 |   |   |   | 1,090 |   |   |
| Total       |       | $1,296                                 |       |   | $552 |   |   |   | $1,849 |   |   |   | $902 |   |   |   | $384 |   |   |   | $1,286 |   |   |   | $764 |   |   |   | $326 |   |   |   | $1,090 |   |   |

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        (a) The Company did not have tax-exempt loans infiscal 2005 or fiscal 2004.

**Rate/VolumeAnalysis**

Thefollowing table shows the effect of changing rates and volumes on net interestincome for the years ended June 30, 2006 and 2005, compared to the prior fiscalyear. Information provided shows the effect on net interest income of (1) rates(changes in rate times prior volume), (2) volume (changes in volume timesprior rate) and (3) rate/volume (changes in rate times change in volume).

| ** **                                                   | ** ** | **Increase (decrease) in net interest  income for the year ended June 30,  2006 compared to the year ended  June 30, 2005 due to** | ** ** | **Increase (decrease) in net interest  income for the year ended June 30,  2005 compared to the year ended  June 30, 2004 due to** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **Rate**                                                                                                                                                                                                                          | ** ** | **Volume**                                                                                                                                                                                                                        | ** ** | **Rate/  Volume** | ** ** | **Increase/  (Decrease)** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Rate/  Volume** | ** ** | **Increase/  (Decrease)** | ** ** |
| ** **                                                   | ** ** | **(Dollars in thousands)**                                                                                                                                                                                              | ** ** |
| Interest-earning assets:                                     |       |                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans receivable                                             |       | $2,952                                                                                                                                                                                                                            |       |                                                                                                                                                                                                                              | $25,349    |   |   |   | $2,930 |   |   |   | $31,231 |   |   | $(1,252 | ) |   | $6,980 |   |   |   | $(315 | ) |   |   | $5,413 |   |   |
| Securities                                                   |       | 2,852                                                                                                                                                                                                                             |       |                                                                                                                                                                                                                              | (1,335     | ) |   |   | (368 | ) |   |   | 1,149 |   |   | 1,514 |   |   | 1,943 |   |   |   | 257 |   |   |   | 3,714 |   |   |
| Interest-bearing  deposits                                   |       | 57                                                                                                                                                                                                                                |       |                                                                                                                                                                                                                              | (100       | ) |   |   | (16 | ) |   |   | (59 | ) |   | 529 |   |   | (222 | ) |   |   | (316 | ) |   |   | (9 | ) |   |
| Total net change  in income on interest-earning assets       |       | 5,861                                                                                                                                                                                                                             |       |                                                                                                                                                                                                                              | 23,914     |   |   |   | 2,546 |   |   |   | 32,321 |   |   | 791 |   |   | 8,701 |   |   |   | (374 | ) |   |   | 9,118 |   |   |
| Interest-bearing liabilities:                                |       |                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                     |       | 1,702                                                                                                                                                                                                                             |       |                                                                                                                                                                                                                              | 5,189      |   |   |   | 817 |   |   |   | 7,708 |   |   | 242 |   |   | 206 |   |   |   | 202 |   |   |   | 650 |   |   |
| FHLB Advances                                                |       | 1,251                                                                                                                                                                                                                             |       |                                                                                                                                                                                                                              | 2,275      |   |   |   | 323 |   |   |   | 3,849 |   |   | (591 | ) |   | 4,016 |   |   |   | (400 | ) |   |   | 3,025 |   |   |
| Repurchase  agreements                                       |       | —                                                                                                                                                                                                                            |       |                                                                                                                                                                                                                              | —     |   |   |   | 1,056 |   |   |   | 1,056 |   |   | — |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Trust preferred  Securities                                  |       | —                                                                                                                                                                                                                            |       |                                                                                                                                                                                                                              |       |   |   |   | 875 |   |   |   | 875 |   |   | — |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total net change  in expense on interest-bearing liabilities |       | 2,953                                                                                                                                                                                                                             |       |                                                                                                                                                                                                                              | 7,464      |   |   |   | 3,071 |   |   |   | 13,489 |   |   | (349 | ) |   | 4,222 |   |   |   | (198 | ) |   |   | 3,675 |   |   |
| Change in net  interest income                               |       | $2,908                                                                                                                                                                                                                            |       |                                                                                                                                                                                                                              | $16,450    |   |   |   | $(525 | ) |   |   | $18,832 |   |   | $1,140 |   |   | $4,479 |   |   |   | $(176 | ) |   |   | $5,443 |   |   |

 

**Results ofOperations**

***General.******  ***Net income forthe year ended June 30, 2006 was $11.1 million, an increase of $4.4million or 64.7%. The increase resulted primarily from an increase in netinterest income of $18.4 million and an increase in non-interest income of$4.2 million. Each of these were partially offset by an increase in theprovision for loan losses of $2.0 million, an increase in operating expenses of$14.0 million or 59.9% and an increase in income tax expense of $2.2 million.The improvement was largely driven by the Merger, which was effective after theclose of business on August 31, 2005.

Net income for the year ended June 30, 2005 was$6.7 million, an increase of $615 thousand or 10.1% over fiscal 2004.The increase resulted primarily from an increase in net interest income of$5.4 million, which was partially offset by a reduction in non-interestincome of $506 thousand along with increases in 

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the provision for loanlosses and operating expenses of $806 thousand and $3.0 million(which included a $913 thousand litigation settlement), respectively. Netincome for the year ended June 30, 2004 was $6.1 million compared to$7.5 million for the year ended June 30, 2003.

***Net Interest Income.******  ***Net interestincome increased by $18.4 million or 59.4% to $49.3 million for theyear ended June 30, 2006 as compared to $30.9 million for the yearended June 30, 2005. One factor that influences net interest income is theinterest rate spread (i.e., the difference between the average yields oninterest-earning assets and the average rates paid on interest-bearingliabilities). The average interest rate spread for the years ended June 30,2006, 2005 and 2004 was 3.62%, 3.09% and 2.94%, respectively. The net interestmargin (i.e., net interest income expressed as a percentage of average interest-earningassets) was 3.72%, 3.30% and 3.17% for the same three respective fiscal years.The significant improvement largely resulted from the Merger and the balancesheet de-leveraging strategy deployed by the Company. Chester Valley’s balancesheet was asset sensitive (assets reprice quicker than liabilities) during ayear in which the Federal Reserve aggressively raised short-term rates.Additionally, the Company received the full benefit of the additional earningassets from the acquisition for ten months. The balance sheet de-leveragingallowed the Company to sell lower yielding investment securities while repayinghigher costing borrowings.

Net interest income increased by $5.4 million or21.0% to $30.9 million for the year ended June 30, 2005 as compared to$25.6 million for the year ended June 30, 2004. After years ofdeclines in the Company’s interest rate spread resulting from the historicallylow interest rate environment, the interest spread increased by 15 basis pointsin fiscal 2005 as the yield on interest earning assets increased by 26 basispoints while the cost of interest-bearing liabilities rose by 11 basispoints. In addition to the improvement in the interest rate spread, the Company’saverage earning assets increased by approximately $133.1 million therebypositively impacting net interest income during the year ended June 30,2005.

***Interest Income.******  ***Interestincome includes the interest earned on loans and investment securities, as wellas yield adjustments for the premiums, discounts and deferred fees or costsrecorded in connection with the acquisition of these assets. Total interestincome for the year ended June 30, 2006 was $81.5 million compared to$49.7 million and $40.6 million for fiscal 2005 and 2004,respectively.

The increase in interest income in fiscal 2006compared to fiscal 2005 was $31.9 million or 64.1% due primarily to anincrease in the average balance of outstanding loans of $428.8 million as aresult of the Merger. Additionally, the yield on loans increased approximately 52basis points, as Chester Valley’s loans were re-pricing at a time when theFederal Reserve aggressively increased short-term rates. Also contributing tothe increase was an approximate 68 basis point increase in the average yield inthe investment portfolio as the Company completed a de-leveraging strategy byliquidating approximately $95.9 million of investment securities with anaverage yield of 3.96%. The above factors were partially offset by reducedlevels in the average balance of investment securities.

The increase in interest income in fiscal 2005compared to fiscal 2004 was $9.1 million or 22.3% due primarily to anincrease in the average balance of outstanding loans of $109.6 million aswell as an increase in the average balance of investment securities of$52.4 million. Additionally, during the same period, the tax equivalentyields on interest earning assets increased by 26 basis points to 5.28% from5.02%.

***Interest Expense.******  ***Interestexpense consists of the interest paid to depositors on their interest-bearingdeposit accounts as well as interest paid on borrowings. For the fiscal yearended June 30, 2006, total interest expense was $32.2 millioncompared to $18.7 million and $15.1 million, for the fiscal yearsended June 30, 2005 and 2004, respectively.

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For the fiscal year ended June 30, 2006, interestexpense increased by $13.5 million, or 71.9% compared to the fiscal yearended June 30, 2005. This increase was due primarily to an increase inaverage interest-bearing liabilities resulting from the Merger. Average depositand borrowings balances increased $318.4 million and $106.4 million,respectively, in fiscal 2006 as compared to fiscal 2005. Additionally, theCompany’s cost of funds increased approximately 32 basis points in fiscal 2006compared to fiscal 2005, as the Federal Reserve aggressively raised short-termrates coupled with the competition for deposits in the Bank’s market area,which led the Bank to raise its interest rate paid on money market balances andcertificates of deposits. Additionally, the trust preferred security assumed inthe Merger is a floating rate borrowing, for which the rate increasedthroughout the year.

For the fiscal year ended June 30, 2005, interestexpense increased by $3.7 million, or 24.4% compared to the fiscal yearended June 30, 2004. This increase was due primarily to an approximate$102.5 million increase in average borrowings from the FHLB as well as anapproximate increase in average interest-bearing deposits of approximately$30.6 million. Also contributing to the increase was a 0.11% increase inthe cost of interest-bearing liabilities. Compared to fiscal 2004, theaverage cost of interest-bearing deposits in fiscal 2005 increased to1.63% from 1.61%. The increased cost along with the increase in average balancesresulted in an approximate $654 thousand increase in interest expense ondeposits. Although the average cost of borrowings declined to 3.52% from 3.92%for fiscal 2005 compared to fiscal 2004, interest expense on borrowingsincreased by $3.0 million due primarily to the aforementioned significantincrease in average borrowings.

***Provision for LoanLosses.******  ***In order to maintain the allowance forlosses at a level that management deems adequate to absorb known and unknownlosses which are both probable and can be reasonably estimated, a provision forloan losses is recorded through charges to earnings. The determination of theadequacy of the allowance is based upon the Company’s regular review of creditquality and is based upon, but not limited to, the following factors: anevaluation of our loan portfolio, loss experience, current economic conditions,volume, growth, composition of the loan portfolio and other relevant factors.The balance of the allowance for loan losses is an estimate and actual lossesmay vary from these estimates. Management assesses the allowance for loanlosses at least quarterly and makes any necessary adjustments to maintain theallowance for losses at a level deemed adequate. For the years ended June 30,2006, 2005 and 2004, the provisions for loan losses were $3.2 million, $1.2million and $426 thousand, respectively. The increased provision in fiscal 2006was due primarily to the increase in non-performing assets of $12.7 million.The increased provision for loan losses during fiscal 2005 was due primarily tothe increase in outstanding loan balances as well as a change in the mix of theloan portfolio to increased balances in commercial real estate and constructionloan categories, which typically have a higher degree of inherent credit risk.

At June 30, 2006, the balance in the allowancefor loan losses was $16.7 million compared to $6.1 million at June 30,2005, with the increase resulting from the increased provision for loan lossesas well as the acquisition of Chester Valley’s allowance for loan losses of$6.9 million, in the Merger. Management believes that the allowance for loanlosses at June 30, 2006 was appropriate given the decline of certainsectors and the inherent credit risk associated with. The percentage of theallowance for losses to loans increased to 1.55% at June 30, 2006 comparedto 1.05% at June 30, 2005.

Management believes, to the best of its knowledgebased upon knowledge available to them at the time, the allowance for loan losswas adequate at June 30, 2006 and represents all known and inherent losesin the portfolio that are both probable and reasonably estimable, however, noassurance can be given as to the amount or timing of additional provisions forloan losses in the future as a result of potential increases in the amount ofthe Company’s non-performing loans in the remainder of the Company’s loan portfolio.Regulatory agencies, in the course of their regular examinations, review theallowance for losses and carrying value of non-performing assets. No assurancecan be given that these agencies might not require changes to the allowance forlosses in the future.

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***Non-Interest Income.******  ***Non-interestincome is comprised of investment services income, account service fees andcharges, loan servicing fees, realized gains and losses on assets available orheld for sale and increases in the cash surrender value of bank owned lifeinsurance (“BOLI”). Total non-interest income for the years ended June 30,2006, 2005, and 2004 was $7.6 million, $3.5 million and$4.0 million, respectively.

The increase in non-interest income of $4.2 millionduring fiscal 2006 compared to fiscal 2005 was due primarily to investmentservices income of $2.6 million received from the acquisition of PCIS andChester Valley’s Trust division in the Merger. These were two new lines ofbusiness for the Company. Service charges and fees increased by $2.6 million or106.8% in fiscal 2006 due primarily to increased deposit fees associated withthe growth in checking accounts from the Merger as well as increases in theoverdraft protection fees for which Chester Valley was further along inimplementation and thus had a higher volume of users. Gains on loans availablefor sale declined $223 thousand due primarily to lower loan volumes resultingfrom the rising interest rate environment. This was largely offset by anincrease in other income of $169 thousand, which resulted primarily from incomeon the BOLI acquired from Chester Valley. As noted previously, the Companyimplemented a de-leveraging strategy in which it incurred approximately $919thousand in losses in the sale of investment securities.

The decline in non-interest income of$506 thousand during fiscal 2005 compared to fiscal 2004 was due primarilyto reduction in gains on investment securities available for sale ofapproximately $723 thousand due primarily to the rising interest rateenvironment throughout the year. This was partially offset by an increase inservice charges and fees of $96 thousand due to the continued growth inthe Overdraft Protection Plan implemented during fiscal 2004. Also, positivelyimpacting non-interest income was an increase in loan servicing income of$202 thousand due to growth in the portfolio experienced in the prior yearas well as reduced pre-payments within this portfolio. Gains on the sale ofloans held for sale declined by $30 thousand in fiscal 2005 compared tofiscal 2004 as a result of the rising interest rate environment and incomecredited on BOLI declined by $51 thousand as the crediting rate wasreduced.

***Non-InterestExpense.******  ***The primary components of non-interestexpense are compensation and employee benefits, occupancy and equipmentexpenses, data processing costs, deposit account services, professional feesand a variety of other expenses. For the years ended June 30, 2006, 2005,and 2004, non-interest expense totaled $37.4 million, $23.4 millionand $20.4 million, respectively. The primary reason for the increase innon-interest expense in fiscal 2006 compared to fiscal 2005 was the Merger. Theprimary reasons for the increase in non-interest expense in fiscal 2005compared to fiscal 2004 was a $2.0 million increase in other non-interestexpense due primarily to $275 thousand in Merger related charges,$583 thousand in consulting fees and a $913 thousand settlement of a legalproceeding.

Salaries and employee benefit expenses totaled$20.1 million, $13.1 million and $12.7 million, respectively,for the fiscal years ended June 30, 2006, 2005, and 2004. For the yearended June 30, 2006, compensation and benefit costs increasedapproximately $7.0 million or 53.9% due primarily to an increased numberof employees as a result of the merger. At June 30, 2006, the Company had312 full-time employees as compared to 170 at June 30, 2005. Additionally,the Company incurred severance costs of approximately $550 thousand resultingfrom job eliminations upon consummation of the Merger. For the year ended June 30,2005, compensation and benefit costs increased approximately $367 thousandor 2.9% due primarily to normal salary increases.

Occupancy and equipment expenses were$6.0 million, $2.6 million, and $2.6 million for the fiscalyears ended June 30, 2006, 2005, and 2004, respectively. During fiscalyear 2006, these costs increased $3.4 million due to the addition of 13 branchlocations from the Merger as well as the Company’s relocation to a newcorporate headquarters and operations building in February 2006. In fiscal2006, the approximate occupancy cost of $237 thousand for the headquartersbuilding was offset by a sale-leaseback of certain of the Bank’s branches forwhich the cash proceeds were invested in loans or repaid borrowings. The 

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Company’s rent expenseincreased from $837 thousand in fiscal 2005 to $2.0 million in fiscal 2006 andis expected to increase to $2.6 million in fiscal 2007 based on current leases.

Advertising expenses for fiscal 2006, 2005 and 2004were $1.5 million, $978 thousand and $702 thousand, respectively. Theincrease during fiscal 2006 was due primarily to direct mail campaigns to thecombined company’s customer base as the Company commissioned a study of itscustomer base and found there were significant opportunities to cross-sell itsexisting products. During fiscal 2005, the Company increased its local mediaadvertising as part of a campaign to grow core deposits as well as increasingthe Bank’s name recognition in the marketplace.

For the fiscal years ended June 30, 2006, 2005,and 2004, amortization of intangible assets was $1.9 million, $57 thousand and$83 thousand respectively. The significant increase in fiscal 2006 is theresult of the amortization of the core deposit intangible recorded as a resultof the Merger. The asset is being amortized using an accelerated method over atwelve-year period. Amortization of intangible assets is expected to be $2.1million for the fiscal year ending June 30, 2007.

Data processing expenses were $1.2 million,$960 thousand, and $810 thousand, respectively, for fiscal 2006, 2005and 2004. The increase in the current fiscal year was the result of the largeincrease in the number of accounts resulting from the Merger. On a per accountbasis, the cost declined as a new contract was negotiated with the third partydata processing company. The increase in fiscal year 2005 resulted fromincreased accounts and a rate increase in the Company’s third-party dataprocessing contract, as the Company did not renew the contract for the fullterm in anticipation of the Merger.

Professional fees were $2.6 million, $1.4 million and$812 thousand for fiscal 2006, fiscal 2005 and fiscal 2004, respectively.The $1.1 million increase in the current year resulted primarily from increasedconsulting costs related to the integration of the Sarbanes-Oxley 404compliance for the combined company, the aforementioned analysis of ourcustomer base, and assistance with the development of the combined company’sstrategic plan and branding initiatives. The fiscal 2005 increase inprofessional fees was due primarily to costs related to the Company’s review ofpotential acquisition transactions (including the Merger) and other generalcorporate matters.

For the fiscal years ended June 30, 2006, 2005,and 2004, other expenses, which include miscellaneous operating items, were$3.9 million, $4.2 million and $2.6 million, respectively.Included in other expenses for the year ended June 30, 2005 is anapproximate $913 thousand settlement of a legal proceeding.

***Income Tax Provision.******  ***Income taxexpense amounted to $5.3 million for the year ended June 30, 2006.This compares to a tax expense of $3.1 million, and $2.6 million forthe years ended June 30, 2005 and 2004, respectively. The effective taxrates for fiscal 2006, 2005 and 2004 were 32.2%, 31.2% and 29.9%, respectively.The increase in the income tax expense and the effective tax rate for the yearended June 30, 2006 and June 30, 2005, was primarily related to anincrease in the pre-tax income and a reduction in the level of tax-freeinvestment income as a percentage of pre-tax income.

**Liquidity andCommitments**

The Company’s primary sources of funds are fromdeposits, principal amortization of loans, loan and securities prepayments andrepayments, interest income from loans, mortgage-backed securities andother investments, and other funds provided from operations. While scheduledpayments from the amortization of loans and mortgage-backed securitiesand maturing investment securities are relatively predictable sources of funds,deposit flows and loan prepayments can be greatly influenced by generalinterest rates, economic conditions and competition. We also maintain excessfunds in short-term, interest-bearing assets that provide additionalliquidity. We have also utilized outside borrowings, primarily from the FHLB ofPittsburgh as an additional funding source.

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We use our liquidity resources to fund existing andfuture loan commitments, to fund maturing certificates of deposit and demanddeposit withdrawals, to invest in other interest-earning assets, and tomeet operating expenses. At June 30, 2006, outstanding approved loancommitments were $14.7 million and certificates of deposit maturing withinthe next twelve months amounted $216.1 million. Based upon historicalexperience, it is anticipated that a significant portion of the maturingcertificates of deposit will be reinvested in the Bank. However, the Bank maynot aggressively try to retain funds from maturing certificates of deposits ifit is a single relationship customer driven by higher rates.

Due to the interest rate environment during the yearended June 30, 2006, in which long-term rates remained relatively low froma historical standpoint, the Company continued to experience higher than anormal amount of prepayments of loans and mortgage-backed securities asborrowers repaid higher rate loans and refinanced those loans at lower rates.

During the past two fiscal years, the Companyincreased its use of borrowings from the FHLB as a cost effective means toobtain funds at varying maturities to implement asset/liability strategies.Outstanding borrowings from the FHLB have increased to $282.7 million at June 30,2006 compared to $237.4 million at June 30, 2005. Under terms of theborrowing agreement with the FHLB, the Bank pledges certain assets such asresidential mortgage loans and mortgage-backed securities as well asstock in the FHLB as collateral for these advances. At June 30, 2006, theBank had $764.3 million in additional borrowing capacity available fromthe FHLB.

Prior to the Merger, the Company had not in the pastused any significant off-balance sheet financing arrangement for liquidity orother purposes. Our financial assets with off-balance sheet risk are limited toobligations to fund loans to borrowers pursuant to existing loan commitments.Additionally, the Company has not had any transactions, arrangements or otherrelationships with any unconsolidated, limited purpose entities that couldaffect its liquidity or capital resources, nor do we currently intend to engagein trading commodity contracts. With the Merger and the resulting increasedsize of the combined companies, the Company may, from time to time, utilizecertain derivative financial instruments to assist in its asset/liabilitystrategies and has in fact assumed the liability for certain interest ratederivatives entered into by Chester Valley.

The Company fully anticipates that it will continue tohave sufficient funds and alternative funding sources to meet its currentcommitments.

TheCompany’s contractual obligations as of June 30, 2006 are as follows:

| ** **             | ** ** | **Payments Due by Period:** | ** ** |
|------------------------|------------|--------------------------------------------|------------|
| ** **             | ** ** | **Total**                                  | ** ** | **Less Than  1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **             | ** ** | **(Dollars in thousands)**       | ** ** |
| Federal Home Loan Debt |       | $                                          | 282,717    |   |   | $ | 60,145 |   |   | $ | 92,615 |   | $ | 64,917 |   |   | $ | 65,040 |   |   |
| Operating Leases       |       | 27,312                                     |       |   | 2,560 |   |   | 6,781 |   | 4,972 |   |   | 12,999 |   |   |
| Total Obligations      |       | $                                          | 310,029    |   |   | $ | 62,705 |   |   | $ | 99,396 |   | $ | 69,889 |   |   | $ | 78,039 |   |   |

 

| ** **                       | ** ** | **Total** | ** ** | **Less Than  1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than  5 Years** | ** ** |
|----------------------------------|------------|-----------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|----------------------------------|------------|
| Lines of credit                  |       | $         | 146,001    |                            |       | $                  | 33,864     |               |       | $                                | 6,076      |   |   | $ | 2,380 |   |   |   | $ | 103,681 |   |   |
| Standby letters  of credit       |       | 9,012     |       |                            | 8,911      |               |       | 101                |       |                             | —     |   |   |   | — |   |   |
| Other commitments  to make loans |       | 14,747    |       |                            | 14,747     |               |       | —             |       |                             | —     |   |   |   | — |   |   |
| Construction  loans              |       | 61,609    |       |                            | 40,295     |               |       | 21,314             |       |                             | —     |   |   |   | — |   |   |
| Total                            |       | $         | 231,369    |                            |       | $                  | 97,817     |               |       | $                                | 27,491     |   |   | $ | 2,380 |   |   |   | $ | 103,681 |   |   |

 

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**Impact of Inflationand Changing Prices**

The financial statements,accompanying notes, and related financial data presented herein have beenprepared in accordance with U.S. generally accepted accounting principles,which require the measurement of financial position and operating results interms of historical dollars without considering the changes in purchasing powerof money over time due to inflation. The impact of inflation is reflected inthe increased cost of our operations. Most of our assets and liabilities aremonetary in nature; therefore, the impact of interest rates has a greaterimpact on our performance than the effects of general levels of inflation.Interest rates do not necessarily move in the same direction or to the sameextent as the prices of goods and services.

**Item 7A.**                Quantitativeand Qualitative Disclosure of Market Risk

***Asset/Liability Management and Interest Rate Risk***

The market value of assets and liabilities, as well asfuture earnings, can be affected by interest rate risk. Market values offinancial assets have an inverse relationship to rates, i.e., when interestrates rise, the market value of many of the Company’s assets decline and whenrates fall, the market value of many of the Company’s assets rise. The primaryassets of the Company are loans to borrowers who often have the ability toprepay their loan. Therefore, in a falling rate environment, the increase inthe market value of the Company’s assets is limited by this option for theborrower to prepay the loan.

The ability to maximize net interest income is largelydependent upon the achievement of a positive interest spread that can bemaintained during fluctuations in prevailing interest rates. Interest ratesensitivity gap (“gap”) is a measure of the difference between interest-earningassets and interest-bearing liabilities that either mature or re-pricewithin a specified time period. A gap is considered positive when the amount ofinterest-earning assets exceeds the amount of interest-bearingliabilities, and is considered negative when interest-bearing liabilitiesexceed interest-earning assets. Generally, during a period of risinginterest rates, a negative gap would adversely affect net interest income,while a positive gap would result in an increase in net interest income. Duringa period of falling interest rates, a negative gap would generally result in anincrease in net interest income, and a positive gap would result in a decreasein net interest income. This is usually the case; however, interest rates on differingfinancial instruments will not always change at the same time or to the sameextent.

