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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-K



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



For the fiscal year ended June 30, 2004



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



For the transition period from
 to



Commission File Number: 0-50347



JEFFERSON BANCSHARES, INC.

(Exact
name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|TENNESSEE                                                      |  | 45-0508261                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                         |  |           
|---------------------------------------- |  | ----------
|120 Evans Avenue, Morristown, Tennessee  |  | 37814     
|(Address of principal executive offices) |  | (Zip Code)



Registrants
telephone number, including area code: (423) 586-8421



Securities registered pursuant to Section 12(b) of the Act: None



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



Common Stock, par value $0.01 per share

(Title of Class)



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



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ̈



The aggregate market value of the voting and non-voting common equity held by non-affiliates was $98,292,083, based upon the closing price ($12.99 per share) as quoted on the Nasdaq National Market as of the last business day of the
registrants most recently completed second fiscal quarter.



The number of shares outstanding of the registrants common stock as of August 31, 2004 was 8,330,517.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the Proxy Statement for the 2004 Annual Meeting of Stockholders

are incorporated by
reference in Part III of this Form 10-K.



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INDEX



|         |  |                                                                                                              |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                              |  | Page
|         | 
|Part I   |  |                                                                                                             
|Item 1.  |  | Business                                                                                                     |  | 3   
|Item 2.  |  | Properties                                                                                                   |  | 17  
|Item 3.  |  | Legal Proceedings                                                                                            |  | 17  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 17  
|         | 
|Part II  |  |                                                                                                             
|         |  |                                                                                                             
|Item 5.  |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 18  
|Item 6.  |  | Selected Financial Data                                                                                      |  | 20  
|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operation                         |  | 22  
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 43  
|Item 8.  |  | Financial Statements and Supplementary Data                                                                  |  | 44  
|Item 9.  |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure                         |  | 44  
|Item 9A. |  | Controls and Procedures                                                                                      |  | 44  
|         | 
|Part III |  |                                                                                                             
|         |  |                                                                                                             
|Item 10. |  | Directors and Executive Officers of the Registrant                                                           |  | 45  
|Item 11. |  | Executive Compensation                                                                                       |  | 45  
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 45  
|Item 13. |  | Certain Relationships and Related Transactions                                                               |  | 46  
|Item 14. |  | Principal Accountant Fees and Services                                                                       |  | 46  
|         | 
|Part IV  |  |                                                                                                             
|         |  |                                                                                                             
|Item 15. |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                                             |  | 47  





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This report contains certain forward-looking statements within the meaning of the federal
securities laws. These statements are not historical facts, rather statements based on Jefferson Bancshares, Inc.s current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are
preceded by terms such as expects, believes, anticipates, intends and similar expressions.



Managements ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual
results include interest rate trends, the general economic climate in the market area in which Jefferson Bancshares operates, as well as nationwide, Jefferson Bancshares ability to control costs and expenses, competitive products and pricing,
loan delinquency rates and changes in federal and state legislation and regulation. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Jefferson Bancshares
assumes no obligation to update any forward-looking statements.



PART I



|Item 1. | Business
|------- | --------



General



Jefferson
Bancshares, Inc. (also referred to as the Company or Jefferson Bancshares) was organized as a Tennessee corporation at the direction of Jefferson Federal Bank, formerly Jefferson Federal Savings and Loan Association of
Morristown (referred to as the Bank or Jefferson Federal), in March 2003 to become the holding company for Jefferson Federal upon the completion of its second-step mutual-to-stock conversion (the
Conversion) of Jefferson Bancshares, M.H.C. (the MHC). The Conversion was completed on July 1, 2003. As part of the Conversion, the MHC merged into Jefferson Federal, thereby ceasing to exist and Jefferson Federal Savings and
Loan Association of Morristown changed its name to Jefferson Federal Bank. The Company sold 6,612,500 shares of its common stock at a price of $10.00 per share to depositors of the Bank in a subscription offering raising approximately
$64.5 million in net proceeds. The Company also exchanged approximately 1,389,000 shares of its common stock for all the outstanding shares of the Banks common stock (other than shares held by the MHC), representing an exchange ratio of 4.2661
for each share of Jefferson Federal outstanding. In addition, the Bank established the Jefferson Federal Charitable Foundation, which was funded with $250,000 and 375,000 shares of Company common stock.



Management of the Company and the Bank are substantially similar and the
Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Bank. Accordingly, the information set forth in this report, including the consolidated financial statements and related financial data,
relates primarily to the Bank.



Jefferson Federal operates as a
community-oriented financial institution offering traditional financial services to consumers and businesses in its market area. Jefferson Federal attracts deposits from the general public and uses those funds to originate loans, which it holds for
investment.



Available Information



We maintain an Internet website at http://www.jeffersonfederal.com. We make
available our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, and
other information related to us, free of charge, on this site as soon as reasonably practicable after we electronically file those documents with, or otherwise furnish them to, the SEC. Our Internet website and the information contained therein or
connected thereto are not intended to be incorporated into this annual report on Form 10-K.



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Market Area



We are located in Morristown, Tennessee, which is situated approximately 40 miles northeast of Knoxville, Tennessee in the northeastern section of the
state. We consider Hamblen County, with a population of approximately 59,000, and its contiguous counties to be our primary market area. The economy of our market area is primarily oriented to manufacturing and agriculture. Morristown and Hamblen
County also serve as a hub for retail shopping and medical services for a number of surrounding rural counties. The manufacturing sector is focused on three types of products: automotive and heavy equipment components; plastics, paper and corrugated
products; and furniture. According to the U.S. Bureau of Labor Statistics, the unemployment rates for the State of Tennessee have compared favorably to the national rate as well as the rate in Hamblen County. In this regard, the average monthly
unemployment rate in Hamblen County has increased from 5.6% for 2002 to 6.0% for 2003, but remained above the state average and slightly below the national average. Importantly, the slow economy in Jefferson Federals market has been evidenced
in other ways such as through diminished hours worked for hourly employees in the manufacturing sector, which is the largest component of the local economy.



Competition



We face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits has historically come
from the several financial institutions operating in our market area and, to a lesser extent, from other financial service companies, such as brokerage firms, credit unions and insurance companies. We also face competition for investors funds
from money market funds and other corporate and government securities. At June 30, 2003, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation, we held 38.1% of the deposits in Hamblen County, which
is the largest market share out of ten financial institutions with offices in the county. However, banks owned by Suntrust Banks, Inc., First Tennessee National Corporation, Union Planters Corporation and National Commerce Financial Corporation, all
of which are large regional bank holding companies, also operate in Hamblen County. These institutions are significantly larger than us and, therefore, have significantly greater resources.