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Thefollowing gap table shows the amount as of June 30, 2006 of assets andliabilities projected to mature or re-price within various time periods. Thistable includes certain assumptions management has made that affect the rate atwhich loans will prepay as well as the duration of core deposits. Changes ininterest rates may affect these assumptions, which would impact our gapposition.

| ** **                                                                                                              | ** ** | **0 to 3  months**         | ** ** | **3 to 12  months** | ** ** | **1 to 3  years** | ** ** | **3 to 5  years** | ** ** | **over 5  years** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------|------------|-----------------------------|------------|-----------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                                                                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Securities and  interest-bearing deposits                                                                               |       | $                                    | 49,239     |                          | $          | 34,586                      |       | $                           | 94,900     |                   | $          | 41,849    |       | $ | 94,482 |   | $ | 315,056 |   |
| Loans receivable                                                                                                        |       | 302,875                              |       | 156,403                       |       | 342,732                     |       | 169,288                     |       | 110,491                |       | 1,081,789 |       |
| Total interest-earning assets                                                                                           |       | 352,114                              |       | 190,989                       |       | 437,632                     |       | 211,138                     |       | 204,973                |       | 1,396,845 |       |
| Certificates of deposit                                                                                                 |       | 47,873                               |       | 168,635                       |       | 62,804                      |       | 20,831                      |       | 1,484                  |       | 301,627   |       |
| Other interest-bearing  deposits                                                                                        |       | 164,908                              |       | 106,009                       |       | 179,447                     |       | 68,527                      |       | 1,856                  |       | 520,747   |       |
| Borrowings                                                                                                              |       | 73,231                               |       | 52,709                        |       | 120,377                     |       | 38,135                      |       | 87,566                 |       | 372,018   |       |
| Total interest-bearing  liabilities                                                                                     |       | 286,012                              |       | 327,353                       |       | 362,628                     |       | 127,493                     |       | 90,906                 |       | 1,194,392 |       |
| Excess (deficiency) of interest-earning assets  over interest-bearing liabilities                                  |       | $                                    | 66,102     |                          | $          | (136,364                    | )          | $                           | 75,004     |                   | $          | 83,645    |       | $ | 114,067 |   | $ | 202,452 |   |
| Cumulative excess (deficiency) of interest-earning  assets over interest-bearing liabilities                            |       | $                                    | 66,102     |                          | $          | (70,262                     | )          | $                           | 4,742      |                   | $          | 88,385    |       | $ | 202,452 |   | $ | 202,452 |   |
| Cumulative excess (deficiency) of interest-earning  assets to Interest-bearing liabilities as a Percent of total assets |       | 4.2                                  | %          | (4.5                          | )%         | 0.3                         | %          | 5.6                         | %          | 12.2                   | %          | 12.2      | %          |
| Ratio of interest-earning assets to interest-bearing  liabilities                                                       |       | 123.1                                | %          | 58.3                          | %          | 120.7                       | %          | 165.6                       | %          | 223.3                  | %          | 116.9     | %          |
| Cumulative ratio  of interest-Earning assets to assets to Interest-bearing  liabilities                                 |       | 123.1                                | %          | 88.5                          | %          | 100.5                       | %          | 108.0                       | %          | 116.9                  | %          |      |       |

 

At June 30, 2006, the ratio of the cumulativeinterest-earning assets maturing or re-pricing in one-year or less tointerest-bearing liabilities maturing or re-pricing in one-year or lesswas 88.5%, which results in a cumulative one-year gap to total assets ratio ofnegative 4.5%, indicating that the Bank’s net interest income could declinedepending upon the degree to which interest rates change and the change in therelationship between interest rates used to re-price assets and interest ratesused in the re-pricing of liabilities.

The Company has adopted asset/liability managementpolicies designed to quantify the interest rate risk caused by mismatches inthe maturities and re-pricing of our interest-earning assets and interest-bearingliabilities. These interest rate risk and asset/liability management actionsare taken under the guidance of the Finance Committee. The Finance Committee’spurpose is to communicate, coordinate and control asset/liability managementconsistent with our business plan and Board approved policies. The objective ofthe Finance Committee is to manage asset and funding sources to produce resultsthat are consistent with liquidity, capital adequacy, growth, risk andprofitability goals. The Finance Committee meets at least quarterly andmonitors the volume and mix of assets and funding sources taking into account 

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the relative costs andspreads, the interest rate sensitivity gap and liquidity needs. The FinanceCommittee also reviews economic conditions and interest rate projections,current and projected liquidity needs and capital positions, anticipatedchanges in the mix of assets and liabilities, and interest rate exposure limitsversus current projections pursuant to gap analysis and interest incomesimulations. At each meeting, the Finance Committee recommends changes instrategy as appropriate. Interest rate risk issues are also discussed by theBoard of Directors on a regular basis. Management meets periodically to monitorprogress in achieving asset/liability targets approved by the Board,particularly the type and rate on asset generation and sources of funding.

In order to manage the Company’s assets andliabilities and improve our interest rate risk position, emphasis has beenplaced on the origination of assets with shorter maturities or adjustable ratessuch as commercial and multi-family real estate loans, constructionloans, home equity loans and to a lesser extent commercial business loans. Atthe same time, other actions include attempts to increase our core deposits andthe use of FHLB advances as additional sources of funds. Additionally, longerterm fixed rate single-family residential mortgage loans are originatedand held for sale.

The Finance Committee regularly reviews interest raterisk by, among other things, examining the impact of alternative interest rateenvironments on net interest income and net portfolio value (“NPV”), and thechange in NPV. NPV is the difference between the market value of assets and themarket value of liabilities and off-balance sheet items under various interestrate scenarios. Sensitivity is the difference (measured in basis points)between the NPV to assets ratio at market rate and the NPV to assets ratiodetermined under each rate scenario. The Finance Committee monitors both theNPV and sensitivity according to guidelines established by the OTS in ThriftBulletin 13A “Management of Interest Rate Risk, Investment Securities and DerivativeActivities,” and board approved limitations.

Presented below, as of June 30,2006 and 2005, is an analysis of the interest rate risk position as measured byNPV and sensitivity based upon various rate scenarios. These values for 2006were obtained from an internal model produced by the Bank as required by OTSregulation as total assets now exceed $1.0 billion. Fiscal 2005 values wereobtained from data submitted by the Bank to the OTS. The OTS performs scenarioanalysis to estimate current or base case economic value and estimates NPV thatwould result from instantaneous, parallel shifts of the yields on variousfinancial instruments of plus and minus 100, 200 and 300 basis points. Due tothe level of interest rates at the time, no values are calculated forhypothetical rate scenarios of down 300 basis points at June 30, 2005. Itonly provides an estimate of economic value at a point in time and the economicvalue of the same portfolio under the above referenced interest rate scenarios.

**Estimatedchange in NPV and SensitivityAt June 30, 2006**

| ** **                             | ** ** | **Net Portfolio Value** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **Amount of  Change**        | ** ** | **Percent of  change** | ** ** | **To  Assets** | ** ** |
| ** **                             | ** ** | **(in thousands)**           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Hypothetical change in  interest rates |       |                              |       |   |   |   |   |   |   |   |   |
| up 300 basis points                    |       |                              | $          | (56,211 | ) |   |   | (27.5 | )% |   | 9.76 | % |
| up 200 basis points                    |       |                              | (33,116    | ) |   |   | (16.2 | ) |   | 11.12 |   |
| up 100 basis points                    |       |                              | (14,395    | ) |   |   | (7.1 | ) |   | 12.16 |   |
| no change—base case               |       |                              | —     |   |   |   | — |   |   | 12.91 |   |
| down 100 basis points                  |       |                              | 8,812      |   |   |   | 4.3 |   |   | 13.34 |   |
| down 200 basis points                  |       |                              | 1,726      |   |   |   | 0.8 |   |   | 12.89 |   |
| down 300 basis  points                 |       |                              | (15,299    | ) |   |   | (7.5 | ) |   | 11.87 |   |
|                                        |            |                                   |            |  |  |  |  |  |  |  |  |  |

 

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**Estimatedchange in NPV and SensitivityAt June 30, 2005**

| ** **                             | ** ** | **Net Portfolio Value** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **Amount of  Change**        | ** ** | **Percent of  change** | ** ** | **To  assets** | ** ** |
| ** **                             | ** ** | **(in thousands)**           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Hypothetical change in  interest rates |       |                              |       |   |   |   |   |   |   |   |   |
| up 300 basis points                    |       |                              | $          | (32,238 | ) |   |   | (25 | )% |   | 10.12 | % |
| up 200 basis points                    |       |                              | (20,207    | ) |   |   | (16 | ) |   | 11.20 |   |
| up 100 basis points                    |       |                              | (9,073     | ) |   |   | (7 | ) |   | 12.15 |   |
| no change—base case               |       |                              | —     |   |   |   | — |   |   | 12.87 |   |
| down 100 basis points                  |       |                              | 1,705      |   |   |   | 1 |   |   | 12.92 |   |
| down 200 basis  points                 |       |                              | (2,179     | ) |   |   | (2 | ) |   | 12.45 |   |
|                                        |            |                                   |            |  |  |  |  |  |  |  |  |  |

 

The Bank’s sensitivity remained relatively stable forfiscal 2006 as compared to fiscal 2005 due primarily to interest sensitiveassets acquired in the Merger, which was partially offset, by the intangibleassets recorded with the acquisition.

NPV is more sensitive andmay be more negatively impacted by rising interest rates than by decliningrates. This occurs primarily because as rates rise, the market value oflong-term fixed rate assets, like fixed rate mortgage loans, declines due toboth the rate increase and slowing prepayments. When rates decline, theseassets do not experience similar appreciation in value. This is due to thedecrease in the duration of the asset resulting from the increase inprepayments.

***Recent Accounting Pronouncements***

*FSP- FASB 115-1 and FAS 124-1, The Meaningof Other-Than-Temporary Impairment and Its application to Certain Investments*

In November 2005, theFASB issued FASB Staff Position (FSP) FAS 115-1 and FAS 124-1, “TheMeaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments.” The FSP addresses determining when an investment is consideredimpaired and whether that impairment is other than temporary, and providesguidance on measuring an impairment loss. The FSP requires certain disclosuresabout unrealized losses not recognized as other-than-temporary impairments. Theguidance in the FSP amends FASB Statements No. 115, “Accounting forCertain Investments in Debt and Equity Securities”, and No. 124, “Accountingfor Certain Investments Held by Not-for-Profit Organizations”, and APB Opinion No. 18,“The Equity Method of Accounting for Investments in Common Stock”. The Companyhas considered the requirements of this FSP in its assessment of the investmentportfolio.

*Statement ofPosition 03-3 Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer*

In December 2003, theAmerican Institute of Certified Public Accountants’ (AICPA) AccountingStandards Executive Committee (AcSEC) issued Statement of Position (SOP) 03-3,“Accounting for Certain Loans or Debt Securities Acquired in a Transfer.”SOP 03-3 is effective for loans acquired in fiscal years beginningafter December 15, 2004, with early adoption encouraged. A certaintransition provision applies for certain aspects of loans currently within thePractice Bulletin 6 on Amortization of Discounts on Certain Acquired Loans.SOP 03-3 addresses accounting for differences between contractualcash flows and cash flows expected to be collected from an investor’s initialinvestment in loans or debt securities (loans) acquired in a transfer if thosedifferences are attributable, at least in part, to credit quality. It includesloans acquired in business combinations and applies to all nongovernmentalentities, including not-for-profit organizations. The Company applied theprovisions of SOP 03-3 to the Merger with Chester Valley resulting in anapproximate $436 thousand reduction in the allowance for loan losses acquiredfrom 

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ChesterValley to record the estimated fair value of certain loans classified asdoubtful in the acquired Chester Valley loan portfolio.

*FSP FAS 123(R)-2 Practical Accommodation to theApplication of Grant Date as Defined in FASB Statement No. 123(R)*

In October 2005, theFASB issued FSP FAS 123(R)-2, “PracticalAccommodation to the Application of**GrantDate as Defined in FASB Statement No. 123(R).” The FSP discussesthe application of grant date of a share-based payment award as defined in FASBStatement No. 123(R). One of the criteria established by Statement 123(R) fordetermining the grant date is a mutual understanding by the employer andemployee of the key terms and conditions of a share-based payment award.According to the FSP, a mutual understanding shall be presumed to exist if (a) theaward is a unilateral grant; and (b) the key terms and conditions of theaward are expected to be communicated to the employee within a relatively shortperiod of time from the date of approval. The FSP is effective upon adoption ofFASB Statement No. 123(R) for reporting periods after October 18,2005. The Company has adopted the FSP and has applied its provisions to allgrants that occurred during the year ended June 30, 2006.

*FSP FAS 123(R)-3 Transition Election Related toAccounting for the Tax Effects of Share-Based Payment Awards*

In November 2005, theFASB issued FSP FAS 123(R)-3, “Transition Election Related to Accountingfor the Tax Effects of Share-Based Payment Awards.”  This FSP provides a transition electionrelated to accounting for the tax effects of share-based payment awards toemployees. An entity must follow either the transition guidance for theadditional paid-in capital pool in Statement No. 123(R) or thealternative transition method described in the FSP. This FSP is effective afterNovember 10, 2005, but allows an entity to take up to one year from thelater of its initial adoption of Statement No. 123(R) or November 10,2005 to evaluate its transition alternatives and make a one-time election. TheCompany has elected to implement the alternative transition method inaccordance with the FSP.

*FSP FAS 123(R)-4 Classification of Options andSimilar Instruments Issued as Employee Compensation That Allow for CashSettlement upon the Occurrence of a Contingent Event*

In February 2006, theFASB issued FSP FAS 123(R)-4, which addresses the classification ofoptions and similar instruments issued as employee compensation that allow forcash settlement upon the occurrence of a contingent event. FSP FAS 123(R)-4amends SFAS No. 123R, which requires options or similar instruments to beclassified as liabilities if the employee can be required under anycircumstances to settle the option or similar instrument by transferring cashor other assets. According to FSP FAS 123(R)-4, a cash settlementfeature that can be exercised only upon the occurrence of a contingent eventthat is outside the employee’s control should not be reclassified as aliability until it becomes probable that the event will occur. This FSP iseffective for reporting periods beginning after February 3, 2006, withearly application permitted. As of June 30, 2006, the Company hasaccounted for all options in accordance with FSP FAS 123(R)-4.

*FSP SOP 94-6-1Terms of Loan Products That May Give Rise to a Concentration of CreditRisk*

In December 2005, theFASB issued FSP SOP 94-6-1, “Termsof Loan Products That May Give Rise to a**Concentration of Credit Risk.”  The FSP addresses the concentration of creditrisk arising from certain loan products whose contractual features may increasean entity’s exposure to risk of non-payment or realization. An entity mustdetermine whether its loan products have terms that give rise to aconcentration of credit risk, as defined in FASB Statement No. 107, andassess the adequacy of disclosures and accounting treatment for all lending products.The FSP is effective for reporting periods ending after 

59

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December 19,2005. The Company has reviewed its loan portfolio in accordance with FSP SOP 94-6-1and has determined that no concentration of credit risk exists as of June 30,2006.

*EITF 06-4, Accounting for Deferred Compensationand Postretirement Benefit Aspects of Endorsement Split-Dollar Life InsuranceArrangements*

In June 2006 EITFmeeting, the Task Force reached a tentative conclusion that, for endorsementsplit-dollar life insurance arrangements, an employer should recognize aliability for future benefits based on the substantive agreement with theemployee, since the postretirement benefit obligation is not effectivelysettled. An entity would be permitted to apply the consensus by retrospectiveapplication to all prior periods in accordance with FASB Statement No. 154,including its required disclosures. A final consensus on this Issue is expectedto be effective for fiscal years beginning after December 15, 2006. TheBank has recorded a liability of $246 thousand within other liabilities on theconsolidated statements of financial condition to account for the settlement ofthe future benefit obligation.

*FASB Interpretation48, Accounting for Uncertainty in Income Tax Positions*

In July 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Tax Positions.”  Thisinterpretation clarifies the application of FASB Statement No. 109 byestablishing a threshold condition that a tax position must meet for any partof the benefit of that position to be recognized in the financial statements. Inaddition to recognition, the interpretation provides guidance on themeasurement, derecognition, classification, and disclosure of tax positions andis effective for fiscal years beginning after December 31, 2006. TheCompany is evaluating the potential impact of this interpretation on results ofits future operations and financial condition.

**Selected QuarterlyFinancial Data**

Thefollowing table presents selected quarterly operating data for the fiscal yearsended June 30, 2006 and 2005.

| ** **                  | ** ** | **For the quarter ended**                                        | ** ** |
|-----------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **06/30/06**                                                                    | ** ** | **03/31/06** | ** ** | **12/31/05** | ** ** | **09/30/05** | ** ** |
| ** **                  | ** ** | **(Dollars in thousands, except per share data)** | ** ** |
| Total interest  income      |       | $                                                                               | 22,561     |   | $ | 21,792 |   | $ | 21,605 |   | $ | 15,572 |   |
| Total interest  expense     |       | 9,326                                                                           |       | 8,586 |   | 7,971 |   | 6,355 |   |
| Net interest  income        |       | 13,235                                                                          |       | 13,206 |   | 13,634 |   | 9,217 |   |
| Provision for  loan loss    |       | 2,485                                                                           |       | — |   | 207 |   | 513 |   |
| Total non-interest  income  |       | 2,880                                                                           |       | 2,078 |   | 2,326 |   | 363 |   |
| Total non-interest  expense |       | 10,290                                                                          |       | 9,503 |   | 9,767 |   | 7,842 |   |
| Income tax  expense         |       | 991                                                                             |       | 1,857 |   | 2,109 |   | 299 |   |
| Net income                  |       | 2,349                                                                           |       | 3,924 |   | 3,877 |   | 926 |   |
| Earnings per  share         |       |                                                                            |       |   |   |   |   |   |   |
| Basic                       |       | $                                                                               | 0.17       |   | $ | 0.28 |   | $ | 0.27 |   | $ | 0.08 |   |
| Diluted                     |       | $                                                                               | 0.16       |   | $ | 0.27 |   | $ | 0.27 |   | $ | 0.08 |   |

 

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| ** **                  | ** ** | **For the quarter ended**                                        | ** ** |
|-----------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **06/30/05**                                                                    | ** ** | **03/31/05** | ** ** | **12/31/04** | ** ** | **09/30/04** | ** ** |
| ** **                  | ** ** | **(Dollars in thousands, except per share data)** | ** ** |
| Total interest  income      |       | $                                                                               | 12,921     |   | $ | 12,730 |   | $ | 12,517 |   | $ | 11,511 |   |
| Total interest  expense     |       | 5,121                                                                           |       | 4,863 |   | 4,645 |   | 4,120 |   |
| Net interest  income        |       | 7,800                                                                           |       | 7,867 |   | 7,872 |   | 7,391 |   |
| Provision for  loan loss    |       | 197                                                                             |       | 504 |   | 360 |   | 171 |   |
| Total non-interest  income  |       | 899                                                                             |       | 947 |   | 865 |   | 767 |   |
| Total non-interest  expense |       | 6,048                                                                           |       | 6,577 |   | 5,423 |   | 5,350 |   |
| Income tax  expense         |       | 745                                                                             |       | 527 |   | 948 |   | 833 |   |
| Net income                  |       | 1,709                                                                           |       | $ | 1,206 |   | $ | 2,006 |   | $ | 1,804 |   |
| Earnings per  share         |       |                                                                            |       |   |   |   |   |   |   |
| Basic                       |       | $                                                                               | 0.19       |   | $ | 0.13 |   | $ | 0.22 |   | $ | 0.20 |   |
| Diluted                     |       | $                                                                               | 0.18       |   | $ | 0.13 |   | $ | 0.21 |   | $ | 0.19 |   |

 

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**Item 8.**                        FinancialStatements and Supplementary Data

**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors and StockholdersWillow Financial Bancorp, Inc.:

We have audited the accompanying consolidatedstatements of financial condition of Willow Financial Bancorp, Inc. andsubsidiary (the Company) as of June 30, 2006 and 2005, and the relatedconsolidated statements of income, changes in stockholders’ equity andcomprehensive income, and cash flows for each of the years in the three-yearperiod ended June 30, 2006. These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Willow Financial Bancorp, Inc. and subsidiary as of June 30,2006 and 2005, and the results of their operations and their cash flows foreach of the years in the three-year period ended June 30, 2006, inconformity with U.S. generally accepted accounting principles.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of Willow FinancialBancorp, Inc.’s internal control over financial reporting as of June 30,2006, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated September 25,2006 expressed an unqualified opinion on management’s assessment of, and theeffective operation of, internal control over financial reporting.
| /s/KPMG  LLP               |   |   |
|----------------------------|--------|--------|
| Philadelphia, Pennsylvania |   |
| September 25, 2006    |   |

 

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**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors and StockholdersWillow Financial Bancorp, Inc.:

We have audited management’s assessment, included inthe accompanying Management Report on Effectiveness of Internal Control OverFinancial Reporting, that Willow Financial Bancorp, Inc. and subsidiary(the Company) maintained effective internal control over financial reporting asof June 30, 2006, based on criteria established in *Internal Control—Integrated Framework* issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Willow Financial Bancorp, Inc.’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with U.S. generally accepted accounting principles. Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with U.S. generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, management’s assessment that Willow FinancialBancorp, Inc. maintained effective internal control over financialreporting as of June 30, 2006, is fairly stated, in all material respects,based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Also, in our opinion, Willow FinancialBancorp, Inc. maintained, in all material respects, effective internalcontrol over financial reporting as of June 30, 2006, based on criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO).

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We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated statements of financial condition of Willow FinancialBancorp, Inc. and subsidiary as of June 30, 2006 and 2005, and therelated consolidated statements of income, changes in stockholders’ equity andcomprehensive income, and cash flows for each of the years in the three-yearperiod ended June 30, 2006, and our report dated September 25, 2006expressed an unqualified opinion on those consolidated financial statements.
| /s/  Kpmg Llp               |   |   |
|-----------------------------|--------|--------|
| Philadelphia,  Pennsylvania |   |
| September 25,  2006    |   |

 

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**Willow Financial Bancorp, Inc.Consolidated Statements of Financial Condition**

| ** **                                                                                                                              | ** ** | **At  June 30, 2006**                                          | ** ** | **At  June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                              | ** ** | **(Dollars in thousands,   except share data)** | ** ** |
| Assets:                                                                                                                                 |       |                                                                     |       |                            |       |   |   |   |   |
| Cash and cash  equivalents:                                                                                                             |       |                                                                     |       |                            |       |   |   |   |   |
| Cash on hand and non-interest-earning  deposits                                                                                         |       |                                                                     | $          | 32,930                          |       |   |   | $ | 6,189 |   |   |
| Interest-earning deposits                                                                                                               |       |                                                                     | 4,289      |                            |       |   | 14,420 |   |   |
| Total cash and cash equivalents                                                                                                         |       |                                                                     | 37,219     |                            |       |   | 20,609 |   |   |
| Investment securities:                                                                                                                  |       |                                                                     |       |                            |       |   |   |   |   |
| Trading                                                                                                                                 |       |                                                                     | 902        |                            |       |   | 53 |   |   |
| Available for sale (amortized cost of $203,221 and  $150,666, respectively)                                                             |       |                                                                     | 196,925    |                            |       |   | 148,517 |   |   |
| Held to maturity (fair value of $102,087 and  $164,909, respectively)                                                                   |       |                                                                     | 105,561    |                            |       |   | 164,451 |   |   |
| Federal Home Loan Bank Stock                                                                                                            |       |                                                                     | 16,856     |                            |       |   | 14,256 |   |   |
| Loans (net of allowance for loan losses of $16,737  and $6,113, respectively)                                                           |       |                                                                     | 1,063,882  |                            |       |   | 584,187 |   |   |
| Loans held for sale                                                                                                                     |       |                                                                     | 2,635      |                            |       |   | 1,795 |   |   |
| Accrued interest receivable                                                                                                             |       |                                                                     | 6,647      |                            |       |   | 4,094 |   |   |
| Property and equipment, net                                                                                                             |       |                                                                     | 10,064     |                            |       |   | 5,659 |   |   |
| Bank owned life insurance                                                                                                               |       |                                                                     | 11,483     |                            |       |   | 5,447 |   |   |
| Real estate owned                                                                                                                       |       |                                                                     | 51         |                            |       |   | 439 |   |   |
| Core deposit intangible, net                                                                                                            |       |                                                                     | 12,975     |                            |       |   | 33 |   |   |
| Goodwill                                                                                                                                |       |                                                                     | 94,072     |                            |       |   | 848 |   |   |
| Other assets                                                                                                                            |       |                                                                     | 17,463     |                            |       |   | 8.867 |   |   |
| Total assets                                                                                                                            |       |                                                                     | $          | 1,576,735                       |       |   |   | $ | 959,255 |   |   |
| Liabilities and  Stockholders’ Equity:                                                                                             |       |                                                                     |       |                            |       |   |   |   |   |
| Interest-bearing deposits                                                                                                               |       |                                                                     | $          | 822,374                         |       |   |   | $ | 519,916 |   |   |
| Non-interest-bearing deposits                                                                                                           |       |                                                                     | 162,864    |                            |       |   | 82,762 |   |   |
| Securities sold under agreements to repurchase                                                                                          |       |                                                                     | 53,152     |                            |       |   | — |   |   |
| Federal Home Loan Bank advances                                                                                                         |       |                                                                     | 282,717    |                            |       |   | 237,400 |   |   |
| Advance payments from borrowers for taxes                                                                                               |       |                                                                     | 4,776      |                            |       |   | 2,850 |   |   |
| Trust preferred securities                                                                                                              |       |                                                                     | 36,149     |                            |       |   | — |   |   |
| Accrued interest payable                                                                                                                |       |                                                                     | 2,205      |                            |       |   | 1,064 |   |   |
| Other liabilities                                                                                                                       |       |                                                                     | 9,425      |                            |       |   | 8,220 |   |   |
| Total liabilities                                                                                                                       |       |                                                                     | 1,373,662  |                            |       |   | 852,212 |   |   |
| Commitments and contingencies                                                                                                           |       |                                                                     | —     |                            |       |   | — |   |   |
| Stockholders’  equity:                                                                                                             |       |                                                                     |       |                            |       |   |   |   |   |
| Common stock, $0.01 par value; (40,000,000  authorized; 16,584,870 and 11,457,602 issued at June 30, 2006 and 2005,  respectively) |       |                                                                     | 166        |                            |       |   | 115 |   |   |
| Additional paid-in capital                                                                                                              |       |                                                                     | 178,886    |                            |       |   | 86,086 |   |   |
| Retained earnings—substantially restricted                                                                                         |       |                                                                     | 60,404     |                            |       |   | 56,046 |   |   |
| Accumulated other comprehensive loss                                                                                                    |       |                                                                     | (3,642     | )                               |       |   | (1,353 | ) |   |
| Obligation of deferred compensation plan                                                                                                |       |                                                                     | 1,258      |                            |       |   | 1,076 |   |   |
| Treasury stock at cost, 1,736,308 and 1,730,101  shares at June 30, 2006 and June 30, 2005, respectively                      |       |                                                                     | (28,251    | )                               |       |   | (28,072 | ) |   |
| Unallocated common stock  held by:                                                                                                      |       |                                                                     |       |                            |       |   |   |   |   |
| Employee Stock Ownership Plan (ESOP)                                                                                                    |       |                                                                     | (4,573     | )                               |       |   | (5,035 | ) |   |
| Recognition and Retention Plan Trust (RRP)                                                                                              |       |                                                                     | (1,175     | )                               |       |   | (1,820 | ) |   |
| Total stockholders’ equity                                                                                                         |       |                                                                     | 203,073    |                            |       |   | 107,043 |   |   |
| Total liabilities  and stockholders’ equity                                                                                        |       |                                                                     | $          | 1,576,735                       |       |   |   | $ | 959,255 |   |   |

 

See accompanying Notes to Consolidated Financial Statements

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**Willow FinancialBancorp, Inc.**

**Consolidated Statements of Income**

| ** **                                          | ** ** | **For the year ended June 30,**                                     | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **       2006       ** | ** ** | **       2005       ** | ** ** | **       2004       ** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands, except per share data)**              | ** ** |
| Interest and  dividend income:                      |       |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Loans                                               |       |                                                                                         | $          | 65,472 |   |   |   | $ | 34,536 |   |   |   | $ | 29,123 |   |   |
| Securities, primarily taxable                       |       |                                                                                         | 16,058     |   |   |   | 15,143 |   |   |   | 11,505 |   |   |
| Total interest  income                              |       |                                                                                         | 81,530     |   |   |   | 49,679 |   |   |   | 40,628 |   |   |
| Interest expense:                                   |       |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                            |       |                                                                                         | 17,648     |   |   |   | 9,931 |   |   |   | 9,277 |   |   |
| Securities sold under agreements to repurchase      |       |                                                                                         | 1,056      |   |   |   | — |   |   |   | — |   |   |
| Borrowings                                          |       |                                                                                         | 13,534     |   |   |   | 8,818 |   |   |   | 5,797 |   |   |
| Total interest  expense                             |       |                                                                                         | 32,238     |   |   |   | 18,749 |   |   |   | 15,074 |   |   |
| Net interest  income                                |       |                                                                                         | 49,292     |   |   |   | 30,930 |   |   |   | 25,554 |   |   |
| Provision for  loan losses                          |       |                                                                                         | 3,205      |   |   |   | 1,232 |   |   |   | 426 |   |   |
| Net interest income after provision for loan losses |       |                                                                                         | 46,087     |   |   |   | 29,698 |   |   |   | 25,128 |   |   |
| Non-interest  income:                               |       |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Investment services income, net                     |       |                                                                                         | 2,634      |   |   |   | — |   |   |   | — |   |   |
| Service charges and fees                            |       |                                                                                         | 5,000      |   |   |   | 2,418 |   |   |   | 2,322 |   |   |
| Realized gain  (loss) on sale of:                   |       |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale                                 |       |                                                                                         | 374        |   |   |   | 597 |   |   |   | 627 |   |   |
| Investment securities available for sale            |       |                                                                                         | (919       | ) |   |   | 73 |   |   |   | 796 |   |   |
| Other income                                        |       |                                                                                         | 558        |   |   |   | 389 |   |   |   | 238 |   |   |
| Total non-interest income                           |       |                                                                                         | 7,647      |   |   |   | 3,477 |   |   |   | 3,983 |   |   |
| Non-interest  expense:                              |       |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                      |       |                                                                                         | 20,106     |   |   |   | 13,062 |   |   |   | 12,695 |   |   |
| Occupancy and equipment                             |       |                                                                                         | 6,011      |   |   |   | 2,646 |   |   |   | 2,583 |   |   |
| Data processing                                     |       |                                                                                         | 1,220      |   |   |   | 960 |   |   |   | 810 |   |   |
| Advertising                                         |       |                                                                                         | 1,504      |   |   |   | 978 |   |   |   | 702 |   |   |
| Deposit insurance premiums                          |       |                                                                                         | 124        |   |   |   | 85 |   |   |   | 87 |   |   |
| Amortization of intangible assets                   |       |                                                                                         | 1,928      |   |   |   | 57 |   |   |   | 83 |   |   |
| Professional fees                                   |       |                                                                                         | 2,587      |   |   |   | 1,441 |   |   |   | 812 |   |   |
| Other expense                                       |       |                                                                                         | 3,922      |   |   |   | 4,168 |   |   |   | 2,618 |   |   |
| Total non-interest  expense                         |       |                                                                                         | 37,402     |   |   |   | 23,397 |   |   |   | 20,390 |   |   |
| Income before  income taxes                         |       |                                                                                         | 16,332     |   |   |   | 9,778 |   |   |   | 8,721 |   |   |
| Income tax  expense                                 |       |                                                                                         | 5,256      |   |   |   | 3,052 |   |   |   | 2,610 |   |   |
| Net Income                                          |       |                                                                                         | $          | 11,076 |   |   |   | $ | 6,726 |   |   |   | $ | 6,111 |   |   |
| Earnings per  share:                                |       |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                               |       |                                                                                         | $          | 0.83 |   |   |   | $ | 0.74 |   |   |   | $ | 0.66 |   |   |
| Diluted                                             |       |                                                                                         | $          | 0.81 |   |   |   | $ | 0.71 |   |   |   | $ | 0.62 |   |   |

 

See accompanying Notes to Consolidated Financial Statements

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**Willow Financial Bancorp, Inc.Consolidated Statements of Changes in Stockholders’ Equity and ComprehensiveIncome**

| ** **                                                | ** ** | **Common  stock**                                                               | ** ** | **Additional  paid in  capital** | ** ** | **Retained  earnings** | ** ** | **Accumulated  other  comprehensive  income (loss)** | ** ** | **Obligation of  deferred  compensation  plan** | ** ** | **Treasury  stock** | ** ** | **Common  stock  acquired by  benefit plans** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|---------------------------------------|------------|------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------------|------------|---------------------|------------|---------------------------------------------------------|------------|-----------|------------|
| ** **                                                | ** ** | **(Dollars in thousands, except per share data)** | ** ** |
| Balance—June 30,  2003                          |       |                                                                            | $          | 114                                   |       |                   |       | $                                                         | 83,542     |                                                 |       |                | $          | 51,049                                                  |       |      |       | $ | 1,855 |   |   |   | — |   |   |   | $ | (10,356 | ) |   |   | $ | (9,074 | ) |   | $ | 117,130 |   |
| Net income                                                |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | 6,111      |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 6,111 |   |
| Other  comprehensive loss                                 |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | (4,318     | )         |       |   | — |   |   |   | — |   |   |   | — |   |   | (4,318 | ) |
| Payment of  Deferred Acquisition Costs               |       |                                                                            | —     |                                  |       |                   | (36        | )                                                         |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | (36 | ) |
| Exercise of Stock  Options                                |       |                                                                            | —     |                                  |       |                   | 392        |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 392 |   |
| ESOP shares  committed to be released                     |       |                                                                            | —     |                                  |       |                   | 576        |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | 462 |   |   | 1,038 |   |
| Obligation of  deferred compensation plan                 |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | 525 |   |   |   | — |   |   |   | — |   |   | 525 |   |
| Amortization of  RRP shares                               |       |                                                                            | —     |                                  |       |                   | 34         |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | 707 |   |   | 741 |   |
| Treasury stock  acquired (853,166 shares at cost)    |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | (14,570 | ) |   |   | — |   |   | (14,570 | ) |
| Tax benefit  related to employee stock benefit plans      |       |                                                                            | —     |                                  |       |                   | 407        |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 407 |   |
| Cash dividends  paid—($0.38 per share)     |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | (3,644     | )                   |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | (3,644 | ) |
| Balance at  June 30, 2004                            |       |                                                                            | $          | 114                                   |       |                   |       | $                                                         | 84,915     |                                                 |       |                | $          | 53,516                                                  |       |      |       | $ | (2,463 | ) |   |   | $ | 525 |   |   |   | $ | (24,926 | ) |   |   | $ | (7,905 | ) |   | $ | 103,776 |   |
| Net income                                                |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | 6,726      |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 6,726 |   |
| Other  comprehensive income                               |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | 1,110      |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 1,110 |   |
| Exercise of Stock  Options                                |       |                                                                            | 1          |                                  |       |                   | 284        |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 285 |   |
| ESOP shares  committed to be released                     |       |                                                                            | —     |                                  |       |                   | 566        |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | 462 |   |   | 1,028 |   |
| Obligation of  deferred compensation plan                 |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | 551 |   |   |   | — |   |   |   | — |   |   | 551 |   |
| Amortization of  RRP shares                               |       |                                                                            | —     |                                  |       |                   | 9          |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | 588 |   |   | 597 |   |
| Treasury stock  acquired (155,577 shares at cost)    |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | (3,146 | ) |   |   | — |   |   | (3,146 | ) |
| Tax benefit  related to employee stock benefit plans      |       |                                                                            | —     |                                  |       |                   | 312        |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 312 |   |
| Cash dividends  paid—($0.46 per share)     |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | (4,196     | )                   |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | (4,196 | ) |
| Balance at  June 30, 2005                            |       |                                                                            | $          | 115                                   |       |                   |       | $                                                         | 86,086     |                                                 |       |                | $          | 56,046                                                  |       |      |       | $ | (1,353 | ) |   |   | $ | 1,076 |   |   |   | $ | (28,072 | ) |   |   | $ | (6,855 | ) |   | $ | 107,043 |   |
| Net income                                                |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | 11,076     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 11,076 |   |
| Other  comprehensive income                               |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | (2,289     | )         |       |   | — |   |   |   | — |   |   |   | — |   |   | (2,289 | ) |
| Common stock  issued in acquisition                       |       |                                                                            | 50         |                                  |       |                   | 90,966     |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 91,016 |   |
| Exercise of Stock  Options                                |       |                                                                            | 1          |                                  |       |                   | 1,274      |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 1,275 |   |
| Stock based  compensation                                 |       |                                                                            | —     |                                  |       |                   | 306        |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 306 |   |
| ESOP shares  committed to be released                     |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | 462 |   |   | 462 |   |
| Obligation of deferred  compensation plan                 |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    |       |      |       |   | 182 |   |   |   | — |   |   |   | — |   |   | 182 |   |
| Amortization of  RRP shares                               |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | 645 |   |   | 645 |   |
| Treasury stock  acquired (15,132 shares at cost)     |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | (179 | ) |   |   | — |   |   | (179 | ) |
| Tax benefit  related to employee stock benefit plans |       |                                                                            | —     |                                  |       |                   | 254        |                                                      |       |                                                 | —     |                |       |                                                    | —     |      |       |   | — |   |   |   | — |   |   |   | — |   |   | 254 |   |
| Cash dividends  paid—($0.48 per share)     |       |                                                                            | —     |                                  |       |                   | —     |                                                      |       |                                                 | (6,718     | )                   |       |                                                    |       |      |       |   | — |   |   |   | — |   |   |   | — |   |   | (6,718 | ) |
| Balance at June 30,  2006                            |       |                                                                            | $          | 166                                   |       |                   |       | $                                                         | 178,886    |                                                 |       |                | $          | 60,404                                                  |       |      |       | $ | (3,642 | ) |   |   | $ | 1,258 |   |   |   | $ | (28,251 | ) |   |   | $ | (5,748 | ) |   | $ | 203,073 |   |

 

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| ** **                                                                                             | ** ** | **For the year ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net unrealized  (losses) gains on securities available for sale arising during the period,  net of tax |       | $                                                        | (3,424     | ) | $ | 1,061 |   | $ | (4,812 | ) |
| Reclassification  adjustments for gains included in net income, net of tax                             |       | 630                                                      |       | 49 |   | 494 |   |
| Net unrealized  gain on cash flow hedge                                                                |       | 505                                                      |       | — |   | — |   |
| Other  comprehensive (loss) income                                                                     |       | (2,289                                                   | )          | 1,110 |   | (4,318 | ) |
| Net income                                                                                             |       | 11,076                                                   |       | 6,726 |   | 6,111 |   |
| Comprehensive  income                                                                                  |       | $                                                        | 8,787      |   | $ | 7,836 |   | $ | 1,793 |   |

 

See accompanying Notes to Consolidated Financial Statements.

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**Willow FinancialBancorp, Inc.**

**ConsolidatedStatements of Cash Flows**

| ** **                                                                              | ** ** | **For the year ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                              | ** ** | **(Dollars in thousands)**                     | ** ** |
| Net cash flows from operating activities:                                               |       |                                                     |       |   |   |   |   |
| Net income                                                                              |       | $                                                        | 11,076     |   | $ | 6,726 |   | $ | 6,111 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:      |       |                                                     |       |   |   |   |   |
| Depreciation                                                                            |       | 1,837                                                    |       | 955 |   | 996 |   |
| Amortization of  premium and accretion of discount, net                                 |       | 347                                                      |       | 595 |   | 1,313 |   |
| Amortization of  intangible assets                                                      |       | 1,928                                                    |       | 57 |   | 83 |   |
| Provision for loan  losses                                                              |       | 3,205                                                    |       | 1,232 |   | 426 |   |
| Gain on sale of  loans available for sale                                               |       | (370                                                     | )          | (597 | ) | (627 | ) |
| Loss (gain) on  sale of securities available for sale and trading                       |       | 936                                                      |       | (73 | ) | (796 | ) |
| Increase in loans  held for sale                                                        |       | (76,020                                                  | )          | (108,823 | ) | (85,504 | ) |
| Proceeds from sale  of loans held for sale                                              |       | 81,911                                                   |       | 108,761 |   | 90,288 |   |
| Purchase of  trading account securities                                                 |       | (820                                                     | )          | (53 | ) | — |   |
| Tax benefit from  stock options exercised                                               |       | 198                                                      |       | — |   | — |   |
| Amortization of  deferred loan fees, discounts and premiums                             |       | (1,442                                                   | )          | (124 | ) | 91 |   |
| Decrease  (increase) in accrued interest receivable                                     |       | 335                                                      |       | (529 | ) | (45 | ) |
| Decrease  (increase) in other assets                                                    |       | 9,063                                                    |       | (1,129 | ) | (3,241 | ) |
| (Decrease)  increase in other liabilities                                               |       | 8,455                                                    |       | 3,536 |   | (273 | ) |
| Stock based  compensation                                                               |       | 1,963                                                    |       | 1,625 |   | 1,779 |   |
| (Decrease)  increase in accrued interest payable                                        |       | (351                                                     | )          | 78 |   | 53 |   |
| Net cash provided  by operating activities                                              |       | 25,341                                                   |       | 12,237 |   | 10,654 |   |
| Cash flows from investing activities:                                                   |       |                                                     |       |   |   |   |   |
| Capital  expenditures                                                                   |       | (3,287                                                   | )          | (631 | ) | (617 | ) |
| Proceeds from sale  of office buildings                                                 |       | 11,139                                                   |       | — |   | — |   |
| Net increase in  loans                                                                  |       | (25,825                                                  | )          | (61,029 | ) | (110,389 | ) |
| Purchase of  securities available for sale                                              |       | (23,027                                                  | )          | (23,472 | ) | (153,338 | ) |
| Purchase of  investment securities held to maturity                                     |       | —                                                   |       | (107,388 | ) | (76,949 | ) |
| Proceeds from  sales and calls of securities available for sale                         |       | 80,132                                                   |       | 98,063 |   | 194,965 |   |
| Proceeds from  maturities, payments and calls of investment securities held to maturity |       | 59,159                                                   |       | 41,450 |   | 7,278 |   |
| Net decrease  (increase) in FHLB stock                                                  |       | 11,544                                                   |       | (2,053 | ) | (2,951 | ) |
| Proceeds from sale  of other real estate owned                                          |       | 388                                                      |       | 262 |   | 43 |   |
| Net cash used for  acquisition                                                          |       | (35,032                                                  | )          | — |   | — |   |
| Net cash provided  by (used in) investing activities                                    |       | 75,191                                                   |       | (54,798 | ) | (141,958 | ) |
| Cash flows from financing activities:                                                   |       |                                                     |       |   |   |   |   |
| Net (decrease)  increase in deposits                                                    |       | (55,519                                                  | )          | (437 | ) | 16,472 |   |
| Increase in  securities sold under agreements to repurchase                             |       | 26,636                                                   |       | — |   | — |   |
| Proceeds from FHLB  advances                                                            |       | 215,700                                                  |       | 109,500 |   | 105,917 |   |
| Repayment of FHLB  advances                                                             |       | (291,724                                                 | )          | (78,268 | ) | (32,306 | ) |
| Increase  (decrease) in advance payments from borrowers for taxes and insurance         |       | 1,428                                                    |       | (13 | ) | (41 | ) |
| Net proceeds from  the issuance of trust preferred securities                           |       | 25,000                                                   |       | — |   | — |   |
| Cash dividends on  common stock                                                         |       | (6,718                                                   | )          | (4,196 | ) | (3,644 | ) |
| Proceeds from  stock issuance                                                           |       | —                                                   |       | 285 |   | 392 |   |
| Stock options  exercised                                                                |       | 1,275                                                    |       | — |   | — |   |
| Repayment of stock  subscription expenses                                               |       | —                                                   |       | — |   | (36 | ) |
| Common stock  repurchased as treasury stock                                             |       | —                                                   |       | (3,146 | ) | (14,045 | ) |
| Net cash (used in)  provided by financing activities                                    |       | (83,922                                                  | )          | 23,725 |   | 72,709 |   |
| Net increase  (decrease) in cash and cash equivalents                                   |       | 16,610                                                   |       | (18,836 | ) | (58,595 | ) |
| Cash and cash equivalents:                                                              |       |                                                     |       |   |   |   |   |
| Beginning of year                                                                       |       | 20,609                                                   |       | 39,445 |   | 98,040 |   |
| End of year                                                                             |       | $                                                        | 37,219     |   | $ | 20,609 |   | $ | 39,445 |   |
| Supplemental disclosures of cash and cash flow  information                             |       |                                                     |       |   |   |   |   |
| Interest paid                                                                           |       | $                                                        | 32,589     |   | $ | 18,671 |   | $ | 15,021 |   |
| Income taxes paid                                                                       |       | 2,628                                                    |       | 2,941 |   | $ | 3,838 |   |
| Noncash items:                                                                          |       |                                                     |       |   |   |   |   |
| Net unrealized  (loss) gain on investment securities available for sale, net of tax     |       | (3,424                                                   | )          | 1,061 |   | (4,812 | ) |
| Net unrealized  gain on cash flow hedge, net of tax                                     |       | 505                                                      |       | — |   | — |   |
| Loans transferred  to other real estate owned                                           |       | —                                                   |       | 532 |   | 112 |   |

 

See accompanying Notes to Consolidated Financial Statements.

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**1.**                 Descriptionof Business and Basis of Financial Statement Presentation

Effective at 11:59 p.m.,September 21, 2006, Willow Grove Bancorp, Inc. and Willow Grove Bankchanged their names to Willow Financial Bancorp, Inc. and Willow FinancialBank, respectively. As contained  herein,references to the Company include both Willow Financial Bancorp, Inc. andWillow Grove Bancorp, Inc. and references to the Bank include both WillowFinancial Bank and Willow Grove Bank. Coincident with the name change, the Company’strading symbol on the NASDAQ Select Global Market was changed from “WGBC” to“WFBC”.

Willow Financial Bancorp, Inc. (the “Company”),is a Pennsylvania corporation and parent holding company for Willow FinancialBank (the “Bank”). The Bank, which was originally organized in 1909, is afederally chartered savings bank and wholly owned subsidiary of the Company.The Bank’s business consists primarily of making commercial business andconsumer loans as well as real estate loans, both commercial and residential,funded primarily by retail and business deposits along with borrowings.

After the close of business on August 31, 2005,the Company completed its acquisition of Chester Valley Bancorp Inc. (“ChesterValley”), a registered bank holding company headquartered in Downingtown,Pennsylvania, with over $654 million in assets. Chester Valley had twowholly owned subsidiaries, First Financial Bank, a Pennsylvania charteredcommercial bank (“Chester Valley”)with 13 full-service banking offices, and Philadelphia Corporation forInvestment Services, a registered investment advisor and broker dealer (“PCIS”).The former 13 full-service banking offices of ChesterValley, which are located in Chester County, Pennsylvania, are nowoperating as the “First Financial Division” of Willow Financial Bank.

Pursuant to the Agreement and Plan of Merger, dated asof January 20, 2005 (the “Merger Agreement”), Chester Valley was mergedwith and into the Company, with the Company as the surviving corporation (the “Merger”),and Chester Valley was merged withand into Willow Financial Bank with Willow Financial Bank as the survivingbank (the “Bank Merger”). PCIS became a wholly owned subsidiary of the Company.As a result of the Merger, each outstanding share of Chester Valley commonstock, par value $1.00 per share (the “Chester Valley Common Stock”), wasconverted into the right to receive, at the election of the shareholder, either$27.90 in cash or 1.4823 shares of the Company common stock, par value $0.01per share (the “Company Common Stock”), subject to the allocation and proration provisions set forth in the Merger Agreement. The acquisition resultedin the Company’s issuance of an aggregate of 4,977,256 shares of Company CommonStock and $51.0 million in cash. The total merger consideration paid forthe Chester Valley Common Stock was $145.3 million. This included capitalizedacquisition costs and the value of Chester Valley vested stock options convertedto options of the Company at the average stock price of the Company on the fourdays surrounding the announcement of the acquisition. The Company used generalcorporate funds to pay the aggregate cash consideration of approximately$51.0 million for the shares of Chester Valley Common Stock acquired inthe Merger for cash, as well as the approximate $3.2 million in acquisitioncosts.

The Merger has been accounted for using the purchasemethod of accounting, which requires that our financial statements includeactivity of Chester Valley only subsequent to the acquisition date of August 31,2005. Accordingly, our consolidated financial statements and the informationherein include the combined results of the former Chester Valley and its formersubsidiaries, Chester Valley andPCIS, since September 1, 2005.

Effective February 28, 2006, the Bank completedthe sale of all outstanding shares of capital stock of Philadelphia Corporationfor Investment Services (“PCIS”) to Uvest BD-A, Inc., a North Carolina Corporationand registered broker-dealer (“Uvest”) for consideration of $100 but providingthat such shares may be repurchased for $100 at any time after the closing dateof the stock sale. Concurrently with the execution of the sale of PCIS, theparties entered into a related Sub-Clearing and Brokerage Services Agreement,which provides that an affiliate of Uvest will provide securities clearing andcertain supervisory 

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and compliance servicesfor PCIS, and a Financial Services Agreement between PCIS and the Bank whichprovides that the Bank will be entitled to 92% of the revenue generated by thesecurities brokerage activities conducted at the PCIS office and will bearsubstantially all operational and overhead expenses. Upon consummation of thesale of PCIS stock to Uvest, PCIS is no longer a subsidiary of the Company.However, under the provisions of FIN 46R (“Consolidation of Variable InterestEntities”), the results of PCIS continue to be consolidated in the Company’sfinancial statements. The affiliation agreement with Uvest has the primaryeffect of relieving PCIS of direct responsibility for securities clearing andcertain back-office and oversight obligations.

References to the Company include its subsidiary,Willow Financial Bank and its business segment, PCIS, unless the context of thereference indicates otherwise.

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly owned subsidiary, Willow Financial Bank. The accounts of the Bankinclude its wholly owned subsidiaries, Willow Grove Investment Corporation,Willow Grove Insurance Agency, LLC, D&S Service Corporation, and FirstFinancial Investments. All material intercompany balances and transactions havebeen eliminated in consolidation. Certain amounts in prior years arereclassified for comparability to the current year’s presentation. Suchreclassifications, when applicable, have no effect on net income. The Companyfollows accounting and reporting practices which are in accordance with U.S. generallyaccepted accounting principles.