Our competition for loans comes primarily from financial institutions in our
market area, and to a lesser extent from other financial service providers, such as mortgage companies and mortgage brokers. Competition for loans also comes from the increasing number of non-depository financial service companies entering the
mortgage market, such as insurance companies, securities companies and specialty finance companies.



We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation
in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to
offer products and services that traditionally have been provided by banks. Changes in federal law permit affiliation among banks, securities firms and insurance companies, which promotes a competitive environment in the financial services industry.
Competition for deposits and the origination of loans could limit our growth in the future.



Lending Activities



General. Our loan portfolio consists of a variety of mortgage, commercial and consumer loans. As a community-oriented financial institution, we try to meet the borrowing needs of consumers and businesses in our market area.
Mortgage loans constitute a significant majority of the portfolio, and residential mortgage loans are the largest segment in that category.



One- to Four-Family Residential Loans. Our primary lending activity is the origination of mortgage loans to enable borrowers to purchase or
refinance existing homes or to construct new one- to four-family homes. We offer fixed-rate mortgage loans with terms up to 15 years and adjustable-rate mortgage loans with terms up to 25 years. Borrower demand for adjustable-rate loans versus
fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and the first year interest
rates and loan fees for adjustable-rate loans.



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The relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand
for each in a competitive environment and the effect each has on our interest rate risk.



While we anticipate that adjustable-rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate mortgages, the increased mortgage payments required of adjustable-rate
loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying property also may be adversely affected in a high interest rate environment. In addition, although
adjustable-rate mortgage loans help make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.



The loan fees charged, interest rates and other provisions of mortgage loans
are determined by us on the basis of our own pricing criteria and competitive market conditions. Interest rates and payments on our adjustable-rate loans generally are adjusted annually based on any change in the National Average Contract Mortgage
Rate for the Purchase of Previously Occupied Homes by Combined Lenders as published by the Federal Housing Finance Board. Changes in this index tend to lag behind changes in market interest rates. Our adjustable-rate mortgage loans may have initial
fixed-rate periods ranging from one to five years.



We
originate all adjustable-rate loans at the fully indexed interest rate. The maximum amount by which the interest rate may be increased or decreased is generally 2% per year and the lifetime interest rate cap is generally 5% over the initial interest
rate of the loan. Our adjustable-rate residential mortgage loans generally do not provide for a decrease in the rate paid below the initial contract rate. The inability of our residential real estate loans to adjust downward below the initial
contract rate can contribute to increased income in periods of declining interest rates, and also assists us in our efforts to limit the risks to earnings and equity value resulting from changes in interest rates, subject to the risk that borrowers
may refinance these loans during periods of declining interest rates.



While one- to four-family residential real estate loans are normally originated with up to 25-year terms; such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon sale
of the property pledged as security or upon refinancing the original loan. In addition, substantially all of the mortgage loans in our loan portfolio contain due-on-sale clauses providing that Jefferson Federal may declare the unpaid amount due and
payable upon the sale of the property securing the loan. Jefferson Federal enforces these due-on-sale clauses to the extent permitted by law. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale
activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.



We do not emphasize the origination of loans that conform to guidelines for sale in the secondary mortgage market, as we have not sold any loans in recent
years. We generally do not make conventional loans with loan-to-value ratios exceeding 85% and generally make loans with a loan-to-value ratio in excess of 85% only when secured by first liens on owner-occupied, one-to four-family residences. Loans
with loan-to-value ratios in excess of 90% generally require private mortgage insurance or additional collateral. We require all properties securing mortgage loans in excess of $50,000 to be appraised by a board-approved appraiser. We require title
insurance on all mortgage loans in excess of $25,000. Borrowers must obtain hazard or flood insurance (for loans on property located in a flood zone) prior to closing the loan.



Home Equity Lines of Credit. We offer home equity lines of credit on single family residential property in
amounts up to 80% of the appraised value. Rates and terms vary by borrower qualifications, but are generally offered on a variable rate, open-end term basis with maturities of ten years or less.



Commercial Real Estate and Multi-Family Loans. An important
segment of our loan portfolio is mortgage loans secured by commercial and multi-family real estate. Our commercial real estate loans are secured by professional office buildings, shopping centers, manufacturing facilities, hotels, vacant land,
churches and, to a lesser extent, by other improved property such as restaurants and retail operations. We intend to continue to emphasize and grow this segment of our loan portfolio.



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We originate both fixed- and adjustable-rate loans secured by commercial and multi-family real estate
with terms up to 25 years. Fixed-rate loans have provisions that allow us to call the loan after five years. Adjustable-rate loans are based on prime and adjust monthly. Loan amounts generally do not exceed 85% of the lesser of the appraised value
or the purchase price. When the borrower is a corporation, partnership or other entity, we generally require personal guarantees from significant equity holders. Currently, it is our philosophy to originate commercial real estate loans only to
borrowers known to us and on properties in or near our market area.



Loans secured by commercial and multi-family real estate are generally larger and involve a greater degree of risk than one- to four-family residential mortgage loans. Of primary concern in commercial and multi-family real estate lending is
the borrowers creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties are often dependent on the successful operation or management of the properties. As a result, repayment
of such loans may be subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy. In order to monitor cash flows on income properties, we require borrowers and loan guarantors, if
any, to provide annual financial statements and rent rolls on multi-family loans. We also perform annual reviews and prepare write-ups on all lending relationships of $250,000 or more where the loan is secured by commercial or multi-family real
estate.



At June 30, 2004, loans with principal balances of
$500,000 or more secured by commercial real estate totaled $35.8 million, or 59.6% of commercial real estate loans, and loans with principal balances of $500,000 or more secured by multi-family properties totaled $4.0 million, or 43.7% of
multifamily loans. At June 30, 2004, all of these loans were performing in accordance with their terms.