**2.**                 Risksand Uncertainties

In the normal course ofits business, the Company encounters two significant types of risk: economicand regulatory. There are three main components of economic risk: interest raterisk, credit risk and market risk. The Company is subject to interest rate riskto the degree that its interest-bearing liabilities mature or re-price atdifferent speeds, or on a different basis, from its interest-earningassets. The Company’s primary credit risk is the risk of default on the Company’sloan portfolio that results from the borrower’s inability to make contractuallyrequired payments. The Company’s lending activities are concentrated inPennsylvania. The largest concentration of the Company’s loan portfolio islocated in southeastern Pennsylvania. The ability of the Company’s borrowers torepay amounts owed is dependent on several factors, including the economicconditions in the borrower’s geographic region and the borrower’s financialcondition. Market risk reflects changes in the value of collateral underlyingloans, the valuation of real estate held by the Company, the valuation of loansheld for sale, securities available for sale and mortgage servicing assets. TheCompany is subject to certain Federal banking laws and regulations as furtherdescribed herein and in note 17. Compliance with regulations causes theCompany to incur significant costs. In addition, the possibility of futurechanges to such regulations presents the risk that future additional costs willbe incurred that may impact the Company.

**3.**                 Acquisitionof Chester Valley Bancorp

The above noted Chester Valley acquisition cost was approximately$145.3 million comprised of $88.5 million related to 4,977,256 shares ofcommon stock issued by the Company, $54.2 million in cash, consisting of$51.0 million paid to shareholders of Chester Valley and $3.2 million incapitalizable acquisition costs along with $2.6 million related to theconversion of former stock options of Chester Valley to options of the Company.As a result of the Merger, the Company recorded an approximate $108.1 millionintangible asset, including a $14.9 million core deposit intangible asset withthe remainder recorded as goodwill. The Company’s statement of operations forthe twelve months ended June 30, 2006 includes the results of operationsof the former Chester Valley Bancorp and subsidiaries only for the periodbeginning on September 1, 2005. The fair values used in computing thepurchase accounting adjustments have been finalized.

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The Company believes theMerger enhanced its franchise value through the addition of 13 branch locationsin the growing and affluent county of Chester County, Pennsylvania.Additionally, the Company’s existing customers have benefited from additionalproducts offered by Chester Valley, which were not being offered previously bythe Company.

The following tablesummarizes the purchase accounting adjustments resulting from the Merger:

**ChesterValley Acquisition Summary**(Dollars in Thousands)

| Total  acquisition price                                     |   | $      | 145,314 |   |
|--------------------------------------------------------------|--------|--------|---------|--------|
| Tangible book value of Chester Valley                        |   | 47,530 |    |
| Adjustments to record assets and liabilities at fair  value: |   |   |    |
| Loan discount                                                |   | (1,181 | )       |
| FHLB advance discount                                        |   | (44    | )       |
| Certificate of deposit  premium                              |   | (1,036 | )       |
| Trust preferred premium                                      |   | (277   | )       |
| Other liabilities                                            |   | (7,125 | )       |
| Market value adjustment  on premises and equipment           |   | (661   | )       |
| Core deposit intangible                                      |   | 14,883 |    |
| Resulting goodwill                                           |   | 93,225 |    |

 

The following table summarizes the pro forma operatingresults of Willow Financial Bancorp had the acquisition of Chester Valleyoccurred on July 1, 2005.

**WillowFinancial BancorpPro-forma Operating Results with Chester Valley AcquisitionFor year ended June 30, 2006(Dollars in thousands, except per share amounts)**

| Total interest income      |   | $      | 87,506 |   |
|----------------------------|--------|--------|--------|--------|
| Total interest expense     |   | 34,423 |   |
| Provision for loan  losses |   | 3,649  |   |
| Other income               |   | 8,149  |   |
| Other expense              |   | 46,971 |   |
| Income before tax          |   | 10,612 |   |
| Income tax                 |   | 3,246  |   |
| Net income                 |   | 7,366  |   |
| Non-recurring items(a)     |   | 8,426  |   |
| Adjusted net income(b)     |   | $      | 15,792 |   |
| Earnings per Share:        |   |   |   |
| Basic                      |   | $      | 0.56   |   |
| Diluted                    |   | $      | 0.54   |   |

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        (a) Reflects losses on securities sales ($1.8million), professional fees ($1.8 million) and stock option compensationpayments to holders of certain Chester Valley options ($4.8 million).

  (b) Adjusted for non-recurring items at aneffective tax rate of 35%.

The Company does notbelieve the pro-forma operating results for the year ended June 30, 2005would provide meaningful information to the reader of the financial statementsas the change in interest rates occurring during the fiscal year ended June 30,2006 resulted in significant changes in the purchase accounting adjustmentsresulting from the Merger. Additionally, the Merger was effective on the closeof 

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businesson August 31, 2005 and was therefore close to the beginning of the fiscalyear ending on June 30, 2006.

**4.**                 Summary ofSignificant Accounting Policies

***Use of Estimates***

In preparing theconsolidated financial statements, the Company is required to make estimatesand assumptions that affect the reported amounts of assets and liabilities asof the date of the statement of financial condition and revenue and expense forthe period. Actual results could differ significantly from those estimates.Material estimates that are particularly susceptible to significant change inthe near-term include the determination of the allowance for loan losses andincome taxes. Management believes that the allowance for loan losses and thebalances in income tax accounts are adequate. Various regulatory agencies, asan integral part of their examination process, periodically review the Bank’sallowance for loan losses and valuations of real estate owned. Such agenciesmay require the Bank to recognize additions to the allowance or adjustments tothe valuations based on their judgments about information available to them atthe time of their examination.

***Cash and CashEquivalents***

For purposes of theconsolidated statements of cash flows, cash and cash equivalents include cashand interest-bearing deposits with original maturities of three months orless.

***Loans Held for Sale***

Mortgage loans originatedand intended for sale in the secondary market are carried at the lower of costor market calculated on an aggregate basis, with any unrealized lossesreflected in the consolidated statements of income. Loans transferred fromloans held for sale to loans receivable are transferred at the lower of cost ormarket value at the date of transfer. Gains are recognized upon delivery to thepurchaser of said loans.

***InvestmentSecurities***

The Company divides itssecurities portfolio into three segments: (a) held to maturity, (b) availablefor sale and (c) trading. Securities in the held to maturity category arecarried at cost, adjusted for amortization of premiums and accretion ofdiscounts, using the level yield method, based on the Company’s intent andability to hold the securities until maturity. Marketable securities includedin the available for sale category are carried at fair value, with unrealizedgains or losses that are temporary in nature, net of taxes, reflected as anadjustment to equity. Securities are evaluated periodically to determinewhether a decline in their fair value is other than temporary. Managementutilizes criteria such as the magnitude and duration of the decline, inaddition to the reasons underlying the decline, to determine whether the lossin value is other than temporary. The term “other than temporary” is notintended to indicate that the decline is permanent, but indicates that theprospects for a near-term recovery of value is not necessarily favorable, orthat there is a lack of evidence to support realizable value equal to orgreater than carrying value of the investment. Once a decline in fair value isdetermined to be other than temporary, the fair value of the security isreduced and reflected in the consolidated statements of income. The fair valueof marketable securities is determined from publicly quoted market prices.Securities available for sale that are not readily marketable, which includeFederal Home Loan Bank of Pittsburgh stock, are carried at cost, whichapproximates liquidation value. Premiums and discounts on securities areamortized/accreted using the level yield method. Trading account securities arecarried at fair value, with unrealized gains and losses reflected in theconsolidated statements of income.

At the time of purchase, the Company makes adetermination of whether or not it will hold the securities to maturity, basedupon an evaluation of the probability of future events. Those securities that 

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the Company believes maynot be held to maturity, due to interest rate risk, liquidity needs, or otherasset/liability decisions, are classified as available for sale. If securitiesare sold, a gain or loss is determined by the specific identification methodand is reflected in the operating results in the period the sale occurs.Trading account securities are limited to securities that are part of certainof the Company’s benefit plans.

***Allowance for LoanLosses***

The allowance for loan losses is maintained at a levelthat management believes is adequate to cover known and inherent losses in theloan portfolio that are both probable and reasonable to estimate at eachreporting date. Management establishes the loan loss allowance in accordancewith guidance provided by the Securities and Exchange Commission’s StaffAccounting Bulletin 102 (SAB 102). The determination of the adequacy of theallowance is based upon an evaluation of the portfolio, loss experience,current economic conditions, volume, growth, composition of the portfolio, andother relevant factors. The Company uses historical loss factors for each loantype and, for loans that we consider higher risk for all but single-familymortgage loans and guaranteed consumer loans, a component for qualitativefactors that may not be included in the historical loss calculation is added.This component establishes a range for factors such as, but not limited to,delinquency trends, asset classification trends and current economicconditions. Management then assesses these conditions and establishes, to thebest of its ability, the allowance for loan losses from within the rangecalculated, based upon the facts known at that time. The methodology does notimply that any portion of the allowance for loan loss is restricted, but theallowance for loan loss applies to the entire loan portfolio.

***Loans***

Loans are recorded atcost, net of unearned discounts, deferred fees, and allowances. Discounts orpremiums on purchased loans are amortized using the level yield method over theremaining contractual life of the portfolio, adjusted for actual prepayments.Loan origination fees and certain direct origination costs are deferred andamortized over the contractual life of the related loans using the level yieldmethod.

Interest receivable onloans is accrued to income as earned. Non-accrual loans are loans on which theaccrual of interest has ceased because the collection of principal or interestpayments is determined to be doubtful by management. It is the policy of theCompany to discontinue the accrual of interest and reverse any accrued interestwhen principal or interest payments are delinquent more than 90 days (unlessthe loan principal and interest are determined by management to be fullysecured and in the process of collection), or earlier if the financialcondition of the borrower raises significant concern with regard to the abilityof the borrower to service the debt in accordance with the terms of the loan.Interest income on such loans is not accrued until the financial condition andpayment record of the borrower demonstrates the ability to service the debt.Subsequent cash receipts are applied either to the outstanding principal orrecorded as interest income, depending on management’s assessment of ultimatecollectibility of principal and interest.

Loans are considered past due after one payment hasbeen missed. Loans are charged off when they reach “loss” status in accordancewith the Bank’s asset classification policy. There are three classificationsfor problem assets: “substandard,” “doubtful,” and “loss”. Substandard assetshave one or more defined weaknesses and are characterized by the distinct possibilitythat the insured institution will sustain some loss if the deficiencies are notcorrected. Doubtful assets have weaknesses of substandard assets with theadditional characteristic that the weaknesses make collection or liquidation infull on the basis of current existing facts, conditions and values,questionable, and there is a high probability of loss. An asset classified asloss is considered uncollectible and of such little value that continuance asan asset of the institution is not warranted.

***Property andEquipment***

Property and equipment are stated at cost, lessaccumulated depreciation and amortization. The Company computes depreciationand amortization using the straight-line method over the estimated 

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useful lives of theassets, which range from three to 40 years. Significant renovations andadditions are capitalized. Leasehold improvements are depreciated over theshorter of the useful lives of the assets or the related lease term. Whenassets are retired or otherwise disposed of, the cost and related accumulateddepreciation are removed from the accounts and any resulting gain or loss isreflected in income for the period. The cost of maintenance and repairs ischarged to expense as incurred.

***Goodwill and CoreDeposit Intangibles***

Goodwill represents the excess cost over fair value ofassets acquired over liabilities as a result of the Merger and earlier branchacquisitions. Core deposit intangibles are a measure of the value of checkingand savings deposits acquired in the Merger accounted for under the purchasemethod. The core deposit intangible is being amortized to expense over atwelve-year life using a method that approximates a level yield method. TheCompany follows the provisions of SFAS No. 142, “Goodwill and OtherIntangible Assets,” and performs impairment tests of the intangible assets atleast annually and impairment losses are recognized if the carrying value ofthe intangible exceeds its fair value. The Company has not recorded anyimpairment losses as a result of this analysis in 2006, 2005 or 2004.

***Income Taxes***

Deferred tax assets and liabilities are recognized forfuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin income in the period that includes the enactment date.

***Earnings Per Share***

Earnings per share (“EPS”)consists of two separate components, basic EPS and diluted EPS. Basic EPS iscomputed by dividing net income by the weighted average number of common sharesoutstanding for each period presented, see Note 6 (Earnings Per Share).Diluted EPS is calculated by dividing net income by the weighted average numberof common shares outstanding plus dilutive common stock equivalents (“CSEs”).CSEs consist of dilutive stock options granted through the Company’s stockoption plan and unvested common stock awards.

***Stock Based Compensation***

On July 1,2005, the Company adopted Statements of Financial Accounting Standards (SFAS) No. 123R,“Share-based Payment.” This Statement establishes the standards for accountingfor share-based payment transactions in which an enterprise receives employeeservices in exchange for equity instruments of the enterprise or liabilitiesthat are based on the fair value of the enterprise’s equity instruments or thatmay be settled by the issuance of such equity instruments. SFAS No. 123Rrequires an entity to recognize the grant-date fair-value of stock options andother equity-based compensation issued to employees in the statement ofoperations. The revised Statement generally requires that an entity account forthose transactions using the fair-value based method and eliminates an entity’sability to account for share-based compensation transactions using theintrinsic value method of accounting provided in Accounting Principles Board(APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” whichwas permitted under Statement No. 123, as originally issued. Prior to July 1,2005, the Company did not recognize employee equity-based compensation costs innet income. The remaining unrecognized compensation cost relating to non-vestedstock based compensation awards at June 30, 2006 was $6.9 million. Theweighted average remaining life for these awards is 4.3 years. The adoption ofSFAS No. 123R had the following impact on reported amounts comparedwith amounts that would have been reported using the intrinsic value methodunder previous accounting:

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| ** **                                   | ** ** | **Year ended June 30, 2006**                            | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Using**                                                                   | ** ** | **SFAS** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Previous**                                                                | ** ** | **123R** | ** ** | **As** | ** ** |
| ** **                                   | ** ** | **Accounting**                                                              | ** ** | **Adjustments** | ** ** | **Reported** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands,  except per share data)** | ** ** |
| Income before taxes                          |       |                                                                        | $          | 16,638 |   |   |   | $ | (306 | ) |   | $ | 16,332 |   |
| Income taxes                                 |       |                                                                        | 5,364      |   |   |   | (108 | ) |   | 5,256 |   |
| Net Income                                   |       |                                                                        | $          | 11,274 |   |   |   | $ | (198 | ) |   | $ | 11,076 |   |
| Net income available to  common stockholders |       |                                                                        | $          | 11,198 |   |   |   | $ | (198 | ) |   | $ | 11,000 |   |
| Basic earnings per share                     |       |                                                                        | $          | 0.84 |   |   |   | $ | (0.01 | ) |   | $ | 0.83 |   |
| Diluted earnings per share                   |       |                                                                        | $          | 0.82 |   |   |   | $ | (0.01 | ) |   | $ | 0.81 |   |

 

| ** **                                   | ** ** | **Year ended June 30, 2005**                            | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | **Pro Forma** | ** ** |
| ** **                                   | ** ** | **As**                                                                      | ** ** | **Pro Forma** | ** ** | **if under** | ** ** |
| ** **                                   | ** ** | **Reported**                                                                | ** ** | **Adjustments** | ** ** | **SFAS 123R** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands,  except per share data)** | ** ** |
| Income before taxes                          |       |                                                                        | $          | 9,778 | ** ** |   |   | $ | (350 | ) |   |   | $ | 9,428 |   |   |
| Income taxes                                 |       |                                                                        | 3,052      | ** ** |   |   | (118 | ) |   |   | 2,934 |   |   |
| Net Income                                   |       |                                                                        | $          | 6,726 | ** ** |   |   | $ | (232 | ) |   |   | $ | 6,494 |   |   |
| Net income available to  common stockholders |       |                                                                        | $          | 6,627 | ** ** |   |   | $ | (232 | ) |   |   | $ | 6,395 |   |   |
| Basic earnings per share                     |       |                                                                        | $          | 0.74 | ** ** |   |   | $ | (0.03 | ) |   |   | $ | 0.71 |   |   |
| Diluted earnings per share                   |       |                                                                        | $          | 0.71 | ** ** |   |   | $ | (0.04 | ) |   |   | $ | 0.67 |   |   |

 

| ** **                                   | ** ** | **Year ended June 30, 2004**                            | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | **Pro Forma** | ** ** |
| ** **                                   | ** ** | **As**                                                                      | ** ** | **Pro Forma** | ** ** | **if under** | ** ** |
| ** **                                   | ** ** | **Reported**                                                                | ** ** | **Adjustments** | ** ** | **SFAS 123R** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands,  except per share data)** | ** ** |
| Income before taxes                          |       |                                                                        | $          | 8,721 | ** ** |   |   | $ | (450 | ) |   |   | $ | 8,271 |   |   |
| Income taxes                                 |       |                                                                        | 2,610      | ** ** |   |   | (153 | ) |   |   | 2,457 |   |   |
| Net Income                                   |       |                                                                        | $          | 6,111 | ** ** |   |   | $ | (297 | ) |   |   | $ | 5,814 |   |   |
| Net income available to  common stockholders |       |                                                                        | $          | 6,004 | ** ** |   |   | $ | (297 | ) |   |   | $ | 5,707 |   |   |
| Basic earnings per share                     |       |                                                                        | $          | 0.66 | ** ** |   |   | $ | (0.03 | ) |   |   | $ | 0.63 |   |   |
| Diluted earnings per share                   |       |                                                                        | $          | 0.62 | ** ** |   |   | $ | (0.03 | ) |   |   | $ | 0.59 |   |   |

 

***Recent AccountingPronouncements***

*FSP-FASB 115-1 and FAS 124-1, The Meaning of Other-Than-TemporaryImpairment and Its application to Certain Investments*

In November 2005, theFASB issued FASB Staff Position (FSP) FAS 115-1 and FAS 124-1, “TheMeaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments.” The FSP addresses determining when an investment isconsidered impaired and whether that impairment is other than temporary, andprovides guidance on measuring an impairment loss. The FSP requires certaindisclosures about unrealized losses not recognized as other-than-temporaryimpairments. The guidance in the FSP amends FASB Statements No. 115, “Accountingfor Certain Investments in Debt and Equity Securities”, and No. 124, “Accountingfor Certain Investments Held by Not-for-Profit Organizations”, and APB Opinion No. 18,“The Equity Method of Accounting for Investments in Common Stock”. The Companyhas considered the requirements of this FSP in its assessment of the investmentportfolio.

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*Statement ofPosition 03-3 Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer*

In December 2003, theAmerican Institute of Certified Public Accountants’ (AICPA) AccountingStandards Executive Committee (AcSEC) issued Statement of Position (SOP) 03-3,“Accounting for Certain Loans or Debt Securities Acquired in a Transfer.”SOP 03-3 is effective for loans acquired in fiscal years beginningafter December 15, 2004, with early adoption encouraged. A certaintransition provision applies for certain aspects of loans currently within thePractice Bulletin 6 on Amortization of Discounts on Certain Acquired Loans.SOP 03-3 addresses accounting for differences between contractualcash flows and cash flows expected to be collected from an investor’s initialinvestment in loans or debt securities (loans) acquired in a transfer if thosedifferences are attributable, at least in part, to credit quality. It includesloans acquired in business combinations and applies to all nongovernmentalentities, including not-for-profit organizations. The Company applied theprovisions of SOP 03-3 to the Merger with Chester Valley resulting in anapproximate $436 thousand reduction in the allowance for loan losses acquiredfrom Chester Valley to record the estimated fair value of certain loansclassified as doubtful in the acquired Chester Valley loan portfolio.

*FSP FAS 123(R)-2 Practical Accommodation to theApplication of Grant Date as Defined in FASB Statement No. 123(R)*

In October 2005, theFASB issued FSP FAS 123(R)-2, “PracticalAccommodation to the Application of**GrantDate as Defined in FASB Statement No. 123(R).” The FSP discussesthe application of grant date of a share-based payment award as defined in FASBStatement No. 123(R). One of the criteria established by Statement 123(R) fordetermining the grant date is a mutual understanding by the employer andemployee of the key terms and conditions of a share-based payment award.According to the FSP, a mutual understanding shall be presumed to exist if (a) theaward is a unilateral grant; and (b) the key terms and conditions of theaward are expected to be communicated to the employee within a relatively shortperiod of time from the date of approval. The FSP is effective upon adoption ofFASB Statement No. 123(R) for reporting periods after October 18,2005. The Company has adopted the FSP and has applied its provisions to allgrants that occurred during the year ended June 30, 2006.

*FSP FAS 123(R)-3 Transition Election Related toAccounting for the Tax Effects of Share-Based Payment Awards*

In November 2005, theFASB issued FSP FAS 123(R)-3, “Transition Election Related to Accountingfor the Tax Effects of Share-Based Payment Awards.”  This FSP provides a transition electionrelated to accounting for the tax effects of share-based payment awards toemployees. An entity must follow either the transition guidance for theadditional paid-in capital pool in Statement No. 123(R) or thealternative transition method described in the FSP. This FSP is effective afterNovember 10, 2005, but allows an entity to take up to one year from thelater of its initial adoption of Statement No. 123(R) or November 10,2005 to evaluate its transition alternatives and make a one-time election. TheCompany has elected to implement the alternative transition method inaccordance with the FSP.

*FSP FAS 123(R)-4 Classification of Options andSimilar Instruments Issued as Employee Compensation That Allow for CashSettlement upon the Occurrence of a Contingent Event*

In February 2006, theFASB issued FSP FAS 123(R)-4, which addresses the classification ofoptions and similar instruments issued as employee compensation that allow forcash settlement upon the occurrence of a contingent event. FSP FAS 123(R)-4amends SFAS No. 123R, which requires options or similar instruments to beclassified as liabilities if the employee can be required under anycircumstances to settle the option or similar instrument by transferringcash or other assets. According to FSP FAS 123(R)-4, a cashsettlement feature that can be exercised only upon the occurrence of acontingent event that is outside the employee’s control should not bereclassified as a liability until it becomes 

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probablethat the event will occur. This FSP is effective for reporting periodsbeginning after February 3, 2006, with early application permitted. As of June 30,2006, the Company has accounted for all options in accordance with FSP FAS123(R)-4.

*FSP SOP 94-6-1 Terms of Loan Products ThatMay Give Rise to a Concentration of Credit Risk*

In December 2005, theFASB issued FSP SOP 94-6-1, “Termsof Loan Products That May Give Rise to a**Concentration of Credit Risk.”  The FSP addresses the concentration of creditrisk arising from certain loan products whose contractual features may increasean entity’s exposure to risk of non-payment or realization. An entity mustdetermine whether its loan products have terms that give rise to aconcentration of credit risk, as defined in FASB Statement No. 107, andassess the adequacy of disclosures and accounting treatment for all lendingproducts. The FSP is effective for reporting periods ending after December 19,2005. The Company has reviewed its loan portfolio in accordance with FSP SOP 94-6-1and has determined that no concentration of credit risk exists as of June 30,2006.

*EITF 06-4, Accounting for Deferred Compensationand Postretirement Benefit Aspects of Endorsement Split-Dollar Life InsuranceArrangements*

In June 2006 EITFmeeting, the Task Force reached a tentative conclusion that, for endorsementsplit-dollar life insurance arrangements, an employer should recognize aliability for future benefits based on the substantive agreement with theemployee, since the postretirement benefit obligation is not effectivelysettled. An entity would be permitted to apply the consensus by retrospectiveapplication to all prior periods in accordance with FASB Statement No. 154,including its required disclosures. A final consensus on this Issue is expectedto be effective for fiscal years beginning after December 15, 2006. TheBank has recorded a liability of $246 thousand within other liabilities on theconsolidated statements of financial condition to account for the settlement ofthe future benefit obligation.

*FASB Interpretation 48, Accounting for Uncertainty inIncome Tax Positions*

In July 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Tax Positions.”  Thisinterpretation clarifies the application of FASB Statement No. 109 byestablishing a threshold condition that a tax position must meet for any partof the benefit of that position to be recognized in the financial statements. Inaddition to recognition, the interpretation provides guidance on themeasurement, derecognition, classification, and disclosure of tax positions andis effective for fiscal years beginning after December 31, 2006. TheCompany is evaluating the potential impact of this interpretation on results ofits future operations and financial condition.

**5.**                 StockCompensation Plans

The stockholders of the Company approved a stockoption plan in fiscal 2000 (the “1999 Plan”) for officers, directors andcertain employees of the Company and its subsidiaries. Pursuant to the terms ofthe 1999 Plan, the number of common shares reserved for issuance was a total of510,961, of which 42,037 options were unawarded at June 30, 2006. Includedin this amount are 6,672 shares forfeited during the year ended June 30,2006. Additionally, the stockholders of the Company approved a stock optionplan in fiscal 2003 (the “2002 Plan”) for officers, directors and certainemployees of the Company and its subsidiaries. Pursuant to the terms of the2002 Plan, the number of common shares reserved for issuance was 641,412 ofwhich 117,826 were available for future grants at June 30, 2006. Includedin this amount are 11,584 shares forfeited during the year ended June 30,2006. Generally, options were granted with an exercise price equal to fairmarket value at the date of grant and expire in 10 years from the date ofgrant. Generally, stock options granted vest over a five-year period commencingon the first anniversary of the date of grant. In addition, as part of theMerger, options previously granted under plans of Chester Valley were convertedinto options to acquire 365,662 shares of Company common stock.

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Thefollowing table provides information about options outstanding for the yearended June 30, 2006:

| ** **                                | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Weighted**        | ** ** |
|-------------------------------------------|------------|------------|------------|--------------|------------|---------------------|------------|
| ** **                                | ** ** | ** ** | ** ** | **Average**  | ** ** | **Average**         | ** ** |
| ** **                                | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Grant Date** | ** ** |
| ** **                                | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Fair Value** | ** ** |
| Options outstanding,  beginning of period |       | 794,315    |       |         | $          | 10.25               |       |   |   | $ | 2.41 |   |   |
| Granted                                   |       | 21,044     |       |         | 14.98      |                |       |   | 2.89 |   |   |
| Forfeited                                 |       | (18,258    | )          |         | 11.57      |                |       |   | 2.88 |   |   |
| Exercised                                 |       | (150,014   | )          |         | 8.50       |                |       |   | 5.16 |   |   |
| Assumed from  Chester Valley Bancorp Inc. |       | 365,662    |       |         | 10.28      |                |       |   | 7.39 |   |   |
| Options  outstanding, end of period       |       | 1,012,749  |       |         | $          | 10.41               |       |   |   | $ | 3.79 |   |   |
| Options  exercisable end of period        |       | 915,531    |       |         | 10.33      |                |       |   | 3.90 |   |   |

 

Thefollowing table provides information about unvested options for the year ended June 30,2006:

| ** **                             | ** ** | ** ** | ** ** | **Weighted**        | ** ** |
|----------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                             | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **                             | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Unvested options,  beginning of period |       | 282,892    |       |                | $          | 2.69 |   |   |
| Granted                                |       | 21,044     |       |                | 2.89       |   |   |
| Vested                                 |       | (126,439   | )          |                | 2.64       |   |   |
| Forfeited                              |       | (18,258    | )          |                | 2.88       |   |   |
| Unvested options, period  end          |       | 159,239    |       |                | $          | 2.65 |   |   |

 

Proceeds,related tax benefits realized from options exercised and intrinsic value ofoptions exercised were as follows:

| ** **                            | ** ** | **Year ended June 30,** | ** ** |
|---------------------------------------|------------|----------------------------------------|------------|
| ** **                            | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Proceeds of  options exercised        |       | $                                      | 1,275,040  |   | $ | 288,171 |   | $ | 389,060 |   |
| Related tax  benefit recognized       |       | $                                      | 198,851    |   | $ | — |   | $ | — |   |
| Intrinsic value of  options exercised |       | $                                      | 1,134,995  |   | $ | 245,762 |   | $ | 647,972 |   |

 

Thefollowing table provides information about options outstanding and exercisableoptions at June 30, 2006:

| ** **                         | ** ** | **Options**     | ** ** | **Exercisable** | ** ** |
|------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                         | ** ** | **Outstanding** | ** ** | **Options**     | ** ** |
| Number                             |       | 1,012,749       |       | 915,531         |       |
| Weighted average  exercise price   |       | $               | 10.41      |            | $          | 10.33 |   |
| Aggregate  intrinsic value         |       | $               | 7,397,922  |            | $          | 6,760,094 |   |
| Weighted average  contractual term |       | 5.6             |       | 6.0             |       |

 

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Theweighted average remaining contractual life for options outstanding andweighted average exercise price per share for exercisable options at June 30,2006 were as follows:

| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Exercisable Options** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|-------------------------|------------|
| **Exercise Price**                     | ** ** | ** **                   | ** ** | **Shares**              | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** | **Weighted  Average  Remaining  Contractual Life  (in Years)** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** |
| $  3.50 -  $  5.00 |       | 132,687                      |       |                    | 3.97       |   |   |   | 3.3 |   |   | 132,687 |   |   | $ | 3.97 |   |   |
| $  8.00 -  $  9.50 |       | 272,701                      |       |                    | 8.65       |   |   |   | 5.2 |   |   | 272,701 |   |   | 8.65 |   |   |
| $10.00 -  $14.00                       |       | 547,348                      |       |                    | 12.66      |   |   |   | 6.2 |   |   | 465,733 |   |   | 12.68 |   |   |
| $14.50 -  $17.50                       |       | 60,013                       |       |                    | 15.19      |   |   |   | 8.0 |   |   | 44,410 |   |   | 14.90 |   |   |
| Total                                       |       | 1,012,749                    |       |                    | 10.41      |   |   |   | 5.6 |   |   | 915,531 |   |   | 10.33 |   |   |
|                                             |            |                              |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

TheCompany granted 21,044 stock options during the year ended June 30, 2006.No options were granted in 2005 or 2004. The fair value for stock optionsgranted during the year ended June 30, 2006 was determined at the date ofgrant using a Black-Scholes options-pricing model. The fair value of optionawards under the Option Plans is estimated on the date of grant using theBlack-Scholes valuation methodology, which is dependent upon certainassumptions, as summarized in the following table.

| **Assumption**                            | ** ** | ** ** | ** ** | **Year  ended June 30, 2006** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------------------------|------------|
| Expected average  risk-free interest rate |       |       | 4.37       | %                                            |       |
| Expected average  life (in years)         |       |       | 5.51       |                                         |       |
| Expected  volatility                      |       |       | 17.70      | %                                            |       |
| Expected dividend yield                   |       |       | 3.37       | %                                            |       |

 

The expected averagerisk-free rate is based on the U.S. Treasury yield curve on the day of grant. Theexpected average life represents the weighted average period of time thatoptions granted are expected to be outstanding giving consideration to vestingschedules and historical option exercise experience. Expected volatility isbased on historical volatilities of the Company’s common stock. The expecteddividend yield is based on historical information.

**RRP**

Pursuant to the 1999 Recognition and Retention Planand Trust Agreement (the “1999 RRP”), the Company acquired 204,384 shares at acost of $929 thousand. Pursuant to the terms of the agreement, all 204,384shares have been awarded to directors and management from the 1999 RRP Trust.As of June 30, 2006, 197,622 granted shares were vested pursuant to theterms of the 1999 Plan. In fiscal 2003, the Company adopted the 2002Recognition and Retention Plan and Trust Agreement (the “2002 RRP”), andacquired 256,565 shares at a cost of $3.2 million. Pursuant to the termsof the 2002 RRP, 222,468 shares have been awarded to directors and management;however 13,600 shares have been forfeited. As of June 30, 2006, 159,547granted shares were vested pursuant to the terms of the 2002 RRP. At the November 9,2005 Annual Meeting, shareholders approved the 2005 Recognition and RetentionPlan and Trust Agreement (the “2005 RRP”). Under the 2005 RRP, the Trust canpurchase 350,000 shares of common stock for future awards of restricted stockto certain officers and directors of the Company. Coincident with the approvalof the 2005 RRP, the Company terminated its Directors Retirement Plan and theDirectors Incentive Compensation Plan, at which time the directors became fullyvested in their accrued benefit under the Directors Retirement Plan. As of June 30,2006, 82,643 shares were granted under the 2005 RRP.

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Activityin issued but unvested RRP shares under the three plans during the year ended June 30,2006 was as follows:

| ** **                           | ** ** | ** ** | ** ** | **Weighted**        | ** ** |
|--------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                           | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **                           | ** ** | ** ** | ** ** | **Fair**            | ** ** |
| **RRP Shares**                  | ** ** | ** ** | ** ** | **RRP Shares** | ** ** | **Value** | ** ** |
| Unvested awards  beginning of period |       |       | 97,759     |                |       |   | $ | 12.26 |   |   |
| Vested                               |       |       | (54,571    | )                   |       |   | 12.74 |   |   |
| Granted                              |       |       | 82,643     |                |       |   | 15.57 |   |   |
| Unvested awards period  end          |       |       | 125,831    |                |       |   | $ | 13.28 |   |   |
|                                      |            |            |            |                     |            |  |  |  |  |  |  |  |

 

The aggregate intrinsicvalue of unvested RRP awards under the three plans at June 30, 2006 is$520,577.

**6.**                 EarningsPer Share

For the years ended June 30, 2006, 2005 and 2004earnings per share, basic and diluted, were $0.83 and $0.81, $0.74 and $0.71,and $0.66 and $0.62, respectively.

Thefollowing is a reconciliation of the numerators and denominators of the basicand diluted earnings per share calculations.

| ** **                                                               | ** ** | **Year Ended June 30,**                                 | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                               | ** ** | **Basic**                                                              | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| ** **                                                               | ** ** | **(Dollars in thousands, except share data)** | ** ** |
| Net income                                                               |       | $                                                                      | 11,076     |   | $ | 11,076 |   | $ | 6,726 |   | $ | 6,726 |   | $ | 6,111 |   | $ | 6,111 |   |
| Dividends on  unvested stock awards                                      |       | (76                                                                    | )          | (76 | ) | (99 | ) | (99 | ) | (107 | ) | (107 | ) |
| Income available  to common stock holders                                |       | $                                                                      | 11,000     |   | $ | 11,000 |   | $ | 6,627 |   | $ | 6,627 |   | $ | 6,004 |   | $ | 6,004 |   |
| Weighted average  shares outstanding                                     |       | 13,271,077                                                             |       | 13,271,077 |   | 8,961,090 |   | 8,961,090 |   | 9,097,015 |   | 9,097,015 |   |
| Effect of  dilutive  securities                                          |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Common stock  equivalents                                                |       | —                                                                 |       | 322,052 |   | — |   | 289,673 |   | — |   | 325,357 |   |
| Unvested stock  awards                                                   |       | —                                                                 |       | 18,014 |   | — |   | 137,859 |   | — |   | 215,394 |   |
| Adjusted weighted  average shares used in earnings per share calculation |       | 13,271,077                                                             |       | 13,611,143 |   | 8,961,090 |   | 9,388,622 |   | 9,097,015 |   | 9,637,766 |   |
| Earnings per share                                                       |       | $                                                                      | 0.83       |   | $ | 0.81 |   | $ | 0.74 |   | $ | 0.71 |   | $ | 0.66 |   | $ | 0.62 |   |

 

 

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**7.**                 InvestmentSecurities

HTMand AFS investment securities at June 30, 2006 and 2005 consisted of thefollowing:

| ** **                      | ** ** | **June 30, 2006**          | ** ** |
|---------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **Amortized  cost**                  | ** ** | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair value** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Held to maturity:               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Mortgage-backed  securities:    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| FNMA                            |       | $                                    | 18,639     |   |   | $ | — |   |   |   | $ | (779 | ) |   | $ | 17,860 |   |
| FHLMC                           |       | 14,567                               |       |   | — |   |   |   | (765 | ) |   | 13,802 |   |
| CMOs                            |       | 72,355                               |       |   | — |   |   |   | (1,930 | ) |   | 70,425 |   |
| Total held to  maturity         |       | 105,561                              |       |   | — |   |   |   | (3,474 | ) |   | 102,087 |   |
| Available for sale:             |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| US government agency securities |       | 35,473                               |       |   | — |   |   |   | (1,176 | ) |   | 34,297 |   |
| Municipal bonds                 |       | 9,105                                |       |   | 90 |   |   |   | (68 | ) |   | 9,127 |   |
| Mortgage-backed  securities:    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| FNMA                            |       | 52,181                               |       |   | 13 |   |   |   | (2,054 | ) |   | 50,140 |   |
| FHLMC                           |       | 47,153                               |       |   | 6 |   |   |   | (1,988 | ) |   | 45,171 |   |
| GNMA                            |       | 4,189                                |       |   | 4 |   |   |   | (35 | ) |   | 4,158 |   |
| CMOs                            |       | 29,059                               |       |   | — |   |   |   | (561 | ) |   | 28,498 |   |
| Corporate debt securities       |       | 14,419                               |       |   | 24 |   |   |   | (235 | ) |   | 14,208 |   |
| Equities                        |       | 11,642                               |       |   | 69 |   |   |   | (385 | ) |   | 11,326 |   |
| Total available  for sale       |       | 203,221                              |       |   | 206 |   |   |   | (6,502 | ) |   | 196,925 |   |
| Total securities                |       | $                                    | 308,782    |   |   | $ | 206 |   |   |   | $ | (9,976 | ) |   | $ | 299,012 |   |

 

| ** **                      | ** ** | **June 30, 2005**          | ** ** |
|---------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **Amortized  cost**                  | ** ** | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair value** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Held to maturity:               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Municipal bonds                 |       | $                                    | 19,801     |   |   | $ | 429 |   |   |   | $ | — |   |   | $ | 20,230 |   |
| US government agency securities |       | 15,000                               |       |   | — |   |   |   | (182 | ) |   | 14,818 |   |
| Mortgage-backed  securities:    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| FNMA                            |       | 21,887                               |       |   | 47 |   |   |   | (23 | ) |   | 21,911 |   |
| FHLMC                           |       | 17,314                               |       |   | — |   |   |   | (220 | ) |   | 17,094 |   |
| CMOs                            |       | 90,449                               |       |   | 451 |   |   |   | (44 | ) |   | 90,856 |   |
| Total held to maturity          |       | 164,451                              |       |   | 927 |   |   |   | (469 | ) |   | 164,909 |   |
| Available for  sale:            |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| US government agency securities |       | 45,484                               |       |   | — |   |   |   | (617 | ) |   | 44,867 |   |
| Interest earning time deposits  |       | 98                                   |       |   | — |   |   |   | — |   |   | 98 |   |
| Mortgage-backed  securities:    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| FNMA                            |       | 46,272                               |       |   | 9 |   |   |   | (635 | ) |   | 45,646 |   |
| FHLMC                           |       | 45,293                               |       |   | — |   |   |   | (685 | ) |   | 44,608 |   |
| GNMA                            |       | —                               |       |   | — |   |   |   | — |   |   | — |   |
| CMOs                            |       | 3,786                                |       |   | 10 |   |   |   | — |   |   | 3,796 |   |
| Corporate debt securities       |       | —                               |       |   | — |   |   |   | — |   |   | — |   |
| Equities                        |       | 9,733                                |       |   | — |   |   |   | (231 | ) |   | 9,502 |   |
| Total available for sale        |       | 150,666                              |       |   | 19 |   |   |   | (2,168 | ) |   | 148,517 |   |
| Total securities                |       | $                                    | 315,117    |   |   | $ | 946 |   |   |   | $ | (2,637 | ) |   | $ | 313,426 |   |

 

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Proceeds from the sales of securities available forsale for the years ended June 30, 2006, 2005, and 2004 were $103.3million, $51.3 million, and $72.7 million, respectively. Gross gainsof $533 thousand, $415 thousand, and $948 thousand were realized infiscal 2006, 2005, and 2004, respectively. There were gross losses of $1.5million, $342 thousand, and $152 thousand for fiscal 2006, 2005 and 2004,respectively. Additionally, there were no recognized losses in fiscal 2006,2005 or fiscal 2004 resulting from other than temporary declines in values ofcertain equity securities.

As a result of the Company’s de-leveraging strategyimplemented as a result of the Merger, $34.9 million in held-to-maturity (HTM)securities were liquidated. This was performed in accordance with theprovisions of SFAS No. 115, which allows for a sale of HTM securitiescoincident with a merger to allow the Company to maintain its interest ratesensitivity immediately prior to the merger. The Company realized a net gain ofapproximately $181 thousand on the sale of the securities.

This gain is reflected in loss (gain) on sale ofsecurities available for sale and trading on the consolidated statements ofcash flow.

Accrued interest receivable on securities amounted to$1.5 million and $1.8 million at June 30, 2006 and 2005,respectively.

Of the U.S. government and agency securities in our portfolio,$4.0 million were being held at the Federal Reserve Bank at June 30,2005, as collateral for certain municipal accounts and treasury, tax and loanpayments. Additionally, $30.2 million of investment securities are held at theFederal Home Loan Bank as additional collateral for certain municipal deposits.

Theamortized cost and estimated fair value of investment securities held tomaturity, investment securities and available for sale at June 30, 2006,by contractual maturity, are shown below.

| ** **                          | ** ** | **1 year  or less**        | ** ** | **After 1 year  but less than  5 years** | ** ** | **After 5 years  but less than  10 years** | ** ** | **After 10 years  or with  no stated  maturity** | ** ** | **Total** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------|------------|
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| US government  agency securities    |       |                                 | $          | —                                                            |       |                                                                |       | $                                                                    | 2,928      |      |       |   | $ | 13,882 |   |   |   | $ | 17,487 |   |   | $ | 34,297 |   |
| Mortgage-backed  securities         |       |                                 | 19         |                                                              |       |                                                                | 13,885     |                                                                 |       |      | 36,083     |   |   |   | 180,067 |   |   | 230,054 |   |
| Municipal bonds                     |       |                                 | —     |                                                              |       |                                                                | 1,450      |                                                                 |       |      | 1,753      |   |   |   | 5,924 |   |   | 9,127 |   |
| Corporate bonds                     |       |                                 | 99         |                                                              |       |                                                                | —     |                                                                 |       |      | 1,371      |   |   |   | 12,738 |   |   | 14,208 |   |
| Equity securities                   |       |                                 | —     |                                                              |       |                                                                | —     |                                                                 |       |      | —     |   |   |   | 11,326 |   |   | 11,326 |   |
| Total securities  at fair value     |       |                                 | 118        |                                                              |       |                                                                | 18,263     |                                                                 |       |      | 53,089     |   |   |   | 227,542 |   |   | 299,012 |   |
| Total securities at  amortized cost |       |                                 | $          | 118                                                               |       |                                                                |       | $                                                                    | 18,934     |      |       |   | $ | 55,599 |   |   |   | $ | 234,131 |   |   | $ | 308,872 |   |

 

The Company must maintain ownership of specifiedamounts of stock as a member of the Federal Home Loan Bank of Pittsburgh (“FHLB”).The Company’s ownership of FHLB stock was $16.9 million and $14.3 millionas of June 30, 2006 and 2005, respectively.

For mortgage-backed securities, expectedmaturities will differ from contractual maturities because borrowers may havethe right to prepay the obligation. Of the Company’s $34.3 million U.S.Government and Government agency securities at June 30, 2006, $4.0 millionare callable within one year.

As described in note 12, certain investmentsecurities available for sale are maintained to collateralize advances from theFHLB.

Providedbelow is a summary of investment securities available-for-sale which were in anunrealized loss position at June 30, 2006. Approximately $255 thousand or4.1% of the unrealized loss was comprised of securities in a continuous lossposition for twelve months or more, which consisted of equity securities. Asignificant portion of these equity securities represents mutual fundinvestments backed primarily by 

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investments in adjustable-rate mortgage-backedsecurities. The Company has the ability and intent to hold these securitiesuntil such time as the value recovers. Further, the Company believes thedeterioration in value is attributable to changes in market conditions as theloss relates to certain mutual fund investments and not the credit quality ofthe issuer.

| ** **                       | ** ** | **June 30, 2006**          | ** ** |
|----------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **Under One Year**         | ** ** | **One Year or More** | ** ** |
| ** **                       | ** ** | **Estimated  Fair Value**       | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** | **Gross  Unrealized  Losses** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| US government  agency securities |       | $                                    | 34,297     |   |   | $ | (1,176 | ) |   |   | $ | — |   |   |   | $ | — |   |   |
| Mortgage-backed  securities      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| FNMA                             |       | 49,317                               |       |   | (2,054 | ) |   |   | — |   |   |   | — |   |   |
| FHLMC                            |       | 43,962                               |       |   | (1,988 | ) |   |   | — |   |   |   | — |   |   |
| GNMA                             |       | 4,158                                |       |   | (35 | ) |   |   | — |   |   |   | — |   |   |
| CMOs                             |       | 28,480                               |       |   | (561 | ) |   |   | — |   |   |   | — |   |   |
| Corporate debt  securities       |       | 7,916                                |       |   | (235 | ) |   |   | — |   |   |   | — |   |   |
| Municipal bonds                  |       | 5,656                                |       |   | (68 | ) |   |   | — |   |   |   | — |   |   |
| Equity securities                |       | 2,320                                |       |   | (130 | ) |   |   | 8,304 |   |   |   | (255 | ) |   |
| Total available for sale         |       | $                                    | 176,106    |   |   | $ | (6,247 | ) |   |   | $ | 8,304 |   |   |   | $ | (255 | ) |   |

 

Management does notbelieve any individual unrealized loss as of June 30, 2006 represents another-than-temporary impairment. The temporary impairment is directly relatedto changes in market interest rates. In general, as interest rates rise, thefair value of fixed-rate securities will decrease and, as interest rates fall,the fair value of fixed-rate securities will increase. The severity of theimpairment as a percent of the total investment position is nominal and theduration of the impairment to date is short. The impairments are deemedtemporary based on the direct relationship of the decline in fair value tomovements in interest rates, as well as the relatively short duration of theinvestments and their high credit quality. Additionally, the Company has theability and intent to hold these securities until such time as the valuerecovers or the securities mature.

**8.**                 Loans

Loansreceivable as of June 30, 2006 and 2005 consisted of the following:

| ** **                                     | ** ** | **June 30, 2006**          | ** ** | **June 30, 2005** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Mortgage loans:                                |       |                                 |       |                        |       |   |   |   |   |
| Single-family                                  |       |                                 | $          | 298,509                     |       |   |   | $ | 202,942 |   |   |
| Multi-family & commercial real estate |       |                                 | 326,268    |                        |       |   | 174,920 |   |   |
| Construction                                   |       |                                 | 112,774    |                        |       |   | 86,658 |   |   |
| Home equity                                    |       |                                 | 259,119    |                        |       |   | 100,805 |   |   |
| Total mortgage loans                           |       |                                 | 996,670    |                        |       |   | 565,325 |   |   |
| Consumer loans                                 |       |                                 | 4,304      |                        |       |   | 2,106 |   |   |
| Commercial  business loans                     |       |                                 | 80,815     |                        |       |   | 23,492 |   |   |
| Total loans  receivable                        |       |                                 | 1,081,789  |                        |       |   | 590,923 |   |   |
| Allowance for  loan losses                     |       |                                 | (16,737    | )                           |       |   | (6,113 | ) |   |
| Deferred loan  fees, net                       |       |                                 | (1,170     | )                           |       |   | (623 | ) |   |
| Loans receivable, net                          |       |                                 | $          | 1,063,882                   |       |   |   | $ | 584,187 |   |   |

 

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Included in loans receivable are loans on non-accrualstatus in the amounts of $15.5 million, $666 thousand, and$1.4 million at June 30, 2006, 2005 and 2004, respectively. Interestincome that would have been recognized on such non-accrual loans during theyears ended June 30, 2006, 2005 and 2004, had they been current inaccordance with their original terms was $1.4 million, $34 thousand, and$84 thousand, respectively. There were no loans that were 90 days or moredelinquent for which the Company continued to accrue interest at June 30,2006.

As of June 30, 2006, 2005 and 2004, the Companyhad impaired loans with a total recorded investment of $12.8 million,$121 thousand, and $2.1 million, respectively. Cash of $281 thousand,$77 thousand and $51 thousand was collected on these impaired loansduring the years ended June 30, 2006, 2005 and 2004, respectively. $196thousand of interest income was recognized on such loans during the years endedJune 30, 2006 and no interest income was recognized during the year ended June 30,2005 and 2004. As of June 30, 2006, 2005 and 2004, there were no recordedinvestments in impaired loans for which there was a related specific allowancefor credit losses.

Thefollowing is a summary of the activity in the allowance for loan losses for theyears ended June 30, 2006, 2005 and 2004:

| ** **                        | ** ** | **For the year ended June 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **(Dollars in thousands)**                     | ** ** |
| Balance,  beginning of the period |       | $                                                        | 6,113      |   | $ | 5,220 |   | $ | 5,312 |   |
| Plus: Provisions for loan losses  |       | 3,205                                                    |       | 1,232 |   | 426 |   |
| Less charge-offs  for:            |       |                                                     |       |   |   |   |   |
| Mortgage loans                    |       | (24                                                      | )          | (7 | ) | (58 | ) |
| Consumer loans                    |       | (62                                                      | )          | (22 | ) | (11 | ) |
| Commercial business loans         |       | (47                                                      | )          | (316 | ) | (658 | ) |
| Total Charge-offs                 |       | (133                                                     | )          | (345 | ) | (727 | ) |
| Plus: Recoveries                  |       | 615                                                      |       | 6 |   | 209 |   |
| Allowance acquired in the Merger  |       | 6,937                                                    |       | — |   | — |   |
| Balance, end of the  period       |       | $                                                        | 16,737     |   | $ | 6,113 |   | $ | 5,220 |   |

 

**9.**                 Goodwilland Core Deposit Intangible Assets

The Company recorded goodwill of $93.2 million in2006 that resulted from the Merger. The remaining goodwill balance, whichapproximates $848 thousand at June 30, 2006, relates to a branchacquisition in 1994. The net core deposit intangible balance of $13.0 millionprimarily resulted from the Merger. Theamortization expense of the core deposit intangible for the fiscal year ended June 30,2006 was $1.9 million.

Theestimated aggregate amortization expense related to core deposit intangiblesfor each of the five succeeding calendar years is:

| **Year ending** | ** ** | ** ** | ** ** | **(Dollars in thousands)** | ** ** |
|----------------------|------------|------------|------------|--------------------------------------|------------|
| June 30,  2007  |       |       | $          | 2,142,761                            |       |   |
| June 30,  2008  |       |       | 1,950,873  |                                 |       |
| June 30,  2009  |       |       | 1,758,983  |                                 |       |
| June 30,  2010  |       |       | 1,567,094  |                                 |       |
| June 30,  2011  |       |       | 1,375,205  |                                 |       |
|                 |       |       | $          | 8,794,916                            |       |   |

 

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**10.**          Propertyand Equipment

Propertyand equipment by major classification are summarized as follows:

| ** **                         | ** ** | ** **                | ** ** | **For the year ended  June 30,**     | ** ** |
|------------------------------------|------------|---------------------------|------------|----------------------------------------------------------|------------|
| ** **                         | ** ** | **Depreciable life** | ** ** | **    2006    ** | ** ** | **    2005    ** | ** ** |
| ** **                         | ** ** | ** **                | ** ** | **(Dollars in thousands)**                     | ** ** |
| Land                               |       |                      |       | $                                                        | 1,129      |   |   | $ | 1,424 |   |   |
| Buildings                          |       | 15  to 40 years      |       | 5,710                                                    |       |   | 5,341 |   |   |
| Furniture,  fixtures and equipment |       | 3 to  7 years        |       | 6,649                                                    |       |   | 2,501 |   |   |
| Total                              |       |                      |       | 13,488                                                   |       |   | 9,266 |   |   |
| Accumulated  depreciation          |       |                      |       | (3,424                                                   | )          |   | (3,607 | ) |   |
| Property and equipment,  net       |       |                      |       | $                                                        | 10,064     |   |   | $ | 5,659 |   |   |

 

Depreciation expense for the years ended June 30,2006, 2005 and 2004 amounted to $1.8 million, $955 thousand, and $996 thousand,respectively.