Construction Loans. We originate loans to finance the construction of one-to four-family homes and, to a lesser extent,
multi-family and commercial real estate properties. At June 30, 2004, $2.6 million of our construction loans was for the construction of one- to four-family homes and $438,000 was for the construction of commercial or multi-family real estate. We
principally finance the construction of single-family, owner-occupied homes. Construction loans are generally made on a pre-sold basis; however, contractors who have sufficient financial strength and a proven track record are considered
for loans for model and speculative purposes, with preference given to contractors with whom we have had successful relationships. We generally limit loans to contractors for speculative construction to a total of $225,000 per contractor.
Construction loans generally provide for interest-only payments at fixed-rates of interest and have terms of six to 12 months. At the end of the construction period, the loan generally converts into a permanent loan. Construction loans to a borrower
who will occupy the home, or to a builder who has pre-sold the home, will be considered for loan-to-value ratios of up to 85%. Construction loans for speculative purposes, models, and commercial properties may be considered for loan-to-value ratios
of up to 80%. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant. We generally use in-house inspectors for construction disbursement purposes; however, we may rely on architect certifications for
disbursements on larger commercial loans.



Construction
financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the
propertys value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of
construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, we may be confronted, at or prior to
the maturity of the loan, with a project having a value which is insufficient to assure full repayment. As a result of the foregoing, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the
success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. If we are forced to foreclose on a project prior to or at completion due to a default, there can be no assurance that we will be
able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.



Land Loans. We originate loans secured by unimproved property, including lots for single family homes, raw land, commercial property and
agricultural property. We originate both fixed- and adjustable-rate



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land loans with terms up to 15 years. Adjustable-rate loans are based on prime and adjust monthly. Loans secured by unimproved commercial property or for
land development generally have five-year terms with a longer amortization schedule. Loans secured by undeveloped land or improved lots generally involve greater risks than residential mortgage lending because land loans are more difficult to
evaluate. If the estimate of value proves to be inaccurate, in the event of default and foreclosure, we may be confronted with a property the value of which is insufficient to assure full repayment. Loan amounts generally do not exceed 75% of the
lesser of the appraised value or the purchase price.



At June
30, 2004, our largest land loan was for $4.3 million and was secured by commercial real estate. At June 30, 2004, loans with principal balances of $500,000 or more secured by unimproved property totaled $6.6 million, or 61.3% of land loans. All of
these loans were performing in accordance with their terms at that date.



Commercial Business Loans. We extend commercial business loans on an unsecured and secured basis. Secured loans generally are collateralized by industrial/commercial machinery and equipment, livestock,
farm machinery and, to a lesser extent, accounts receivable and inventory. We originate both fixed- and adjustable-rate commercial loans with terms up to 20 years. Fixed-rate loans have provisions that allow us to call the loan after five years.
Adjustable-rate loans are based on prime and adjust monthly. Where the borrower is a corporation, partnership or other entity, we generally require personal guarantees from significant equity holders.



Commercial business lending generally involves greater risk than residential
mortgage lending and involves risks that are different from those associated with commercial and multi-family real estate lending. Although the repayment of commercial and multi-family real estate loans depends primarily on the cash-flow of the
property or related business, the underlying collateral generally provides a sufficient source of repayment. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the
liquidation of collateral if a borrower defaults is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things. Accordingly, the
repayment of a commercial business loan depends primarily on the cash-flow, character and creditworthiness of the borrower (and any guarantors), while liquidation of collateral is secondary.



Consumer Loans. We offer a variety of consumer loans, primarily
secured by automobiles and savings accounts. Other consumer loans include loans on recreational vehicles and boats, debt consolidation loans and personal unsecured debt. We market education loans as a Team Lender through Educational
Funding of the South, Inc. (EdSouth), whereby EdSouth funds the loans and pays a marketing fee to us.



The procedures for underwriting consumer loans include an assessment of the applicants payment history on other debts and ability to meet existing
obligations and payments on the proposed loans. Although the applicants creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount. We
use a credit scoring system and charge borrowers with poorer credit scores higher interest rates to compensate for the additional risks associated with those loans.



Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that
are unsecured or secured by assets that depreciate rapidly, such as automobiles, boats and recreational vehicles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding
loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrowers continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be
recovered on such loans.



Subprime Loans. In the
past, as part of our philosophy of serving the credit needs of all of the members of our local community, we regularly made loans to persons with poor or marginal credit histories. In making loans to these persons, we often relied on the value of
the collateral securing the loan and gave less consideration



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to their credit history. Several years ago, we began to monitor our residential mortgage and consumer loans by reference to the borrowers Beacon credit
score. A Beacon score is a principal measure of credit quality and is one of the significant criteria we now rely upon in our underwriting. We categorized loans to borrowers with a Beacon credit score below 600 as subprime and loans to
borrowers with a Beacon credit score of 600 or above as prime. Although in the past we frequently made loans to subprime borrowers, we did not have a subprime lending program in the sense that we did not focus on subprime lending through
planned business strategies, tailored products or explicit borrower targeting. Our subprime loans were made as part of our general lending efforts on the same terms and under the same policies as prime loans.



We have revised our underwriting guidelines to focus on the borrowers
income or cash flow as the primary source of repayment, with the collateral as the second or third source of payment. As a result of these changes in our underwriting guidelines, we generally do not make loans to borrowers with a Beacon credit score
below 600. With approval of our Loan Committee or Board of Directors, we may make exceptions to this policy for existing customers. The consequence of our revised underwriting guidelines is that the balance of subprime loans in our portfolio is
declining as these loans are repaid and not replaced.



Loan Originations. All of our loans are originated by in-house lending officers and are underwritten and processed in-house. We rely on advertising, referrals from realtors and customers, and personal contact by our staff to
generate loan originations. We generally retain for our portfolio all of the loans that we originate. We occasionally purchase participation interests in commercial real estate loans through other financial institutions in our market area.



Loan Approval Procedures and Authority. Loan
approval authority has been granted by the Board of Directors to certain officers on an individual and combined basis for consumer (including residential mortgages) and commercial purpose loans up to a maximum of $500,000 per transaction. All loans
with aggregate exposure of $1.0 million or more require the approval of our Loan Committee or Board of Directors.



The Loan Committee meets every two weeks to review all mortgage loans made within granted lending authority of $75,000 or more and all non-mortgage loans
made within granted lending authority of $50,000 or more. The committee approves all requests which exceed granted lending authority or when the request carries aggregate exposure to us of $1.0 million or more. The committee reviews credit
relationships of $250,000 or more on a periodic basis in addition to addressing all other credit guideline issues as they may arise. The minutes of the committee are reported to and reviewed by the Board of Directors.



Loans to One Borrower. The maximum amount that we may lend to
one borrower and the borrowers related entities is limited by regulation. At June 30, 2004, our regulatory limit on loans to one borrower was $9.8 million. At that date, our largest lending relationship was $7.8 million and consisted of a
commercial real estate loan. This loan was performing according to its original repayment terms at June 30, 2004.



Loan Commitments. We issue commitments for fixed-rate and adjustable-rate single-family residential mortgage loans conditioned upon the
occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements to lend to our customers and generally expire in 90 days or less.



Delinquencies. When a borrower fails to make a required loan payment, we take a number of steps to have the
borrower cure the delinquency and restore the loan to current status. We make initial contact with the borrower when the loan becomes 17 days past due. If payment is not then received, additional letters and phone calls generally are made. When the
loan becomes 60 days past due, we send a letter notifying the borrower that we will commence foreclosure proceedings if the loan is not brought current within 30 days. When the loan becomes 90 days past due, we will commence foreclosure proceedings
against any real property that secures the loan or attempt to repossess any personal property that secures a consumer loan. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure
sale, the real property securing the loan generally is sold at foreclosure. Exceptions on commencement of foreclosure actions for commercial real estate loans and mortgage loans are made on a case-by-case basis by the Board of Directors. We may
consider loan workout arrangements with certain borrowers under certain circumstances.



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Investment Activities



We have legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of
state and municipal governments, deposits at the Federal Home Loan Bank of Cincinnati and certificates of deposit of federally insured institutions. Within certain regulatory limits, we also may invest a portion of our assets in corporate
securities. We also are required to maintain an investment in Federal Home Loan Bank of Cincinnati stock.



At June 30, 2004, our investment portfolio consisted of federal agency debt securities with maturities of seven years or less and mortgage-backed
securities issued by Fannie Mae, Freddie Mac and Ginnie Mae with stated final maturities of 30 years or less and municipal bonds with maturities of 20 years or less. We purchase mortgage-backed securities in an effort to increase yield, improve
liquidity, provide call protection, and enhance our qualified thrift lender ratio.



Our investment objectives are to provide and maintain liquidity, to maintain a balance of high quality, to diversify investments to minimize risk, to provide collateral for pledging requirements, to establish an
acceptable level of interest rate risk, to provide an alternate source of low-risk investments when demand for loans is weak, and to generate a favorable return. Any two of the following officers are authorized to purchase or sell investments: the
President, Executive Vice President and/or Vice President. There is a limit of $2.0 million par value on any single investment purchase unless approval is obtained from the Board of Directors. For mortgage-backed securities, real estate mortgage
investment conduits and collateralized mortgage obligations issued by Ginnie Mae, Freddie Mac or Fannie Mae, purchases are limited to a current par value of $2.5 million without Board approval.



Deposit Activities and Other Sources of Funds



General. Deposits and loan repayments are the major sources of
our funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions.
We may use borrowings on a short-term basis to compensate for reductions in the availability of funds from other sources. Borrowings may also be used on a longer term basis for general business purposes.



Deposit Accounts. Substantially all of our depositors are
residents of the State of Tennessee. Deposits are attracted from within our primary market area through the offering of a broad selection of deposit instruments, including NOW accounts, money market accounts, regular savings accounts, Christmas club
savings accounts, certificates of deposit and retirement savings plans. We do not utilize brokered funds. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate,
among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, profitability to us, matching deposit and loan products and customer preferences and concerns. We generally review our deposit
mix and pricing monthly. In the past, our strategy had been to attract and retain deposits by offering the highest rates in our market area. Our current strategy is to offer competitive rates, but not be the market leader in every type and maturity.
We have also changed our advertising to emphasize transaction accounts, with the goal of shifting our mix of deposits towards a smaller percentage of higher cost time deposits.



Borrowings. We have occasionally relied upon advances from the Federal Home Loan Bank of Cincinnati to
supplement our supply of lendable funds and to meet deposit withdrawal requirements. Advances from the Federal Home Loan Bank are typically secured by our first mortgage loans.



The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions. As a
member, we are required to own capital stock in the Federal Home Loan Bank and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or
guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each



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credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed
percentage of an institutions net worth or on the Federal Home Loan Banks assessment of the institutions creditworthiness. Under its current credit policies, the Federal Home Loan Bank generally limits advances to 25% of a
members assets, and short-term borrowings of less than one year may not exceed 10% of the institutions assets. The Federal Home Loan Bank determines specific lines of credit for each member institution. We have the authority to borrow up
to 20% of assets under a short-term line of credit.



Personnel



As of June 30, 2004, we had 62 full-time employees and 3
part-time employees, none of whom is represented by a collective bargaining unit. We believe our relationship with our employees is good.



Executive Officers



The executive officers of Jefferson Bancshares are elected annually by the Board of Directors and serve at the Boards discretion. Ages presented are
as of June 30, 2004. The executive officers of Jefferson Bancshares are:



|                  |  |     |  |                                                 
|----------------- |  | --- |  | ------------------------------------------------
|Name              |  | Age |  | Position                                        
|Anderson L. Smith |  | 56  |  | President and Chief Executive Officer           
|Jane P. Hutton    |  | 46  |  | Chief Financial Officer, Treasurer and Secretary



The executive officers
of Jefferson Federal are elected annually by the Board of Directors and serve at the Boards discretion. Ages presented are as of June 30, 2004. The executive officers of Jefferson Federal are:



|                  |  |     |  |                                             
|----------------- |  | --- |  | --------------------------------------------
|Name              |  | Age |  | Position                                    
|Anderson L. Smith |  | 56  |  | President and Chief Executive Officer       
|Douglas H. Rouse  |  | 51  |  | Senior Vice President                       
|Jane P. Hutton    |  | 46  |  | Vice President and Comptroller              
|Eric S. McDaniel  |  | 33  |  | Vice President and Senior Operations Officer



Biographical Information



Anderson L. Smithhas been President and Chief
Executive Officer of Jefferson Bancshares since March 2003 and President and Chief Executive Officer of Jefferson Federal since January 2002. Prior to joining Jefferson Federal, Mr. Smith was President, Consumer Financial Services - East Tennessee
Metro, First Tennessee Bank National Association. Age 56. Director since 2002.



Jane P. Hutton has been Treasurer and Secretary of Jefferson Bancshares since March 2003 and Vice President and Comptroller of Jefferson Federal since July 2002.Ms. Hutton was named Chief Financial
Officer of Jefferson Bancshares in connection with the consummation of the Conversion on July 1, 2003.From June 1999 until July 2002, Ms. Hutton served as Assistant Financial Analyst. Age 46.