In February 2006, theBank completed a sale-leaseback of eight of its branch offices resulting in thereceipt of approximately $11.1 million in cash and a premium over book value ofapproximately $722 thousand. The premium attributed to the former FirstFinancial branches of $194 thousand reduced goodwill while the premiumattributed to the former Willow Grove Bank branches of $528 thousand isdeferred and amortized as a reduction of rent expense over the term of thelease.

**11.**          Deposits

Depositbalances by type consisted of the following at June 30, 2006, and 2005:

| ** **                                             | ** ** | **June 30, 2006**          | ** ** | **June 30, 2005** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **Amount**                           | ** ** | **Percent of  total**  | ** ** | **Amount** | ** ** | **Percent of  total** | ** ** |
| ** **                                             | ** ** | **(Dollars in thousands)** | ** ** |
| Savings accounts  (passbooks, statements, clubs)       |       | $                                    | 101,119    |                        |       | 10.3 | % |   | $ | 84,164 |   |   | 14.0 | % |   |
| Money market  accounts                                 |       | 305,299                              |       |                        | 31.0       |   |   | 133,883 |   |   | 22.2 |   |   |
| Certificates of  deposit less than $100,000            |       | 238,603                              |       |                        | 24.2       |   |   | 189,357 |   |   | 31.4 |   |   |
| Certificates of  deposit greater or equal to  $100,000 |       | 63,024                               |       |                        | 6.4        |   |   | 51,579 |   |   | 8.6 |   |   |
| Interest-bearing  checking accounts                    |       | 114,329                              |       |                        | 11.6       |   |   | 60,933 |   |   | 10.1 |   |   |
| Non-interest-bearing  checking accounts                |       | 162,864                              |       |                        | 16.5       |   |   | 82,762 |   |   | 13.7 |   |   |
| Total                                                  |       | $                                    | 985,238    |                        |       | 100.0 | % |   | $ | 602,678 |   |   | 100.0 | % |   |

 

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Whilecertificates of deposit are frequently renewed at maturity rather than paidout, a summary of certificates of deposit by contractual maturity and rate at June 30,2006 is as follows:

| ** **             | ** ** | **Maturity Date**            | ** ** |
|------------------------|------------|-----------------------------------|------------|
| ** **             | ** ** | **Six months  or less** | ** ** | **Over  six months  through  one year** | ** ** | **Over  one year  through  two years** | ** ** | **Over  two years  through  three years** | ** ** | **Over  three years** | ** ** |
| **Interest rate** | ** ** | ** **                        | ** ** | **(Dollars in thousands)** | ** ** |
| 0.00% -  2.99%    |       |                              | $          | 36,051 |   |   |   | $ | 22,065 |   |   | $ | 13,001 |   |   | $ | 3,241 |   |   |   | $ | 1,986 |   |   |
| 3.00% -  3.99%    |       |                              | 65,608     |   |   |   | 31,728 |   |   | 13,543 |   |   | 2,091 |   |   |   | 2,732 |   |   |
| 4.00% -  4.99%    |       |                              | 24,440     |   |   |   | 30,985 |   |   | 16,105 |   |   | 8,416 |   |   |   | 16,260 |   |   |
| 5.00% -  5.99%    |       |                              | 801        |   |   |   | 3,273 |   |   | 2,799 |   |   | 3,168 |   |   |   | 1,170 |   |   |
| 6.00% and over         |       |                              | 401        |   |   |   | 793 |   |   | 213 |   |   | 228 |   |   |   | 529 |   |   |
| Total                  |       |                              | $          | 127,301 |   |   |   | $ | 88,844 |   |   | $ | 45,661 |   |   | $ | 17,144 |   |   |   | $ | 22,677 |   |   |
|                        |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As of June 30,2006 certificates of deposit contractual maturities are:

| **Year ending** | ** ** | ** ** | ** ** | **(Dollars in thousands)** | ** ** |
|----------------------|------------|------------|------------|--------------------------------------|------------|
| June 30,  2007  |       |       | $          | 216,145                              |       |   |
| June 30,  2008  |       |       | 45,661     |                                 |       |
| June 30,  2009  |       |       | 17,144     |                                 |       |
| June 30,  2010  |       |       | 18,587     |                                 |       |
| June 30,  2011  |       |       | 2,243      |                                 |       |
| Thereafter           |       |       | 1,847      |                                 |       |
|                 |       |       | $          | 301,627                              |       |   |

 

Interestexpense on deposits for the years ended June 30, 2006, 2005 and 2004consisted of the following:

| ** **               | ** ** | **For the year ended June 30,** | ** ** |
|--------------------------|------------|----------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **               | ** ** | **(Dollars in thousands)**                     | ** ** |
| Savings accounts         |       | $                                                        | 5,980      |   | $ | 411 |   | $ | 571 |   |
| Checking accounts        |       | 1,962                                                    |       | 2,687 |   | 1,284 |   |
| Certificates of  deposit |       | 9,706                                                    |       | 6,833 |   | 7,422 |   |
| Total                    |       | $                                                        | 17,648     |   | $ | 9,931 |   | $ | 9,277 |   |

 

**12.**          Federal Home Loan Bank Advances

Under terms of its collateral agreement with the FHLB,the Company maintains otherwise unencumbered qualifying assets (principallyqualifying 1-4 family residential mortgage loans and U.S. governmentagency, and mortgage-backed securities) in the amount of at least as muchas its advances from the FHLB. The Company’s FHLB stock is also pledged tosecure these advances.

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At June 30,2006, the Company’s FHLB advances have contractual maturities as follows:

| ** **         | ** ** | **Amount  outstanding**              | ** ** | **Weighted  average rate** | ** ** |
|--------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **         | ** ** | **(dollars in thousands)** | ** ** |
| Due by:            |       |                                 |       |                            |       |   |   |   |   |
| June 30, 2007 |       |                                 | $          | 60,145                          |       |   |   | 4.0 | % |   |
| June 30, 2008 |       |                                 | 18,481     |                            |       |   | 3.8 |   |   |
| June 30, 2009 |       |                                 | 65,100     |                            |       |   | 4.6 |   |   |
| June 30, 2010 |       |                                 | 9,034      |                            |       |   | 4.9 |   |   |
| June 30, 2011 |       |                                 | 25,242     |                            |       |   | 5.2 |   |   |
| Thereafter         |       |                                 | 104,715    |                            |       |   | 3.9 |   |   |
| Total              |       |                                 | $          | 282,717                         |       |   |   | 4.2 | % |   |

 

At June 30, 2006,$164.0 million of the above advances were callable at the direction of theFHLB within certain parameters, of which $119.0 million could be calledwithin one year. Included in the $119.0 million are $60.0 million in advanceswhich could only be called if an index reaches a certain strike rate. At June 30,2006, these advances were between approximately 0.65 % and 2.65% from thestrike rate.

**13.**          TrustPreferred Securities and Other Borrowings

**Effective with the acquisition ofChester Valley, the Company assumed the liability for $10.5 million of JuniorSubordinated Debentures to the Chester Valley Statutory Trust, a PennsylvaniaBusiness Trust, in which the Company owns all of the common equity as a resultof the acquisition of Chester Valley. The Trust issued $10.0 million of TrustPreferred Securities to investors, which are secured by the Junior SubordinatedDebentures and the guarantee of the Company. The Junior Subordinated Debenturesare treated as debt of the Company but they qualify as Tier I capital, subjectto certain limitations under the risk-based capital guidelines of the Office of Thrift Supervision (“OTS”). TheTrust Preferred Securities are callable by the Company on or after March 26,2007, or at any time in the event the deduction of related interest expense forfederal income taxes is prohibited, the treatment as Tier I capital is nolonger permitted or under certain other circumstances. The Trust PreferredSecurities must be redeemed by the Company upon their maturity in the year2032.**

On March 31, 2006 the Company issued $25.8million of Junior Subordinated Debentures to Willow Grove Statutory Trust I, aConnecticut Statutory Trust, in which the Company owns all of the common equity.The Trust then issued $25.0 million of Trust Preferred Securities, which payinterest quarterly at three-month Libor plus 1.31% to investors, which aresecured by the Junior Subordinated Debentures and the guarantee of the Company.The Junior Subordinated Debentures are treated as debt of the Company butqualify as Tier I capital of the Bank to the extent of the amount of theproceeds, which are invested in the Bank. The Trust Preferred Securities arecallable by the Company at par on or after June 15, 2011. The TrustPreferred Securities must be redeemed by the Company upon their maturity in theyear 2036.

The Bank utilizes outsideborrowings to supplement its funding needs. At June 30, 2006, the Bank had$53.2 million outstanding in repurchase agreements. This included $33.1 millionin short-term repurchase sweep arrangements with deposit customers with interestrates ranging from 4.13% to 4.78% and $20.0 million in wholesale reverserepurchase transactions with an interest rate of 4.98%. The repurchase sweepagreements were collateralized by $34.1 million in investment securities at June 30,2006.

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**14.**          Income Taxes

Incometax expense (benefit) for the years ended June 30, 2006, 2005 and 2004consisted of the following:

|                                        | ** ** | ** ** | ** ** | **Current**                          | ** ** | **Deferred** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|------------|------------|--------------------------------------|------------|--------------|------------|-----------|------------|
| ** **                             | ** ** | ** ** | ** ** | **(Dollars in thousands)** | ** ** |
| For the year ended  June 30, 2006 |       | Federal    |       |                                 | $          | 2,646        |       |      |       | $ | 2,586 |   |   | $ | 5,232 |   |
|                                        |       | State      |       |                                 | 24         |         |       |      | —     |   |   | 24 |   |
|                                        |       | Total      |       |                                 | $          | 2,670        |       |      |       | $ | 2,586 |   |   | $ | 5,256 |   |
| For the year  ended June 30, 2005 |       | Federal    |       |                                 | $          | 3,050        |       |      |       | $ | 3 |   |   | $ | 3,053 |   |
|                                   |       | State      |       |                                 | —     |         |       |      | —     |   |   | — |   |
|                                   |       | Total      |       |                                 | $          | 3,050        |       |      |       | $ | 3 |   |   | $ | 3,053 |   |
| For the year ended  June 30, 2004 |       | Federal    |       |                                 | $          | 2,851        |       |      |       | $ | (269 | ) |   | $ | 2,582 |   |
|                                        |       | State      |       |                                 | 28         |         |       |      | —     |   |   | 28 |   |
|                                        |       | Total      |       |                                 | $          | 2,879        |       |      |       | $ | (269 | ) |   | $ | 2,610 |   |

 

Theexpense (benefit) for income taxes differed from that computed at the statutoryfederal corporate rate for the years ended June 30, 2006, 2005 and 2004 asfollows:

| ** **                             | ** ** | **For the year ended June 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                             | ** ** | **Amount**                                               | ** ** | **Percent of  pretax  income** | ** ** | **Amount** | ** ** | **Percent of  pretax  income** | ** ** | **Amount** | ** ** | **Percent of  pretax  income** | ** ** |
| ** **                             | ** ** | **(Dollars in thousands)**                     | ** ** |
| At statutory rate                      |       |                                                     | $          | 5,716 |   |   |   | 35.0 | % |   |   | $ | 3,324 |   |   |   | 34.0 | % |   |   | $ | 2,965 |   |   |   | 34.0 | % |   |
| State tax, net of  federal tax benefit |       |                                                     | 15         |   |   |   | 0.1 |   |   |   | — |   |   |   | — |   |   |   | 18 |   |   |   | 0.2 |   |   |
| Low income  housing credits            |       |                                                     | (154       | ) |   |   | (0.9 | ) |   |   | (29 | ) |   |   | (0.3 | ) |   |   | (29 | ) |   |   | (0.3 | ) |   |
| Tax-exempt  interest                   |       |                                                     | (269       | ) |   |   | (1.6 | ) |   |   | (280 | ) |   |   | (2.9 | ) |   |   | (256 | ) |   |   | (2.9 | ) |   |
| Meals and  entertainment               |       |                                                     | 6          |   |   |   | 0.0 |   |   |   | 6 |   |   |   | 0.1 |   |   |   | 7 |   |   |   | 0.1 |   |   |
| BOLI                                   |       |                                                     | (130       | ) |   |   | (0.8 | ) |   |   | (65 | ) |   |   | (0.7 | ) |   |   | (82 | ) |   |   | (0.9 | ) |   |
| Dividends on ESOP  shares              |       |                                                     | (106       | ) |   |   | (0.7 | ) |   |   | (108 | ) |   |   | (1.1 | ) |   |   | (98 | ) |   |   | (1.1 | ) |   |
| Non-deductible  expenses               |       |                                                     | —     |   |   |   | 0.0 |   |   |   | 1 |   |   |   | 0.0 |   |   |   | 2 |   |   |   | 0.0 |   |   |
| ESOP compensation  expense             |       |                                                     | 174        |   |   |   | 1.1 |   |   |   | 196 |   |   |   | 2.0 |   |   |   | 115 |   |   |   | 1.2 |   |   |
| Stock based  compensation              |       |                                                     | 107        |   |   |   | 0.7 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Change in  statutory federal tax rate  |       |                                                     | (93        | ) |   |   | (0.6 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Other                                  |       |                                                     | (10        | ) |   |   | (0.1 | ) |   |   | 7 |   |   |   | 0.1 |   |   |   | (32 | ) |   |   | (0.4 | ) |   |
| Income tax  expense                    |       |                                                     | $          | 5,256 |   |   |   | 32.2 | % |   |   | $ | 3,052 |   |   |   | 31.2 | % |   |   | $ | 2,610 |   |   |   | 29.9 | % |   |

 

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Significantdeferred tax assets and liabilities included in other assets and liabilities ofthe Company as of June 30, 2006 and 2005 are as follows:

| ** **                                        | ** ** | **June 30,**                                                    | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                        | ** ** | **     2006     ** | ** ** | **    2005    ** | ** ** |
| ** **                                        | ** ** | **(Dollars in thousands)**                                 | ** ** |
| Impairment  reserves                              |       |                                                                 | $          | — |   |   |   | $ | 52 |   |   |
| Deferred loan  fees                               |       |                                                                 | 115        |   |   |   | 212 |   |   |
| Retirement plan  reserves                         |       |                                                                 | 586        |   |   |   | 569 |   |   |
| Employee benefits                                 |       |                                                                 | 222        |   |   |   | 380 |   |   |
| Uncollected  interest                             |       |                                                                 | 274        |   |   |   | 23 |   |   |
| Book bad debt  reserves                           |       |                                                                 | 6,024      |   |   |   | 2,078 |   |   |
| Unrealized loss  on available for sale securities |       |                                                                 | 1,966      |   |   |   | 772 |   |   |
| Investment impairment  reserves                   |       |                                                                 | 1,504      |   |   |   | — |   |   |
| Loan discounts                                    |       |                                                                 | 325        |   |   |   | — |   |   |
| Sale/Leaseback                                    |       |                                                                 | 167        |   |   |   | — |   |   |
| Purchase accounting  fair value adjustments       |       |                                                                 | 292        |   |   |   | — |   |   |
| Fixed asset  write-downs                          |       |                                                                 | 299        |   |   |   | — |   |   |
| Money market fee  reserves                        |       |                                                                 | 96         |   |   |   | — |   |   |
| Investment in  joint venture                      |       |                                                                 | 188        |   |   |   | — |   |   |
| Net operating  loss carryover                     |       |                                                                 | 196        |   |   |   | — |   |   |
| Other, net                                        |       |                                                                 | 110        |   |   |   | 63 |   |   |
| Gross deferred  tax assets                        |       |                                                                 | 12,364     |   |   |   | 4,149 |   |   |
| Prepaid expenses                                  |       |                                                                 | (14        | ) |   |   | (14 | ) |   |
| Originated  mortgage servicing rights             |       |                                                                 | (63        | ) |   |   | (106 | ) |   |
| Gain on transfer  of AFS securities               |       |                                                                 | —     |   |   |   | (5 | ) |   |
| Intangible asset  amortization                    |       |                                                                 | (3,534     | ) |   |   | 65 |   |   |
| Prepayment  penalties                             |       |                                                                 | (55        | ) |   |   | — |   |   |
| Swap loss                                         |       |                                                                 | (19        | ) |   |   | — |   |   |
| Depreciation                                      |       |                                                                 | (411       | ) |   |   | (145 | ) |   |
| Gross deferred  tax liabilities                   |       |                                                                 | (4,096     | ) |   |   | (205 | ) |   |
| Net tax deferred asset                            |       |                                                                 | $          | 8,268 |   |   |   | $ | 3,943 |   |   |

 

During the year, as a result of the Merger, theCompany recorded historical net deferred tax assets from Chester Valley of $4.9 million,along with net deferred tax assets created due to purchase accounting adjustmentsof $780 thousand. The realizability of deferred tax assets is dependentupon a variety of factors, including the generation of future taxable income,the existence of taxes paid and recoverable, the reversal of deferred taxliabilities and tax planning strategies. Based upon these and other factors,management believes it is more likely than not that the Company will realizethe benefits of these deferred tax assets.

At June 30, 2006, the Company had $559 thousandin net operating loss carry-forwards for federal income tax purposes as aresult of the Merger. The net operating loss carry-forwards expire in June 2025.

 

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The Small Business Job Protection Act of 1996 (the“1996 Act”) eliminated the use of the reserve method of accounting for bad debtreserves by savings institutions, effective for taxable years beginning after1995. Prior to the 1996 Act, bad debt reserves created prior to January 1,1988 were subject to recapture into taxable income if the Bank failed to meetcertain thrift asset and definitional tests. New federal legislation eliminatedthese thrift related recapture rules. However, under current law, pre-1988reserves remain subject to recapture should the Bank make certain non-dividenddistributions or ceases to maintain a bank charter.

At June 30, 2006, theBank’s total federal pre-1988 tax bad debt reserve was approximately$8.9 million. The reserve reflects the cumulative effects of federal taxdeductions for which no federal income tax provisions have been made.

**15.**          BenefitPlans

*401(k) Plan*

The 401(k)/ESOP covers alleligible employees and permits them to make certain contributions to their 401(k) accountsin the plan on a pretax basis. Employees are permitted to contribute up to 25%of their salary to this plan. The Company matches fifty cents for every dollarcontributed up to 6% of salary. The expense related to the 401(k) portionof this plan was $255 thousand, $70 thousand, and $167 thousand for the yearsended June 30, 2006, 2005 and 2004, respectively.

*Employee StockOwnership Plan*

On December 23, 1998,the Company adopted an Employee Stock Ownership Plan (“ESOP”). The ESOPborrowed $1.8 million from the Company and used the funds to purchase408,769 shares (179,270 shares pre-exchange) of the Company’s common stock. Theloan has an interest rate of 7.75% and has an amortization schedule of15 years. In April 2002, an additional ESOP loan was made of$5.1 million to purchase an additional 513,130 shares of the Company’scommon stock issued in its “second step” reorganization. This loan has aninterest rate of 4.75% and an amortization schedule of 15 years. Sharespurchased are held in a suspense account for allocation among the participantsas the loans are repaid. Effective January 31, 2000, the Company mergedthe 401(k) Plan and ESOP. Contributions to the ESOP portion of the401(k)/ESOP and shares released from the loan collateral will be in an amountproportional to repayment of the original ESOP loans. Shares are allocated toparticipants based on compensation as described in the 401(k)/ESOP, in the yearof allocation. At June 30, 2006, there were 349,770 ESOP shares allocatedto participants, representing a fair value of $3.2 million, in addition,there were 30,730 shares committed to be released. The Company recordedcompensation expense of $955 thousand, $1.0 million, and $1.0 millionfor the ESOP for the years ended June 30, 2006, 2005 and 2004,respectively.

*SupplementalRetirement Plans*

Effective June 30, 1998, the Company adoptednon-qualified supplemental retirement plans for the Company’s Board ofDirectors (the “Directors’ Plan”) and for the Company’s president (the “President’sPlan”). The Directors’ Plan provides for fixed annual payments to qualifieddirectors for a period of ten years from retirement. Benefits to be paidaccrued at the rate of 20% per year on completion of six full years of service,with full benefit accrual at ten years of service. At the time these plans wereadopted credit was given for past service. The President’s Plan provides forpayments for a period of ten years beginning at retirement based on apercentage of annual compensation not to exceed an established cap. Fullbenefits become accrued at age 68 with partial vesting prior thereto. Bothplans provide for full payments in the event of a change in control of theCompany. The costs of each of the Directors’ Plan and President’s Plan were $0and $0, $142 thousand and $99 thousand, and $163 thousand and$35 thousand for fiscal years ended 2006, 2005 and 2004, respectively. TheDirectors’ Plan and President’s Plan are 

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intended to be, and are,unfunded. The accrued liability of the Directors’ Plan and the President’s Planwere $965 thousand and $710 thousand and $983 thousand and$735 thousand at June 30, 2006 and 2005, respectively.

In November 2005, theCompany terminated its Directors Retirement Plan and the Directors IncentiveCompensation Plan, at which time the directors became fully vested in theiraccrued benefit as of October 31, 2005, under the Directors RetirementPlan. The President has retired and is fully vested in the Plan.

**16.**          Commitmentsand Contingencies

At June 30, 2006 and2005, the Company was committed to fund loans as follows:

| ** **                          | ** ** | **June 30,**                    | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|
| ** **                          | ** ** | **2006**                             | ** ** | **2005** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Loans with fixed  interest rates    |       | $                                    | 5,923      |   | $ | 17,655 |   |
| Loans with  variable interest rates |       | 8,824                                |       | 2,484 |   |
| Total commitments to  fund loans    |       | $                                    | 14,747     |   | $ | 20,139 |   |

 

**FinancialInstruments With Off-Balance Sheet Risk**

The Company is a party tofinancial instruments with off-balance-sheet risk in the normal course ofbusiness to meet the financing needs of its customers. These financialinstruments include commitments to extend credit and standby letters of credit.Those instruments involve, to varying degrees, elements of credit risk inexcess of the amount recognized in the balance sheet. The Company’s exposure tocredit loss in the event of non-performance by the other party to the financialinstrument for commitments to extend credit and standby letters of credit isrepresented by the contractual notional amount of those instruments. TheCompany uses the same credit policies in making commitments and conditionalobligations as it does for on-balance-sheet instruments (see Note 4above). At June 30, 2006 and June 30, 2005, respectively, the Companywas committed to the funding of first mortgage loans of $9.9 million and$15.7 million, respectively, construction loans of $61.6 million and$48.6 million, respectively, commercial real estate loans of $5.7 millionand $2.7 million, respectively, lines of credit of $146.0 million and$38.2 million, respectively, and standby letters of credit of $9.0 millionand $2.4 million, respectively.

**Guarantees**

In the normal course of business, the Company sellsloans in the secondary market. As is customary in such sales, the Companyprovides indemnification to the buyer under certain circumstances. Thisindemnification may include the obligation to repurchase loans by the Company,under certain circumstances. In most cases repurchases and losses are rare, andno provision is made for losses at the time of sale. When repurchases andlosses are probable and reasonably estimable, a provision is made in thefinancial statements for such estimated losses.

On May 12, 2003, theCompany entered into a sales and servicing master agreement with the FederalHome Loan Bank of Pittsburgh (“FHLB”). The agreement allows the Company to sellloans to the FHLB while retaining servicing and providing for a creditenhancement. Under the terms of the agreement, the Company receives a ten basispoint annual fee in exchange for assuming the credit risk on losses in excessof its contractual obligation up to a maximum of $605 thousand. The Company hassold $16.6 million in loans under this agreement and had a maximum credit riskexposure of $461 thousand at June 30, 2006. The fair value of theseguarantees was determined to be $0 at June 30, 2006.

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**Concentration ofCredit Risk**

The Company offersresidential and construction real estate loans as well as commercial andconsumer loans. The Company’s lending activities are concentrated inPennsylvania. The largest concentration of the Company’s loan portfolio is locatedin eastern Pennsylvania. The ability of the Company’s borrowers to repayamounts owed is dependent on several factors, including the economic conditionsin the borrower’s geographic region and the borrower’s financial condition.

**Legal Proceedings**

*IrvineConstruction Co. v. Sklaroff, et al.,*(Court of CommonPleas of Montgomery County, Pennsylvania). On September 5, 2003, acomplaint was filed against Willow Financial Bank and eight additionaldefendants by Irvine Construction Co., Inc., alleging thirteen causes ofaction related to an agreement for the construction of an office building.Eleven of such causes include the Bank as a defendant and are: breach ofcontract (two counts), unjust enrichment/equitable restitution (in thealternative), fraud, civil conspiracy (two counts), fraudulent transfer andaiding and abetting fraudulent transfers, constructive trust, abuse of process,and tortuous interference with existing contractual relations (two counts).Four counts against the Bank seek damages in excess of $1.0 million, fivecounts seek damages in excess of $50 thousand, punitive damages and otherrelief, and two counts seek constructive relief. On May 12, 2004, theCourt struck the claim for unjust enrichment and all claims for attorney’sfees. The remaining claims continue to be litigated and discovery is ongoing.Plaintiff and all defendants have propounded and responded to interrogatoriesand document requests. Plaintiff has produced in excess of 11,000 document pages tothe Bank, and the Bank is pursuing additional discovery in the form of morecomplete interrogatory responses and requests to admit. The Bank anticipatesfiling additional motions to compel and partially dispositive motions.Presently, plaintiff and five of the defendants are engaged in motions practiceregarding the lis pendens plaintiff filed on the property at issue, althoughthe Bank is not involved in these proceedings. No depositions are presentlyscheduled. The Bank is vigorously defending the claims and believes that they arewithout merit.