Douglas H. Rouse has been Senior Vice President of Jefferson Federal
since January 2002. From March 1994 until January 2002, Mr. Rouse served as Vice President. Age 51.



Eric S. McDaniel has been Vice President and Senior Operations Officer of Jefferson Federal since July 2002. From March 1996 until July 2002, Mr.
McDaniel served as Director of Compliance and Internal Auditor. Age 33.



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Subsidiaries



We have one subsidiary, Jefferson Service Corporation of Morristown, Tennessee, Inc., which owns stock in Intrieve, Inc., a computer service bureau, and
has an ownership interest in Bankers Title of East Tennessee, LLC, a title insurance agency. Our subsidiary also has a small investment in a credit life reinsurance company.



REGULATION AND SUPERVISION



General



As a savings and loan holding company, Jefferson Bancshares is required by federal law to report to, and otherwise comply with, the rules and regulations of the Office of Thrift Supervision. Jefferson Federal is
subject to extensive regulation, examination and supervision by the Office of Thrift Supervision, as its primary federal regulator, and the Federal Deposit Insurance Corporation, as the deposit insurer. Jefferson Federal is a member of the Federal
Home Loan Bank System and, with respect to deposit insurance, of the Savings Association Insurance Fund managed by the Federal Deposit Insurance Corporation. Jefferson Federal must file reports with the Office of Thrift Supervision and the Federal
Deposit Insurance Corporation concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The
Office of Thrift Supervision conducts periodic examinations to test Jefferson Federals safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of
activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation or Congress, could have a material adverse impact on us and our operations. Certain regulatory requirements applicable to us are referenced below or
elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this report does not purport to be a complete description of such statutes and regulations and
their effects on us.



Holding Company Regulation



Jefferson Bancshares is a nondiversified unitary savings and loan holding
company within the meaning of federal law. Under federal law, Jefferson Bancshares may engage only in the activities permitted for financial holding companies under the Federal Bank Holding Company Act or for multiple savings and loan holding
companies as described below. Upon any non-supervisory acquisition by Jefferson Bancshares of another savings association or savings bank that meets the qualified thrift lender test (as described below) and is deemed to be a savings institution by
the Office of Thrift Supervision, Jefferson Bancshares would become a multiple savings and loan holding company (if the acquired association is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding
companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain activities authorized by Office of Thrift Supervision regulations. However, the Office of Thrift
Supervision has issued an interpretation concluding that the multiple savings and loan holding companies may also engage in activities permitted for financial holding companies.



A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of
another savings institution or savings and loan holding company without prior written approval of the Office of Thrift Supervision and from acquiring or retaining control of a depository institution that is not insured by the Federal Deposit
Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision considers the financial and managerial resources and future prospects of the company and institution involved,
the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive factors.



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The Office of Thrift Supervision may not approve any acquisition that would result in a multiple savings
and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (1) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (2) the acquisition of a savings
institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. States vary in the extent to which they permit interstate savings and loan holding company acquisitions.



Although savings and loan holding companies are not currently subject to
specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings institutions as described below. Jefferson Federal must
notify the Office of Thrift Supervision 30 days before declaring any dividend to Jefferson Bancshares. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the Office of Thrift
Supervision and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.



Acquisition of the Company.Under the Federal Change in Bank Control Act (CIBCA), a notice must be
submitted to the Office of Thrift Supervision if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Companys outstanding voting stock, unless the Office of Thrift Supervision has found that the
acquisition will not result in a change of control of the Company. Under the CIBCA, the Office of Thrift Supervision has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and
managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that acquires control would then be subject to regulation as a savings and loan holding company.



Federal Savings Institution Regulation



Business Activities. The activities of federal savings
institutions are governed by federal law and regulations. These laws and regulations delineate the nature and extent of the activities in which federal associations may engage. In particular, certain lending authority for a federal association,
e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institutions capital or assets.



Capital Requirements. The Office of Thrift Supervision capital regulations require savings institutions to
meet three minimum capital standards: a 1.5% tangible capital to total assets ratio, a 4% leverage (core capital) ratio (3% for certain institutions receiving the highest rating on the CAMELS examination rating system) and an 8% total risk-based
capital ratio. In addition, the prompt corrective action regulations discussed below also establish minimum standards of a 4% leverage (core capital) ratio (3% for institutions receiving the highest CAMELS rating), a 4% Tier 1 risk-based ratio and
an 8% total risk-based capital ratio in order for an institution to be adequately capitalized. The Office of Thrift Supervision regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must
generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.



In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to
100%, assigned by the Office of Thrift Supervision capital regulation based on the risks believed inherent in the type of asset. A savings institution also must maintain riskbased capital for recourse obligations, direct credit substitutes and
residual interests. The amount of risk-based capital required for a residual interest generally depends on its credit rating by a nationally recognized statistical rating organization (or lack thereof). Core (Tier 1) capital is defined as common
stockholders equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage
servicing rights and credit card relationships. The components of supplementary capital currently include cumulative perpetual preferred stock and certain other preferred stock, mandatory convertible securities, subordinated debt, the allowance for
loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the



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amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. The Office of Thrift Supervision also has authority to
establish individual minimum capital requirements in appropriate cases upon a determination that an institutions capital level is or may become inadequate in light of the particular circumstances. At June 30, 2004, Jefferson Federal met each
of its capital requirements.



Prompt Corrective
Regulatory Action. The Office of Thrift Supervision is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institutions degree of undercapitalization. Generally, a
savings institution that has total risk-based capital of 10% or more has a Tier 1 risk-based capital ratio of 6% or more, has a Tier 1 leverage capital ratio of 5% or more and is not subject to any order or final capital directive to meet and
maintain a specific capital level for any capital measure is considered to be well capitalized. A savings institution that has a total risk-based capital ratio of 8% or more, a Tier 1 risk-based capital ratio of 4% or more and Tier 1
leverage capital ratio of 4% or more (3% under certain circumstances) and does not meet the definition of well capitalized is considered to be adequately capitalized. A savings institution that has a ratio of total capital to
risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered
to be undercapitalized. A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be significantly
undercapitalized and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be critically undercapitalized. Subject to narrow exceptions, the Office of Thrift Supervision is required
to appoint a receiver or conservator 90 days after an institution becomes critically undercapitalized. The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the
date a savings institution receives notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. The Office of Thrift Supervision will not accept a capital restoration plan
unless it determines that the plan contains all of the required elements, is based on realistic assumptions, is likely to succeed in restoring the institutions capital and would not appreciably increase the risk to which the institution is
exposed. Compliance with the plan must be guaranteed by any parent holding company. This guarantee may prevent the holding company from making any capital distributions to shareholders, repurchasing any of its own stock or incurring additional debt.
In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion.
The Office of Thrift Supervision could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.



Insurance of Deposit Accounts. Jefferson Federal is a member of
the Savings Association Insurance Fund. The Federal Deposit Insurance Corporation maintains a risk-based assessment system by which institutions are assigned to one of three categories based on their capitalization and one of three subcategories
based on examination ratings and other supervisory information. An institutions assessment rate depends upon the categories to which it is assigned. Assessment rates for Savings Association Insurance Fund member institutions are determined
semiannually by the Federal Deposit Insurance Corporation and currently range from zero basis points for the healthiest institutions to 27 basis points for the riskiest. The Federal Deposit Insurance Corporation has authority to increase insurance
assessments. A significant increase in Savings Association Insurance Fund insurance premiums would likely have an adverse effect on the operating expenses and results of operations of Jefferson Federal. Management cannot predict what insurance
assessment rates will be in the future.



In addition to the
assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation (FICO) to recapitalize the predecessor to the Savings Association Insurance Fund. During fiscal
2003, FICO payments for Savings Association Insurance Fund members approximated 1.60 basis points of assessable deposits.



Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that the institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the Federal Deposit Insurance Corporation or the Office of Thrift Supervision. We do not know
of any practice, condition or violation that might lead to termination of deposit insurance.



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Loans to One Borrower. Federal law provides that savings institutions are generally subject
to the limits on loans to one borrower applicable to national banks. A savings institution may generally not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional
amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral.



Qualified Thrift Lender Test. The Home Owners Loan Act requires savings associations to meet a qualified thrift lender test. Under the
test, a savings association is required to either qualify as a domestic building and loan association under the Internal Revenue Code or maintain at least 65% of its portfolio assets (total assets less: (1) specified liquid
assets up to 20% of total assets; (2) intangibles, including goodwill; and (3) the value of property used to conduct business) in certain qualified thrift investments (primarily residential mortgages and related investments, including
certain mortgage-backed securities) in at least 9 months out of each 12-month period.



A savings association that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. In addition, its holding company may be required to
register as a bank holding company. As of June 30, 2004, Jefferson Federal met the qualified thrift lender test.



Limitation on Capital Distributions. Office of Thrift Supervision regulations impose limitations upon all capital distributions by a savings
institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and the prior approval of the Office of Thrift Supervision is
required prior to any capital distribution if the institution does not meet the criteria for expedited treatment of applications under Office of Thrift Supervision regulations (i.e., generally, examination ratings in the two top
categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the
distribution would otherwise be contrary to a statute, regulation or agreement with or condition imposed by the Office of Thrift Supervision. If an application is not required, the institution must still provide prior notice to the Office of Thrift
Supervision of the capital distribution if, like Jefferson Federal, it is a subsidiary of a holding company. In the event Jefferson Federals capital fell below its regulatory requirements or the Office of Thrift Supervision notified it that it
was in need of more than normal supervision, Jefferson Federals ability to make capital distributions could be restricted. As a result of its Conversion, Jefferson Federal also may not make a capital distribution if the distribution would
reduce its regulatory capital below the amount needed for the liquidation account established in connection with the Conversion and may not make a distribution that would constitute a return of capital during the three-year term of the business plan
submitted in connection with the Conversion. In addition, the Office of Thrift Supervision could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Office of Thrift Supervision
determined that such distribution would constitute an unsafe or unsound practice. No insured depository institution may make a capital distribution if, after making the distribution, the institution would be undercapitalized.



Transactions with Related Parties. Jefferson Federals
authority to engage in transactions with affiliates (e.g., any company that controls or is under common control with an institution, including Jefferson Bancshares and its non-savings institution subsidiaries) is limited by
federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of
the savings institutions capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low quality assets from affiliates is generally
prohibited. The transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings
associations are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.



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The Sarbanes-Oxley Act of 2002 generally prohibits loans by Jefferson Bancshares to its executive
officers and directors. However, that act contains a specific exception for loans by federally insured depository institutions to its executive officers and directors in compliance with federal banking laws. Under such laws, Jefferson Federals
authority to extend credit to executive officers, directors and 10% shareholders (insiders), as well as entities such persons control, is limited. The law limits both the individual and aggregate amount of loans Jefferson Federal may
make to insiders and requires certain board approval procedures to be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not to involve more than the normal risk of
repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees.



Enforcement. The Office of Thrift Supervision has primary
enforcement responsibility over savings associations and has the authority to bring actions against the institution and all institution-affiliated parties, including shareholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to
institution of receivership or conservatorship. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The OTS also has enforcement authority over savings and
loan holding companies such as Jefferson Bancshares. The Federal Deposit Insurance Corporation has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings
institution. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.



Standards for Safety and Soundness. The federal banking
agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the Office of Thrift Supervision determines that a savings institution fails to meet any standard prescribed by the guidelines, the Office of Thrift Supervision may require the institution to submit
an acceptable plan to achieve compliance with the standard.



Federal Home
Loan Bank System



Jefferson Federal is a member of the
Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. Jefferson Federal, as a member of the Federal Home Loan Bank of
Cincinnati, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank in an amount at least equal to 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the
beginning of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan Bank, whichever is greater. Jefferson Federal was in compliance with this requirement with an investment in Federal Home Loan Bank stock at June 30, 2004 of $1.6
million.



The Federal Home Loan Banks are required to provide
funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also
result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, Jefferson Federals net interest income would
likely also be reduced. The Gramm-Leach-Bliley Act has changed the structure of the Federal Home Loan Banks funding obligations for insolvent thrifts, revised the capital structure of the Federal Home Loan Banks and implemented entirely voluntary
membership for Federal Home Loan Banks. Management cannot predict the effect that these changes may have with respect to its Federal Home Loan Bank membership.