As previously described in the company’sprospectus/joint proxy statement dated April 27, 2005 and included in itsregistration statement on Form S-4 (file No. 333-123622)filed in connection with the Merger, FFB previously received a subpoena fromthe Regional Municipal Securities Counsel in the Philadelphia Office of theSecurities and Exchange Commission (the “SEC”). The subpoena arose out of anon-public SEC investigation titled “Hummelstown General Authority,” whichAuthority issued non-rated revenue bonds now in default, underwritten by thefirm of a former director of Chester Valley and FFB. The SEC subpoena requestedthe production of certain documents concerning FFB’s involvement with non-ratedmunicipal securities, including those issued to finance the Whitetail GolfCourse by the Dauphin County General Authority and the Hummelstown GeneralAuthority, through the former director’s firm, and related matters. FFBpreviously produced documents to the SEC and certain officers of FFB providedtestimony to the SEC in response to the SEC’s voluntary request for assistancein this matter. On August 3, 2006, the SEC filed a complaint in federalcourt against the former director, his wife, and the former director’s firm.The Bank is not named as a defendant in the complaint filed by the SEC.

FFB is a party to three civil actions relating to someof the revenue bonds which are the subject of the SEC investigation describedabove. On August 30, 2005, a writ of summons was filed by the BoyertownArea School District in the Court of Common Pleas, Montgomery County,Pennsylvania commencing a civil action against, *inter alia,*FFB. *Boyertown Area School District v. First FinancialBank et. al.*, No. 05-21799. A complaint was filed on November 9,2005, asserting the following claims against FFB: Breach of Trust Indenture andFiduciary Duties (Count 1), Breach of Fiduciary Duties (Count 2), CivilConspiracy (Count 3), and Concerted Action (Count 4). Preliminary Objectionshave been filed and are pending. On September 13, 2005, Red Lion AreaSchool District filed a complaint in the Court of Common Pleas, York County,Pennsylvania, against, *inre alia*, FFB.*Red Lion Area School District v.*

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*Bradburyet. al.*, No. 2005-SU-1656-Y01; No. 2005-SU-2544-Y01.This case has been transferred to the Court of Common Pleas of MontgomeryCounty, Pennsylvania. The complaint asserts the following claims against FFB:Civil Conspiracy (Count 14), and Breach of Duty as Trustee (Count 15). PreliminaryObjections have been filed and are pending. On March 16, 2006, PerkiomenValley School District filed a complaint in the Court of Common Pleas,Montgomery County, Pennsylvania, against, *inte alia*, FFB *Perkiomen Valley School District v. First Financial Bank et.al.*,No. 06-06533. The complaint asserts the following claims againstFFB: Breach of Trust Indenture (Count 1), Breach of Fiduciary Duties (Count 2),Vicarious Liability and Respondeat Superior (Count 3), Civil Conspiracy (Count4), and Concert of Action (Count 5).

The actions have been consolidated for discovery andcase management purposes, but not for trial. Preliminary Objections have beenfiled and are pending in each of these actions. No discovery has taken place. Oneof the plaintiffs has filed a motion to stay the proceedings pending theoutcome of the SEC action described above.

In the normal course ofbusiness, the Company is involved in various legal proceedings. Management ofthe Company, based on discussions with legal counsel, believes that suchproceedings will not have a material adverse effect on the financial conditionor operations of the Company. There can be no assurance that any of theoutstanding legal proceedings to which the Company is a party will not bedecided adversely to the Company’s interests and have a material adverse effecton the financial condition and operations of the Company.

**Other Commitments**

Inconnection with the operation of 25 of its banking offices and an operationscenter, the Company leases certain office space. The leases are classified asoperating leases, with rent expense of $2.0 million, $837 thousand, and $767thousand for the years ended June 30, 2006, 2005 and 2004, respectively.Minimum payments over the remainder of the leases are summarized as follows:

| ** **         | ** ** | **Minimum lease payments** | ** ** |
|--------------------|------------|--------------------------------------|------------|
| ** **         | ** ** | **(Dollars in thousands)** | ** ** |
| Year ended:        |       |                                 |       |   |   |
| June 30, 2007 |       |                                 | $          | 2,560 |   |   |
| June 30, 2008 |       |                                 | 2,433      |   |   |
| June 30, 2009 |       |                                 | 2,389      |   |   |
| June 30, 2010 |       |                                 | 1,959      |   |   |
| June 30, 2011 |       |                                 | 1,806      |   |   |
| Thereafter         |       |                                 | 16,165     |   |   |
| Total              |       |                                 | $          | 27,312 |   |   |

 

**17.**          Accountingfor Derivative Instruments and Hedging

The Company may from time to time utilize derivativeinstruments such as interest rate swaps, interest rate collars, interest ratefloors, interest rate swaptions or combinations thereof to assist in itsasset/liability management. In accordance with SFAS No. 133, “Accountingfor Derivative Instruments”, the Company formally documents its hedgerelationships, including identification of the hedging instruments and thehedged items, as well as its risk management objectives and strategies forundertaking the hedge. The Company also formally assesses, both at inceptionand at least quarterly thereafter, whether the derivative instruments that areused in hedging transactions are highly effective in offsetting the changes ineither the fair value or cash flows of the hedged item. For fair value hedges,both the effective and ineffective portions of the changes in the fair value ofthe derivative, along with the gain or loss on the hedged item that isattributable to the hedged risk, are recorded in the statement of operations 

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within interest income orinterest expense. For cash flow hedges, the effective portion of the change inthe fair value of the derivative is recorded in accumulated other comprehensiveincome. When the hedged item impacts the statement of operations, the gain orloss included in accumulated other comprehensive income is reported on the sameline in the statement of operations as the hedged item. In addition, theineffective portion of the changes in the fair value of derivatives used ascash flow hedges is reported in the statement of operations.

As part of the Merger, the Company assumed theresponsibility for a $20 million notional interest rate swap whereby theCompany pays a variable rate and receives a fixed rate. The interest rate swaphad been used to hedge certain Federal Home Loan Bank borrowings of the formerChester Valley. On the date of the Merger, the interest rate swap and thehedged borrowings were marked to fair value in purchase accounting. In September 2005,the hedged borrowings were repaid and $10 million notional amount of theinterest rate swap was unwound with the counter-party. After performing theappropriate documentation of the derivative instrument, the Company designatedthe remaining $10 million notional amount interest rate swap as a fair valuehedge of certain existing borrowings of Willow Financial Bank. The swap had theeffect of converting a fixed rate borrowing to an adjustable rate borrowing.During the year ended June 30, 2006, the derivative instrument ceased tobe a highly effective hedge; therefore, the Company discontinued hedgeaccounting resulting in a pre-tax charge to the statement of operations of $47thousand. The interest rate swap was unwound on January 31, 2006 withoutresulting in any additional impact to the statement of operations. The basisadjustment that was previously recorded on the hedged borrowing that isrecorded in the consolidated statements of financial condition is amortized asa reduction in interest expense over the remaining life of the borrowing usingthe interest method. The net amount of this adjustment was $156 thousand at June 30,2006.

Additionally, in August 2003,Chester Valley had purchased a $30.0million notional amount 3.50% Three Month LIBOR interest rate cap whilesimultaneously selling a $30.0 million notional amount 6.00% Three Month LIBORinterest rate cap (“Interest Rate Corridor”) which expires in August 2008.Chester Valley paid a net premium, which entitled it to receive the differencebetween Three Month LIBOR from 3.50% up to 6.00% times the $30.0 millionnotional amount. Upon consummation of the Merger, the Company assumed theInterest Rate Corridor and designated it to hedge certain borrowings of Willow FinancialBank, which were variable in nature and indexed to Three Month LIBOR. TheInterest Rate Corridor is being used to hedge the cash flows of this borrowing.The Interest Rate Corridor could potentially reduce the negative impact onearnings of the borrowings in a rising interest rate environment. The fairmarket value of the Interest Rate Corridor has two components: the intrinsicvalue and the time value of the option. The Interest Rate Corridor ismarked-to-market quarterly, with changes in the intrinsic value of the InterestRate Corridor, net of tax, included as a separate component of othercomprehensive income and changes in the time value of the option includeddirectly as interest expense as required under SFAS 133. In addition, theineffective portion, if any, would have been expensed in the period in whichineffectiveness was determined. The Corridor was highly effective throughoutthe fiscal year ended June 30, 2006. The fair value of the Interest RateCorridor at June 30, 2006 was $1.2 million.

**18.**          RegulatoryMatters

The Bank is subject to various regulatory capitalrequirements administered by the federal banking agencies. Failure to meetminimum capital requirements can initiate certain mandatory, and possiblyadditional discretionary actions by regulators that if undertaken, could have adirect material effect on the Company’s financial statements. Under capitaladequacy guidelines and the regulatory framework for prompt corrective action,the Bank must meet specific capital guidelines that involve quantitativemeasures of the Bank’s assets, liabilities, and certain off-balance sheet itemsas calculated under accounting practices. The Bank’s capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

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At June 30, 2006, theBank had regulatory capital, which was well in excess of regulatory limits setby the Office of Thrift Supervision. The current requirements and the Bank’sactual capital levels are detailed below:

| ** **                     | ** ** | **Actual Capital**              | ** ** | **Required for Capital  Adequacy Purposes** | ** ** | **Required to Be Well  Capitalized under  Prompt Corrective  Action Provision** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **Amount**                           | ** ** | **Ratio**                                                  | ** ** | **Amount**                                                                                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| *As of June 30, 2006*     |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Tangible capital               |       | $                                    | 114,061    |                                                       |       | 7.8                                                                                                           | %          |   | $ | 22,028 |   |   | 1.5 | % |   | $ | 29,370 |   |   | 2.0 | % |   |
| (to tangible  assets)          |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Core capital                   |       | 114,061                              |       |                                                       | 7.8        | %                                                                                                             |       | 58,711 |   |   | 4.0 | % |   | 73,426 |   |   | 5.0 | % |   |
| (to adjusted  tangible assets) |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Tier I capital                 |       | 114,061                              |       |                                                       | 11.9       | %                                                                                                             |       | N/A |   |   | N/A |   |   | 57,165 |   |   | 6.0 | % |   |
| (to risk-weighted  assets)     |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Risk-based  capital            |       | 125,569                              |       |                                                       | 13.2       | %                                                                                                             |       | 76,220 |   |   | 8.0 | % |   | 95,274 |   |   | 10.0 | % |   |
| (to risk-weighted  assets)     |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| *As of  June 30, 2005*    |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Tangible capital               |       | $                                    | 94,375     |                                                       |       | 9.9                                                                                                           | %          |   | $ | 14,296 |   |   | 1.5 | % |   | $ | 19,061 |   |   | 2.0 | % |   |
| (to tangible  assets)          |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Core capital                   |       | 94,375                               |       |                                                       | 9.9        | %                                                                                                             |       | 38,140 |   |   | 4.0 | % |   | 47,675 |   |   | 5.0 | % |   |
| (to adjusted  tangible assets) |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Tier I capital                 |       | 94,375                               |       |                                                       | 16.6       | %                                                                                                             |       | N/A |   |   | N/A |   |   | 34,091 |   |   | 6.0 | % |   |
| (to risk-weighted  assets)     |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Risk-based  capital            |       | 100,488                              |       |                                                       | 17.7       | %                                                                                                             |       | 45,455 |   |   | 8.0 | % |   | 56,819 |   |   | 10.0 | % |   |
| (to risk-weighted assets)      |       |                                 |       |                                                       |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |

 

In its letter approvingthe merger of Willow Financial Bank and First Financial Bank, the Office ofThrift Supervision (“OTS”), as one of the conditions for approval, indicatedthat, for the periods ending December 31, 2005, 2006, and 2007, Willow FinancialBank must have tier one core capital ratios at least equal to 6.50%, 6.75%, and7.25%, respectively, and total risk-based capital equal to 11.97%, 12.02% and12.40%, respectively. Willow Financial Bank must also submit to the Office ofThrift Supervision, quarterly status reports detailing its compliance with theconditions on regulatory capital outlined in its approval letter. The Office ofThrift Supervision’s conditions for approval of the Bank Merger also indicatedthat, for the periods ending December 31, 2005, 2006, and 2007, Willow FinancialBancorp must have consolidated tangible capital ratios at least equal to 5.14%,5.59% and 6.12%, respectively. The Bank currently exceeds all of theserequirements.

**19.**          FairValue of Financial Instruments

The Company’s methods fordetermining the fair value of its financial instruments as well as significantassumptions and limitations are set forth below.

**Limitations**

Estimates of fair valueare made at a specific point in time, based upon, where available, relevantmarket prices and information about the financial instrument. Such estimates donot include any premium or discount that could result from offering for sale atone time the Company’s entire holdings of a particular financial instrument.For a substantial portion of the Company’s financial instruments, no quotedmarket price exists. Therefore, estimates of fair value are necessarily basedon a number of significant assumptions (many of which involve events outsidethe control of management). Such 

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assumptionsinclude assessments of current economic condition, perceived risks associatedwith these financial instruments and their counterparties, future expected lossexperience, and other factors. Given the uncertainties surrounding theseassumptions, the reported fair values represent estimates only and, therefore,cannot be compared to the historical accounting model. Use of differentassumptions or methodologies is likely to result in significantly differentfair value estimates.

The estimated fair valuespresented neither include nor give effect to the values associated with theCompany’s banking or other businesses, existing customer relationships, branchbanking network, property, equipment, goodwill, or certain tax implicationsrelated to the realization of unrealized gains or losses. The fair value ofnon-interest-bearing demand deposits, savings and NOW accounts, and moneymarket deposit accounts is equal to the carrying amount because these depositshave no stated maturity. This approach to estimating fair value excludes thesignificant benefit that results from the low-cost funding provided by suchdeposit liabilities, as compared to alternative sources of funding. As aconsequence, this presentation may distort the actual fair value of a bankingorganization that is a going concern.

The following methods andassumptions were used to estimate the fair value of each major classificationof financial instruments at June 30, 2006 and 2005:

***Cash and Cash Equivalents, Accrued InterestReceivable, Deposits with No Stated Maturities, Accrued Interest Payable, andCertificates of Deposit***

These financialinstruments have carrying values that approximate fair value.

***SecuritiesAvailable for Sale, Trading and Held to Maturity***

Current quoted marketprices were used to determine fair value.

***Loans***

Fair values were estimatedfor portfolios of loans with similar financial characteristics. Loans weresegregated by type and each loan category was further segmented by fixed andadjustable-rate interest terms. The estimated fair value of the segregatedportfolios was calculated by discounting cash flows based on estimated maturityand prepayment speeds using estimated market discounted rates that reflectedcredit and interest risk inherent in the loans. The estimate of the maturitiesand prepayment speeds was based on the Company’s historical experience. Cashflows were discounted using market rates adjusted for portfolio differences.

***Loans Available forSale***

The fair value of mortgageloans originated and intended for sale in the secondary market is based oncontractual cash flows using current market rates, calculated on an aggregatebasis.

***FHLB Advances***

Fair value was estimatedusing discounted cash flow analysis based on the Company’s current incrementalborrowing rate for similar types of borrowing arrangements.

***Commitments toExtend Credit***

The majority of theCompany’s commitments to extend credit carry current interest rates ifconverted to loans. Because commitments to extend credit are generally notassignable by the borrower, they only have value to the Company and theborrower. The estimated fair value approximates the recorded deferred feeamounts.

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Thecarrying amounts and estimated fair values of the Company’s financialinstruments, including off-balance sheet financial instruments, at June 30,2006 and 2005, are as follows:

| ** **                         | ** ** | **June 30, 2006**          | ** ** | **June 30, 2005** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **Carrying  Amount**                 | ** ** | **Fair  Value**             | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
| Assets:                            |       |                                 |       |                        |       |   |   |   |   |
| Cash and cash equivalents          |       | $                                    | 37,219     |                        | $          | 37,219 |   | $ | 20,609 |   | $ | 20,609 |   |
| Trading securities                 |       | 902                                  |       | 902                         |       | 53 |   | 53 |   |
| Securities available for sale      |       | 196,925                              |       | 196,925                     |       | 148,517 |   | 148,517 |   |
| Securities held to maturity        |       | 105,561                              |       | 102,087                     |       | 164,451 |   | 164,909 |   |
| Loans available for sale           |       | 2,635                                |       | 2,635                       |       | 1,795 |   | 1,813 |   |
| Loans, net                         |       | 1,063,882                            |       | 1,056,425                   |       | 584,187 |   | 590,537 |   |
| Accrued interest receivable        |       | 6,647                                |       | 6,647                       |       | 4,094 |   | 4,094 |   |
| Liabilities:                       |       |                                 |       |                        |       |   |   |   |   |
| Deposits with no stated maturities |       | 683,611                              |       | 683,611                     |       | 361,742 |   | 361,742 |   |
| Certificates of deposits           |       | 301,627                              |       | 301,627                     |       | 240,936 |   | 240,936 |   |
| FHLB Advances                      |       | 282,717                              |       | 275,970                     |       | 237,400 |   | 238,653 |   |
| Accrued interest  payable          |       | 2,205                                |       | 2,205                       |       | 1,064 |   | 1,064 |   |
|                                    |            |                                      |            |                             |            |  |  |  |  |  |  |  |  |

 

| ** **                                | ** ** | **Contract  Amount** | ** ** | **Fair  Value** | ** **                                                                      | **Contract  Amount** | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------|------------|----------------------|------------|-----------------|---------------------------------------------------------------------------------|----------------------|------------|-----------------|------------|
| Off balance sheet  financial instruments: |       |                 |       |            |                                                                            |                 |       |            |       |
| Commitments to  extend credit             |       | $                    | 14,747     |            | $            — |                 | $          | 20,139          |       | $         — |   |
| Standby letters  of credit                |       | $                    | 9,012      |            | $                                                                               | —               |       | $               | 2,400      |   | $ | — |   |
|                                           |            |                      |            |                 |                                                                                 |                      |            |                 |            |  |  |  |  |

 

**20.**          ComprehensiveIncome (Loss)

Thetax effects allocated to each component of other comprehensive income (loss)are as follows:

| ** **                                                                | ** ** | **Year ended June 30, 2006** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                | ** ** | **Before tax  amount**                      | ** ** | **Tax Effect** | ** ** | **After tax  Amount** | ** ** |
| ** **                                                                | ** ** | **(Dollars in thousands)**             | ** ** |
| Unrealized (losses)  gains on securities available for sale:              |       |                                             |       |   |   |   |   |   |   |   |   |
| Unrealized holding losses during the period                               |       |                                             | $          | (5,298 | ) |   |   | $1,874 |   |   | $ | (3,424 | ) |
| Reclassification adjustment for losses included in  net income  |       |                                             | 970        |   |   |   | (340 | ) |   | 630 |   |
| Net unrealized gain on cash flow hedge                                    |       |                                             | 777        |   |   |   | (272 | ) |   | 505 |   |
| Total other  comprehensive loss                                           |       |                                             | $          | (3,551 | ) |   |   | $1,262 |   |   | $ | (2,289 | ) |

 

| ** **                                                    | ** ** | **Year ended June 30, 2005** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **Before tax  amount**                      | ** ** | **Tax Effect** | ** ** | **After tax  Amount** | ** ** |
| ** **                                                    | ** ** | **(Dollars in thousands)**             | ** ** |
| Unrealized  (losses) gains on securities available for sale:  |       |                                             |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding gains during the period                    |       |                                             | $          | 1,749 |   |   |   | $ | (688 | ) |   |   | $ | 1,061 |   |   |
| Reclassification adjustment for gains included in  net income |       |                                             | 73         |   |   |   | (24 | ) |   |   | 49 |   |   |
| Total other  comprehensive income                             |       |                                             | $          | 1,822 |   |   |   | $ | (712 | ) |   |   | $ | 1,110 |   |   |

 

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| ** **                                                    | ** ** | **Year ended June 30, 2004** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **Before tax  amount**                      | ** ** | **Tax Effect** | ** ** | **After tax  Amount** | ** ** |
| ** **                                                    | ** ** | **(Dollars in thousands)**             | ** ** |
| Unrealized gains  (losses) on securities available for sale:  |       |                                             |       |   |   |   |   |   |   |   |   |
| Unrealized holding losses during the period                   |       |                                             | $          | (7,761 | ) |   |   | $ | 2,949 |   |   | $ | (4,812 | ) |
| Reclassification adjustment for gains included in  net income |       |                                             | 796        |   |   |   | (302 | ) |   | 494 |   |
| Total other  comprehensive loss                               |       |                                             | $          | (6,965 | ) |   |   | $ | 2,647 |   |   | $ | (4,318 | ) |

 

**21.**          SegmentInformation

Under the definition of SFAS No. 131, “DisclosuresAbout Segments of an Enterprise and Related Information”,  the Company has twooperating segments at June 30, 2006; Willow Financial Bank and PCIS. TheWillow Financial Bank segment primarily provides loan and deposit services tocommercial and retail customers through its network of 28 branch locations. ThePCIS segment, which was acquired on August 31, 2005 in connection with theMerger, operates a full service investment advisory and securities brokeragefirm.

Segmentinformation for the twelve months ended June 30, 2006 is as follows:

| ** **            | ** ** | **Year ended June 30,** | ** ** |
|-----------------------|------------|----------------------------------------|------------|
| ** **            | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| ** **            | ** ** | **Bank**                               | ** ** | **PCIS** | ** ** | **Total** | ** ** | **Bank** | ** ** | **PCIS** | ** ** | **Total** | ** ** |
| ** **            | ** ** | **(Dollars in thousands)**   | ** ** |
| Interest income       |       | $                                      | 81,530     |   | $ | — |   | $ | 81,530 |   | $ | 49,679 |   |   | $ | — |   |   | $ | 49,679 |   |
| Interest expense      |       | 32,238                                 |       | — |   | 32,238 |   | 18,749 |   |   | — |   |   | 18,749 |   |
| Net interest  income  |       | 49,291                                 |       | 1 |   | 49,292 |   | 30,930 |   |   | — |   |   | 30,930 |   |
| Non-interest  income  |       | 5,558                                  |       | 2,089 |   | 7,647 |   | 3,477 |   |   | — |   |   | 3,477 |   |
| Depreciation  expense |       | 1,837                                  |       | — |   | 1,837 |   | 793 |   |   | — |   |   | 793 |   |
| Income tax  expense   |       | 5,256                                  |       | — |   | 5,256 |   | 3,052 |   |   | — |   |   | 3,052 |   |
| Total net income      |       | 10,722                                 |       | 354 |   | 11,076 |   | 6,726 |   |   | — |   |   | 6,726 |   |
| Total assets          |       | 1,575,921                              |       | 814 |   | 1,576,735 |   | 959,255 |   |   | — |   |   | 959,255 |   |
|                       |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**22.**          ParentCompany Financial Information (Willow Financial Bancorp, Inc.)