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Federal Reserve System



The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $45.4
million; a 10% reserve ratio is applied above $45.4 million. The first $6.6 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The amounts are adjusted annually.
Jefferson Federal complies with the foregoing requirements.



FEDERAL AND STATE TAXATION



Federal Income Taxation



General. We report our income on a fiscal
year basis using the accrual method of accounting. The federal income tax laws apply to us in the same manner as to other corporations with some exceptions, including particularly our reserve for bad debts discussed below. The following discussion
of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to us. Our federal income tax returns have been either audited or closed under the statute of limitations through tax
year 1995. For its 2004 year, the Companys maximum federal income tax rate was 34%.



Bad Debt Reserves. For fiscal years beginning before June 30, 1996, thrift institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code of 1986, as
amended, were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally
secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The reserve for nonqualifying loans was computed using the experience method. Federal legislation enacted in
1996 repealed the reserve method of accounting for bad debts and the percentage of taxable income method for tax years beginning after 1995 and require savings institutions to recapture or take into income certain portions of their accumulated bad
debt reserves. Approximately $1.3 million of our accumulated bad debt reserves would not be recaptured into taxable income unless Jefferson Federal makes a non-dividend distribution to Jefferson Bancshares as described below.



Distributions. If Jefferson Federal makes non-dividend
distributions to Jefferson Bancshares, the distributions will be considered to have been made from Jefferson Federals unrecaptured tax bad debt reserves, including the balance of its reserves as of June 30, 1988, to the extent of the
non-dividend distributions, and then from Jefferson Federals supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves,
will be included in Jefferson Federals taxable income. Non-dividend distributions include distributions in excess of Jefferson Federals current and accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of Jefferson Federals current or accumulated earnings and profits will not be so included in Jefferson Federals taxable
income.



The amount of additional taxable income triggered by a
non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if Jefferson Federal makes a non-dividend distribution to Jefferson Bancshares, approximately one and one-half
times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 35% federal corporate income tax rate. Jefferson Federal does not intend to pay dividends that
would result in a recapture of any portion of its bad debt reserves.



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State Taxation



Tennessee imposes franchise and excise taxes. The franchise tax ($0.25 per $100) is applied either to our apportioned net worth or the value of property
owned and used in Tennessee, whichever is greater, as of the close of our fiscal year. The excise tax (6.5%) is applied to net earnings derived from business done in Tennessee. Under Tennessee regulations, bad debt deductions are deductible from the
excise tax. There have not been any audits of our state tax returns during the past five years.



Any cash dividends, in excess of a certain exempt amount, that are paid with respect to Jefferson Bancshares common stock to a shareholder (including a
partnership and certain other entities) who is a resident of the State of Tennessee will be subject to the Tennessee income tax which is levied at a rate of six percent. Any distribution by a corporation from earnings according to percentage
ownership is considered a dividend, and the definition of a dividend for Tennessee income tax purposes may not be the same as the definition of a dividend for federal income tax purposes. A corporate distribution may be treated as a dividend for
Tennessee tax purposes if it is made from funds that exceed the corporations earned surplus and profits under certain circumstances.



|ITEM 2. | PROPERTIES
|------- | ----------



We conduct our business through our main office and drive-through facilities. The following table sets forth certain information relating to these
facilities as of June 30, 2004.



|                                                         |  |            |  |                                   |       |               |        |               |        |    
|-------------------------------------------------------- |  | ---------- |  | --------------------------------- | ----- | ------------- | ------ | ------------- | ------ | ---
|Location                                                 |  | YearOpened |  | Net Book Valueas of June 30, 2004 |       | SquareFootage |        | Owned/ Leased |       
|                                                         |  |            |  | (Dollars in thousands)            |       |               |       
|Main Office 120 Evans Avenue Morristown, Tennessee       |  | 1997       |  | $                                 | 3,513 |               | 24,000 |               | Owned  |    
|                                                         |  |            |  |                                  
|Drive-Through 143 E. Main Street Morristown, Tennessee   |  | 1995       |  |                                   | 438   |               | 800    |               | Owned  |    
|                                                         |  |            |  |                                  
|Drive-Through 1960 W. Morris Blvd. Morristown, Tennessee |  | 1998       |  |                                   | 48    |               | 700    |               | Leased | (1)

---

|(1) | The current lease expires in April 2007, with an option for an additional five years.
|--- | -------------------------------------------------------------------------------------



|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------



Jefferson Bancshares is not a party to any pending legal proceedings. Periodically, there have been various claims and lawsuits involving Jefferson
Federal, such as claims to enforce liens, condemnation proceedings on properties in which Jefferson Federal holds security interests, claims involving the making and servicing of real property loans and other issues incident to Jefferson
Federals business. Jefferson Federal is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------



None.



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PART II



|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | ------------------------------------------------------------------------------------------------------------



Jefferson Bancshares common stock began trading on the Nasdaq National
Market under the symbol JFBI on July 2, 2003. The initial offering price was $10.00 per share. As of June 30, 2004, Jefferson Bancshares had approximately 629 holders of record (excluding the number of persons or entities holding stock
in street name through various brokerage firms), and 8,385,517 shares outstanding.



The following table sets forth high and low sales prices for each quarter during the fiscal years ended June 30, 2004 and June 30, 2003 for Jefferson Bancshares common stock, and corresponding quarterly
dividends period per share. The data included in this table has been adjusted to reflect the exchange of 4.2661 shares of Jefferson Bancshares common stock for each share of Jefferson Federal common stock.



|                         |  |       |  |       |  |                       
|------------------------ |  | ----- |  | ----- |  | ----------------------
|                         |  | High  |  | Low   |  | Dividend PaidPer Share
|Year Ended June 30, 2004 |  |       |  |       |  |                       
|Fourth quarter           |  | 13.99 |  | 11.30 |  | 0.09                  
|Third quarter            |  | 14.46 |  | 13.26 |  | 0.04                  
|Second quarter           |  | 15.00 |  | 13.25 |  | 0.04                  
|First quarter            |  | 15.09 |  | 11.75 |  | 0.04                  
|                         |  |       | 
|Year Ended June 30, 2003 |  |       |  |       |  |                       
|Fourth quarter           |  | 11.84 |  | 10.08 |  | 0.076                 
|Third quarter            |  | 16.42 |  | 7.50  |  | 0.029                 
|Second quarter           |  | 7.57  |  | 6.56  |  | 0.029                 
|First quarter            |  | 8.20  |  | 6.91  |  | 0.029                 



The Board of Directors
of Jefferson Bancshares has the authority to declare dividends on the common stock, subject to statutory and regulatory requirements. Declarations of dividends by the Board of Directors, if any, will depend upon a number of factors, including
investment opportunities available to Jefferson Bancshares or Jefferson Federal, capital requirements, regulatory limitations, Jefferson Bancshares and Jefferson Federals financial condition and results of operations, tax considerations
and general economic conditions. No assurances can be given, however, that any dividends will be paid or, if commenced, will continue to be paid.