*Condensed Statements of Financial Condition*

| ** **                                                               | ** ** | **At  June 30, 2006**      | ** ** | **At  June 30, 2005** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                                               | ** ** | **(Dollars in thousands)** | ** ** |
| Assets:                                                                  |       |                                 |       |                            |       |   |   |   |   |
| Cash on deposit with subsidiaries                                        |       |                                 | $          | 5,214                           |       |   |   | $ | 127 |   |   |
| Note receivable from subsidiary                                          |       |                                 | 5,182      |                            |       |   | 5,565 |   |   |
| Investment in subsidiaries                                               |       |                                 | 206,076    |                            |       |   | 94,174 |   |   |
| Investment  securities                                                   |       |                                 |       |                            |       |   |   |   |   |
| Trading                                                                  |       |                                 | 902        |                            |       |   | 53 |   |   |
| Available for sale (amortized cost of $10,967 and  $5,403, respectively) |       |                                 | 10,881     |                            |       |   | 5,303 |   |   |
| Goodwill                                                                 |       |                                 | 6,526      |                            |       |   | — |   |   |
| Other assets                                                             |       |                                 | 4,649      |                            |       |   | 2,171 |   |   |
| Total assets                                                             |       |                                 | $          | 239,430                         |       |   |   | $ | 107,393 |   |   |
| Liabilities and  stockholders’ equity:                              |       |                                 |       |                            |       |   |   |   |   |
| Subordinated debentures                                                  |       |                                 | $          | 36,198                          |       |   |   | $ | — |   |   |
| Other liabilities                                                        |       |                                 | 159        |                            |       |   | 350 |   |   |
| Total liabilities                                                        |       |                                 | 36,357     |                            |       |   | 350 |   |   |
| Total  stockholders’ equity                                         |       |                                 | 203,073    |                            |       |   | 107,043 |   |   |
| Total liabilities and  stockholders’ equity                         |       |                                 | 239,430    |                            |       |   | $ | 107,393 |   |   |

 

*Condensed Statements of Income*

| ** **                                  | ** ** | **For the year ended June 30,** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)**                     | ** ** |
| Interest income:                            |       |                                                     |       |   |   |   |   |
| Interest and dividend income                |       | $                                                        | 401        |   | $ | 182 |   | $ | 648 |   |
| Total interest and  dividend income:        |       | 401                                                      |       | 182 |   | 648 |   |
| Non-interest  income:                       |       |                                                     |       |   |   |   |   |
| Realized gain (loss) on investments         |       | 51                                                       |       | (57 | ) | 21 |   |
| Other income                                |       | 48                                                       |       | — |   | — |   |
| Total non-interest  income                  |       | 99                                                       |       | (57 | ) | 21 |   |
| Equity in income of subsidiary              |       | 12,370                                                   |       | 7,676 |   | 6,106 |   |
| Total income                                |       | 12,870                                                   |       | 7,801 |   | 6,775 |   |
| Expense:                                    |       |                                                     |       |   |   |   |   |
| Professional fees                           |       | 281                                                      |       | 452 |   | 400 |   |
| Stationery and printing                     |       | 27                                                       |       | 28 |   | 19 |   |
| Consulting services                         |       | 38                                                       |       | 744 |   | 9 |   |
| Interest expense on subordinated debentures |       | 1,109                                                    |       | — |   | — |   |
| Investor relations                          |       | 70                                                       |       | 134 |   | 3 |   |
| Other expense                               |       | 269                                                      |       | 208 |   | 263 |   |
| Total expense                               |       | 1,794                                                    |       | 1,566 |   | 694 |   |
| Income before  taxes                        |       | 11,076                                                   |       | 6,235 |   | 6,081 |   |
| Income tax  (benefit) expense               |       | —                                                   |       | (491 | ) | (30 | ) |
| Net income                                  |       | $                                                        | 11,076     |   | $ | 6,726 |   | $ | 6,111 |   |

 

100

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*Condensed Statements of Cash Flows*

| ** **                                                                              | ** ** | **For the year ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                              | ** ** | **(Dollars in thousands)**                     | ** ** |
| Cash flow from operating activities:                                                    |       |                                                     |       |   |   |   |   |
| Net income:                                                                             |       | $                                                        | 11,076     |   | $ | 6,726 |   | $ | 6,111 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                                     |       |   |   |   |   |
| Equity in undistributed  income of subsidiary                                           |       | (12,370                                                  | )          | (7,676 | ) | (6,106 | ) |
| Realized (gain) loss on  investments                                                    |       | (51                                                      | )          | 57 |   | (21 | ) |
| Decrease (increase) in  other assets                                                    |       | 208                                                      |       | (1,353 | ) | (262 | ) |
| Purchase of trading  account securities                                                 |       | (574                                                     | )          | (53 | ) | — |   |
| (Decrease) increase in  other liabilities                                               |       | (191                                                     | )          | (60 | ) | 6 |   |
| Net cash used in  operating activities                                                  |       | (1,902                                                   | )          | (2,359 | ) | (272 | ) |
| Cash flows from investing activities:                                                   |       |                                                     |       |   |   |   |   |
| Purchase of securities  available for sale                                              |       | (10,007                                                  | )          | (5,036 | ) | (223 | ) |
| Proceeds from sales and  calls of securities available for sale                         |       | 4,737                                                    |       | — |   | 33 |   |
| Net repayment of notes  receivable                                                      |       | 383                                                      |       | 13,655 |   | 17,573 |   |
| Net cash used for  acquisition                                                          |       | (35,032                                                  | )          | — |   | — |   |
| Net cash (used in)  provided by investing activities                                    |       | (39,919                                                  | )          | 8,619 |   | 17,383 |   |
| Cash flows from financing activities:                                                   |       |                                                     |       |   |   |   |   |
| Capital contribution to  subsidiaries                                                   |       | (15,000                                                  | )          | — |   | — |   |
| Dividends received from  subsidiary                                                     |       | 42,030                                                   |       | — |   | — |   |
| Proceeds from stock  issuance                                                           |       | 1,275                                                    |       | 285 |   | 392 |   |
| Proceeds from issuance  of subordinated debentures                                      |       | 25,000                                                   |       | — |   | — |   |
| Treasury stock purchases                                                                |       | (179                                                     | )          | (2,595 | ) | (14,045 | ) |
| Dividends paid                                                                          |       | (6,218                                                   | )          | (4,196 | ) | (3,644 | ) |
| Net cash provided by  (used in) financing activities                                    |       | 46,908                                                   |       | (6,506 | ) | (17,297 | ) |
| Net increase (decrease)  in cash and cash equivalents                                   |       | 5,087                                                    |       | (246 | ) | (186 | ) |
| Cash and cash  equivalents at beginning of period                                       |       | 127                                                      |       | 373 |   | 559 |   |
| Cash and cash equivalents at end of period                                              |       | $                                                        | 5,214      |   | $ | 127 |   | $ | 373 |   |

 

**23.**          RelatedParty Transactions

The Bank routinely entersinto transactions with its directors and officers. Such transactions are madein the ordinary course of business on substantially the same terms andconditions, including interest rates and collateral, as those prevailing at thesame time for comparable transactions with other customers, and do not, in theopinion of management, involve more than the normal credit risk or presentother unfavorable features. The aggregate amount of loans to such relatedparties was $283 thousand and $174 thousand at June 30, 2006 and 2005,respectively, and all such loans were performing in accordance with their termsat such dates.

**24.**          DividendPolicy

The Company’s ability to pay dividends is dependent,in part, upon its ability to obtain dividends from the Bank. The futuredividend policy of the Company is subject to the discretion of the Board ofDirectors and will depend upon a number of factors, including future earnings,financial conditions, cash needs, and general business conditions. Holders of commonstock will be entitled to receive dividends as and when declared by the Boardof Directors of the Company out of funds legally available for that purpose.Such payment, however, will be subject to the regulatory restrictions set forthby the OTS. In addition, OTS regulations provides that, as a general rule, afinancial institution may not make a capital distribution if it would beundercapitalized after making the capital distribution.

101

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**Item 9.**                        Changesin and Disagreements with Accountants and Financial Disclosure

None

**Item 9A.**                Controlsand Procedures

Management evaluated, with the participation of theCompany’s Chief Executive Officer and Chief Financial Officer, theeffectiveness of its disclosure controls and procedures (as defined in Rules 13a-15(e) or15(d)-15(e) under the Securities Exchange Act of 1934, as amended)as of the end of the period covered by this report. Based on such evaluation,the Chief Executive Officer and Chief Financial Officer have concluded that theCompany’s disclosure controls and procedures are designed to ensure thatinformation required to be disclosed by the Company in the reports that itfiles or submits under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and regulations and are operating in an effective manner.

No change in our internalcontrol over financial reporting (as defined in Rules 13a-15(f) underthe Exchange Act) occurred during the last fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

**MANAGEMENT REPORTON EFFECTIVENESSOF INTERNAL CONTROL OVER FINANCIAL REPORTING**

Management of the Company and the Bank is responsiblefor establishing and maintaining adequate internal control over financialreporting; as such term is defined in the Exchange Act. Under the supervisionand with the participation of management, including our Chief Executive Officerand Chief Financial Officer, we conducted an evaluation of the effectiveness ofour internal control over financial reporting based on the framework inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission.

Basedon our evaluation under the framework in Internal Control—Integrated Framework,management concluded that our internal controls over financial reporting wereeffective as of June 30, 2006. Management’s assessment of theeffectiveness of our internal controls over financial reporting as of June 30,2006 has been audited by KPMG LLP, an independent registered public accountingfirms, as stated in their report which is included in Item 8 herein.
| /s/ DONNA  M. COUGHEY                    | * * | /s/ JOSEPH T.  CROWLE*Y*  |
|------------------------------------------|----------|---------------------------|
| *President and Chief Executive  Officer* | * * | *Chief Financial Officer* |
| September 26, 2006                  | * * | * *                  |

 

**Item 9B.**               OtherInformation

Not applicable.

**PART III**

**Item 10.**                 Directorsand Executive Officers of the Registrant

The information required herein is incorporated byreference from the sections captioned “Information with Respect to Nominees forDirector, Continuing Directors and Executive Officers” and “BeneficialOwnership of Common Stock by Certain Beneficial Owners and Management—Section 16(a) BeneficialOwnership Reporting Compliance” in the Company’s Definitive Proxy Statement forthe Annual Meeting of Stockholders to be held on October 31, 2006, whichwill be filed with the SEC on or prior to October 2, 2006 (“DefinitiveProxy Statement”).

102

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The Company has adopted acode of ethics policy, which applies to its principal executive officer,principal financial officer, principal accounting officer, as well as itsdirectors and employees generally. The Company will provide a copy of its codeof ethics to any person, free of charge, upon request. Any requests for a copyshould be made to our shareholder relations administrator, Willow FinancialBancorp, Inc., 170 South Warner Road, Wayne, Pennsylvania 19087.

**Item 11.**                 ExecutiveCompensation

The information required herein is incorporated byreference from the sections captioned “Management Compensation,” “Report of theCompensation Committee” and “Performance Graph” in the Company’s DefinitiveProxy Statement.

The report of theCompensation Committee included in the Definitive Proxy Statement should not bedeemed filed or incorporated by reference into this filing or any other filingby the Company under the Exchange Act or Securities Act of 1933 except to theextent the Company specifically incorporates said reports herein or therein byreference thereto.

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

*SecurityOwnership of Certain Beneficial Owners and Management.*   Informationregarding security ownership of certain beneficial owners and management isincorporated by reference to “Beneficial Ownership of Common Stock by CertainBeneficial Owners and Management” in the Proxy Statement.

*EquityCompensation Plan Information.*   The followingtable provides information as of June 30, 2006 with respect to shares ofcommon stock that may be issued under our existing equity compensation plans,which consist of the 1999 and 2002 Stock Option Plans and 1999, 2002 and 2005Recognition and Retention Plans, all of which were approved by ourshareholders.

Thetable does not include information with respect to shares of common stocksubject to outstanding options granted under equity compensation plans assumedby us in connection with the acquisition of Chester Valley Bancorp on August 31,2005, which originally granted these options. Note 2 to the table sets forththe total number of shares of common stock issuable upon the exercise ofassumed options as of June 30, 2006 and the weighted average exerciseprice of those options. No additional options may be granted under thoseassumed plans.

| **Plan Category**                                      | ** ** | ** ** | ** ** | **Number of securities to be  issued upon exercise of  outstanding options,  warrants and rights  (a)** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights  (b)** | ** ** | **Number of securities  remaining available for  future issuance under equity  compensation plans  (excluding securities  reflected in column (a))  (c)** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders     |       |       | 870,817    | (1)                                                                                                                                                  |       |                                                                                                             | $          | 10.65                                                                                                                                                                                                                 | (1)        |   |   | 461,317 |   |   |
| Equity compensation plans not approved by security  holders |       |       | n/a        |                                                                                                                                                 |       |                                                                                                             | n/a        |                                                                                                                                                                                                                  |       |   | n/a |   |   |
| Total                                                       |       |       | 870,817    |                                                                                                                                                 |       |                                                                                                             | $          | 10.65                                                                                                                                                                                                                 |       |   |   | 461,317 |   |   |

----

       (1) Includes 125,831 shares subject to restricted stock grants whichwere not vested as of June 30, 2006. The weighted-average exercise priceexcludes such restricted stock grants.

       (2) The table does not include information forequity compensation plans assumed by us in connection with the acquisition ofChester Valley Bancorp which originally established those plans. As of June 30,

103

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2006, a total of267,763 shares of Common Stock were issuable upon exercise of outstandingoptions under those assumed plans and the weighted average exercise price ofthose outstanding options was $10.44 per share. No additional options may begranted under any assumed plans.

**Item 13.**                 CertainRelationships and Related Transactions

The information requiredherein is incorporated by reference from the section captioned “ManagementCompensation—Indebtedness of Management and Related-Party Transactions” in theDefinitive Proxy Statement.

**Item 14.**                 PrincipalAccounting Fees and Services

The information required herein is incorporated byreference from the section captioned “Ratification of Appointment ofIndependent Registered Public Accounting Firm” in the Definitive ProxyStatement.

104

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**PART IV**

**Item 15.**                 Exhibitsand Financial Statement Schedules

(a)           Documents Filed as Part ofthis Report.

(1)          Thefollowing financial statements are incorporated by reference from Item 8hereof:
| Consolidated Statements of  Financial Condition                                           |   |   |
|-------------------------------------------------------------------------------------------|--------|--------|
| Consolidated  Statements of Income                                                        |   |   |
| Consolidated  Statements of Changes in Stockholders’ Equity and Comprehensive Income |   |   |
| Consolidated  Statements of Cash Flows                                                    |   |   |
| Notes  to Consolidated Financial Statements                                               |   |   |

 

(2)          All schedules for which provision is made in the applicable accountingregulations of the SEC are omitted because of the absence of conditions underwhich they are required or because the required information is included in theconsolidated financial statements and related notes thereto.

(3)          Thefollowing exhibits are filed as part of this Form 10-K, and thislist includes the Exhibit Index.
| Exhibit Index | ** ** | ** **                                                                                                                                                                                                                                                         | ** ** | **Description** |
|--------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 3.1                |       | Articles of Incorporation, as amended, of Willow Financial  Bancorp, Inc.(1)                                                                                                                                                                                  |
| 3.2                |       | Amended and Restated Bylaws of Willow Financial  Bancorp, Inc. (through August 31, 2005)(2)                                                                                                                                                         |
| 4.0                |       | Form of Stock Certificate of Willow Grove  Bancorp, Inc.(3)                                                                                                                                                                                              |
| 4.1                |       | Indenture, dated as of March 31, 2006, between  Willow Grove Bancorp, Inc. and U.S. Bank National Association, as  trustee(4)                                                                                                                       |
| 4.2                |       | Amended and Restated Declaration of Trust of Willow  Grove Statutory Trust I, dated as March 31, 2006, among Willow Grove  Bancorp, Inc., as sponsor, U.S. Bank National Association, as  institutional trustee, and the administrators named therein(4) |
| 4.3                |       | Guarantee Agreement, dated as of March 31,  2006, between Willow Grove Bancorp, Inc. and U.S. Bank National Association,  as guarantee trustee(4)                                                                                                        |
| 10.1               |       | Employment Agreement, dated July 15, 2005, by  and among Willow Grove Bancorp, Inc., Willow Grove Bank and Donna M.  Coughey(2)                                                                                                                          |
| 10.2               |       | Retirement and Severance Agreement by and among  Willow Grove Bancorp, Inc., Willow Grove Bank and Frederick A.  Marcell Jr.(5)                                                                                                                          |
| 10.3               |       | Employment Agreement, dated July 15, 2005, by  among Willow Grove Bancorp, Inc., Willow Grove Bank and Joseph T.  Crowley(2)                                                                                                                             |
| 10.4               |       | Employment Agreement, dated November 25, 2002,  between First Financial Bank and Michael J. Sexton(6)*                                                                                                                                                        |
| 10.5               |       | Form of Employment Agreement entered into  between Willow Grove Bank and each of John T. Powers, Jerome P. Arrison and  Ammon J. Baus(7)*                                                                                                                     |
| 10.6               |       | Form of Employment Agreement entered into  between Willow Grove Bank and each of G. Richard Bertolet, Matthew D. Kelly  and Colin N. Maropis(8)                                                                                                               |
| 10.7               |       | Form of Change in Control Severance Agreement  between Willow Grove Bank and each of Christopher M. Breslin, William Byrne,  Margaret H. Leimkuhler and Thomas A. Varley(8)                                                                                   |
| 10.8               |       | Supplemental Executive Retirement Agreement(9)*                                                                                                                                                                                                                    |
| 10.9               |       | Non-Employee Directors’ Retirement Plan and  amendment thereto(10)*                                                                                                                                                                                           |
| 10.10              |       | 1999 Stock Option Plan(11)*                                                                                                                                                                                                                                        |
| 10.11              |       | 1999 Recognition and Retention Plan and Trust  Agreement(11)*                                                                                                                                                                                                      |

105

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| 10.12 |   | 2002 Stock Option Plan(12)*                                                                                                                                                                             |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.13 |   | 2002 Recognition and Retention Plan and Trust  Agreement(12)*                                                                                                                                           |
| 10.14 |   | Deferred Compensation Plan(13)*                                                                                                                                                                         |
| 10.15 |   | Chester Valley Bancorp Inc. 1993 Stock Option Plan,  as amended(14)*                                                                                                                                    |
| 10.16 |   | Chester Valley Bancorp Inc. 1997 Stock Option Plan,  as amended(15)*                                                                                                                                    |
| 10.17 |   | Form of First Financial Bank Executive Survivor  Income Agreement by and between First Financial Bank and each of Donna M.  Coughey, G. Richard Bertolet, Matthew D. Kelly and Colin N. Maropis(8) |
| 10.18 |   | First Financial Bank Executive Deferred Compensation  Plan, as amended and restated effective January 1, 2003, and amendments  thereto(16)                                                         |
| 10.19 |   | First Financial Bank 2005 Executive Deferred  Compensation Plan, and amendments thereto(16)                                                                                                             |
| 10.20 |   | First Financial Bank Board of Directors Deferred  Compensation Plan, as amended and restated effective January 1, 2003,  and amendments thereto(16)                                                |
| 10.21 |   | First Financial Bank  2005 Board of Directors Deferred Compensation Plan, and amendments thereto(16)                                                                                                    |
| 10.22 |   | Change in Control  Severance Agreement Between Willow Grove Bank and Allen L. Wagner(17)                                                                                                                |
| 10.23 |   | Change in Control  Severance Agreement, dated January 18, 2006, between Willow Grove Bank  and Neil Kalani(18)                                                                                     |
| 10.24 |   | Change in Control  Severance Agreement, dated January 18, 2006, between Willow Grove Bank  and Patrick Killeen(18)                                                                                 |
| 10.25 |   | Willow Grove  Bancorp, Inc. 2006 Supplemental Executive Retirement Plan(19)                                                                                                                        |
| 10.26 |   | 2005 Recognition and  Retention Plan and Trust Agreement(20)                                                                                                                                            |
| 21.0  |   | Subsidiaries of the  Registrant—Reference is made to “Item 1. Business—Subsidiaries” for the  required information                                                                  |
| 23.0  |   | Consent of KPMG LLP                                                                                                                                                                                     |
| 31.1  |   | Section 1350  Certification of the Chief Executive Officer                                                                                                                                         |
| 31.2  |   | Section 1350  Certification of the Chief Financial Officer                                                                                                                                         |
| 32.1  |   | Section 906  Certification of the Chief Executive Officer                                                                                                                                          |
| 32.2  |   | Section 906 Certification of the Chief  Financial Officer                                                                                                                                          |

----

                 * Management contract or compensatory plan orarrangement required to be filed as an exhibit to this Form 10-Kpursuant to Item 15(b) hereof.

       (1) Incorporated by reference from the Company’s Form 8-K, dated as ofSeptember 21, 2006 and filed with the SEC on September 22, 2006 (SECFile No. 000-49706).

  (2) Incorporated by reference from the Company’s Form 8-K,dated as of August 31, 2005 and filed with the SEC on September 1,2005 (SEC File No. 000-49706).

       (3) Incorporated by reference from the Company’s Registration Statementon Form S-1 filed on December 14, 2001, as amended, anddeclared effective on February 11, 2002 (Registration No. 333-75106).

       (4) Exhibit not included pursuant to Item 601(b)(4)(iii) ofRegulation S-K. The Company will provide a copy of such exhibit to the SEC uponrequest.

       (5) Incorporated by reference from the Company’s Current Report on Form 8-K/A,dated as of January 20, 2005 and filed with the SEC on January 26,2005 (SEC File No. 0-49706).

106

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       (6) Incorporated by reference from Exhibit 10L to the Annual Reporton Form 10-K of Chester Valley Bancorp Inc. for the fiscal yearended June 30, 2003 and filed with the SEC on September 12, 2003 (SECFile No. 0-18833).

       (7) Incorporated by reference from the Company’s Form 10-Qfor the quarter ended March 31, 2004, filed with the SEC on May 14,2004 (SEC File No. 000-49706).

       (8) Incorporated by reference from the Company’s Form 10-Kfor the year ended June 30, 2005, filed with the SEC on September 13,2005 (SEC File No. 000-49706)

       (9) Incorporated by reference from the registration statement on Form S-1filed by the Company’s predecessor, a federal corporation also known as WillowGrove Bancorp, Inc. (the “Mid-Tier”) on September 18, 1998, asamended, and declared effective on November 12, 1998 (Registration No. 333-63737).

(10) Incorporated by reference from the Company’s Form 10-Qfor the quarter ended September 30, 2002, filed with the SEC on November 14,2002 (SEC File No. 000-49706) and the Company’s Form 8-K,dated as of October 25, 2005 and filed with the SEC on October 31,2005 (SEC File No. 000-49706)

(11) Incorporated by reference from the Definitive Proxy Statement onSchedule 14A filed by the Mid-Tier on June 23, 1999 (SEC File No. 000-25191).

(12) Incorporated by reference from the Company’s Definitive ProxyStatement on Schedule 14A filed on October 9, 2002 (SEC File No. 000-49706).

(13) Incorporated by reference from the Company’s Form 10-Qfor the quarter ended December 31, 2003, filed with the SEC on February 12,2004 (SEC File No. 000-49706).

(14) Incorporated by reference from Chester Valley’s RegistrationStatement on Form S-4/A (Commission File No. 333-50077)filed with the Commission on April 28, 1998.

(15) Incorporated by reference from Chester Valley’s RegistrationStatement on Form S-8 filed with the Commission on January 19,2001 (File No. 333-54020).

(16) Incorporated by reference from the Company’s Form 8-K,dated as of October 25, 2005 and filed with the SEC on October 31,2005 (SEC File No. 000-49706).

(17) Incorporated by reference from the Company’s Form 8-K,dated as of January 5, 2006 and filed with the SEC on January 11,2006 (SEC File No. 000-49706).

(18) Incorporated by reference from the Company’s Form 8-K,dated as of January 18, 2006 and filed with the SEC on January 29,2006 (SEC File No. 000-49706).

(19) Incorporated by reference from the Company’s Form 8-K,dated as of March 28, 2006 and filed with the SEC on April 3, 2006(SEC File No. 000-49706).

(20) Incorporated by reference from the Company’sDefinitive Proxy Statement on Schedule 14A filed on October 5, 2005 (SECFile No. 000-49706).

(B)        *Exhibits*

The exhibits listed under (a)(3) of this Item 15are filed herewith.

(C)        Reference is made to (a)(2) ofthis Item 15.

107

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|        | **WILLOW FINANCIAL  BANCORP, INC.** |
|--------|------------------------------------------|
|   | By:                                      | /s/ DONNA M. COUGHEY |
|   |                                     | Donna M. Coughey |
|   |                                     | *President and Chief Executive Officer* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, thisreport has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated.
| /s/  DONNA M. COUGHEY                             |   | September 26, 2006 |
|---------------------------------------------------|--------|-------------------------|
| Donna M. Coughey                                  |   |                    |
| *President, Chief Executive Officer and Director* |   |                    |
| /s/ JOSEPH T. CROWLEY                             |   | September 26, 2006 |
| Joseph T. Crowley                                 |   |                    |
| *Chief Financial Officer*                         |   |                    |
| /s/ NEELESH KALANI                                |   | September 26, 2006 |
| Neelesh Kalani                                    |   |                    |
| *Chief Accounting Officer*                        |   |                    |
| /s/ MADELEINE WING ADLER                          |   | September 26, 2006 |
| Madeleine Wing Adler                              |   |                    |
| *Director*                                        |   |                    |
| /s/ JOHN J. CUNNINGHAM, III                  |   | September 26, 2006 |
| John J. Cunningham, III                      |   |                    |
| *Director*                                        |   |                    |
| /s/ GERARD F. GRIESSER                            |   | September 26, 2006 |
| Gerard F. Griesser                                |   |                    |
| *Director*                                        |   |                    |
| /s/ LEWIS W. HULL                                 |   | September 26, 2006 |
| Lewis W. Hull                                     |   |                    |
| *Director*                                        |   |                    |
| /s/ CHARLES F. KREMP, 3RD                         |   | September 26, 2006 |
| Charles F. Kremp, 3rd                             |   |                    |
| *Director*                                        |   |                    |

108

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| /s/  WILLIAM W. LANGAN            |   | September 26,  2006 |
|-----------------------------------|--------|--------------------------|
| William W. Langan                 |   |                     |
| *Director*                        |   |                     |
| /s/ ROSEMARY C. LORING, ESQ. |   | September 26, 2006  |
| Rosemary C. Loring, Esq.     |   |                     |
| *Chair of the Board*              |   |                     |
| /s/ FREDERICK A. MARCELL, JR.     |   | September 26, 2006  |
| Frederick A. Marcell Jr.          |   |                     |
| *Director*                        |   |                     |
| /s/ ROBERT J. MCCORMACK           |   | September 26, 2006  |
| Robert J. McCormack               |   |                     |
| *Director*                        |   |                     |
| /s/ JAMES E. MCERLANE             |   | September 26, 2006  |
| James E. McErlane                 |   |                     |
| *Director*                        |   |                     |
| /s/ A. BRENT O’BRIEN         |   | September 26, 2006  |
| A. Brent O’Brien             |   |                     |
| *Director*                        |   |                     |
| /s/ SAMUEL H. RAMSEY, III    |   | September 26, 2006  |
| Samuel H. Ramsey, III        |   |                     |
| *Director*                        |   |                     |
| /s/ THOMAS J. SUKAY               |   | September 26, 2006  |
| Thomas J. Sukay                   |   |                     |
| *Director*                        |   |                     |
| /s/ EMORY S. TODD                 |   | September 26, 2006  |
| Emory S. Todd                     |   |                     |
| *Director*                        |   |                     |
| /s/ WILLIAM B. WEIHENMAYER        |   | September 26 2006   |
| William B. Weihenmayer            |   |                     |
| *Director*                        |   |                     |
| /s/ WILLIAM M. WRIGHT             |   | September 26, 2006  |
| William M. Wright                 |   |                     |
| *Director*                        |   |                     |

 

109

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