Jefferson Bancshares is subject to the requirements of Tennessee law, which generally prohibits distributions to shareholders if, after giving effect to
the distribution, the corporation would not be able to pay its debts as they become due in the usual course of business or the corporations total assets would be less than the sum of its total liabilities plus the amount that would be needed,
if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution.



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The following table provides certain information with regard to shares repurchased by the Company in the
fourth quarter of 2004.



|                                              |  |                                               |  |                                           |  |                                                                                             |  |                                                                                                                        |    
|--------------------------------------------- |  | --------------------------------------------- |  | ----------------------------------------- |  | ------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------- | ---
|Period                                        |  | (a) Total number ofShares (or Units)Purchased |  | (b) Average PricePaid per Share (or Unit) |  | (c) Total Number ofShares (or units)Purchased as Partof Publicly AnnouncedPlans or Programs |  | (d) Maximum Number (orAppropriate DollarValue) of Shares (orunits) that May Yet BePurchased Under thePlans or Programs |    
|Month #1 April 1, 2004 through April 30, 2004 |  |                                              |  |                                          |  |                                                                                            |  |                                                                                                                       |    
|Month #2 May 1, 2004 through May 31, 2004     |  |                                              |  |                                          |  |                                                                                            |  |                                                                                                                       |    
|Month #3 June 1, 2004 through June 30, 2004   |  | 14,250                                        |  | 12.70                                     |  | 14,250                                                                                      |  | 14,250                                                                                                                 | (1)

---

|(1) | On February 10, 2004, the Company announced that it had funded a trust that would purchase up
to 279,500 shares to be used to fund restricted stock awards under the Companys 2004 Stock-Based Incentive Plan. The Plan will continue until it is completed or terminated by the Board of Directors. No plans expired during the three months
ended June 30, 2004. The Company has no plans that it has elected to terminate prior to expiration or under which it does not intend to make further purchases.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



On July 30, 2004, the Company announced a Stock Repurchase Program under which the Company may repurchase up to 838,552
shares, or 10%, of the Companys common stock.



19



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##### Table of Contents

|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------



|                                                                                |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|------------------------------------------------------------------------------- |  | --------------------------------- | ------- | ---- | - | ------- | ------ |  | - | ------- | ------ |  | ---- | ------- | ------ |  | - | ------- | ------
|                                                                                |  | At or For the Year Ended June 30, |        
|                                                                                |  | 2004                              |         | 2003 |   |         | 2002   |  |   | 2001    |        |  | 2000 |        
|Financial Condition Data:                                                       |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Total assets                                                                    |  | $                                 | 305,474 |      | $ | 363,778 |        |  | $ | 267,507 |        |  | $    | 254,522 |        |  | $ | 230,632 |       
|Loans receivable, net                                                           |  |                                   | 186,601 |      |   | 180,010 |        |  |   | 190,032 |        |  |      | 181,191 |        |  |   | 170,172 |       
|Cash and cash equivalents, interest-bearing deposits, and investment securities |  |                                   | 101,416 |      |   | 172,943 |        |  |   | 67,198  |        |  |      | 63,056  |        |  |   | 50,573  |       
|Borrowings                                                                      |  |                                   | 6,000   |      |   | 2,000   |        |  |   | 2,000   |        |  |      | 2,000   |        |  |   | 4,000   |       
|Deposits                                                                        |  |                                   | 204,933 |      |   | 324,247 |        |  |   | 231,849 |        |  |      | 222,061 |        |  |   | 199,141 |       
|Stockholders equity                                                            |  |                                   | 93,383  |      |   | 36,625  |        |  |   | 32,901  |        |  |      | 29,892  |        |  |   | 26,936  |       
|Operating Data:                                                                 |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Interest income                                                                 |  | $                                 | 16,067  |      | $ | 17,259  |        |  | $ | 19,380  |        |  | $    | 19,254  |        |  | $ | 17,646  |       
|Interest expense                                                                |  |                                   | 4,776   |      |   | 6,518   |        |  |   | 10,267  |        |  |      | 11,740  |        |  |   | 10,058  |       
|                                                                                |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Net interest income                                                             |  |                                   | 11,291  |      |   | 10,741  |        |  |   | 9,113   |        |  |      | 7,514   |        |  |   | 7,588   |       
|Provision for loan losses                                                       |  |                                   |        |      |   | 787     |        |  |   | 1,221   |        |  |      | 960     |        |  |   | 1,270   |       
|                                                                                |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Net interest income after provision for loan losses                             |  |                                   | 11,291  |      |   | 9,954   |        |  |   | 7,892   |        |  |      | 6,554   |        |  |   | 6,318   |       
|                                                                                |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Noninterest income                                                              |  |                                   | 1,067   |      |   | 979     |        |  |   | 1,021   |        |  |      | 910     |        |  |   | 1,222   |       
|Noninterest expense                                                             |  |                                   | 10,265  |      |   | 5,273   |        |  |   | 5,069   |        |  |      | 3,993   |        |  |   | 3,732   |       
|                                                                                |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Earnings before income taxes                                                    |  |                                   | 2,093   |      |   | 5,660   |        |  |   | 3,844   |        |  |      | 3,471   |        |  |   | 3,808   |       
|Total income taxes                                                              |  |                                   | 706     |      |   | 2,068   |        |  |   | 1,418   |        |  |      | 1,283   |        |  |   | 1,425   |       
|                                                                                |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Net earnings                                                                    |  | $                                 | 1,387   |      | $ | 3,592   |        |  | $ | 2,426   |        |  | $    | 2,188   |        |  | $ | 2,383   |       
|                                                                                |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Per Share Data:                                                                 |  |                                   |         |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Earnings per share, basic                                                       |  | $                                 | 0.18    |      | $ | 0.45    | (2)    |  | $ | 0.30    | (2)    |  | $    | 0.27    | (2)    |  | $ | 0.30    | (2)   
|Earnings per share, diluted                                                     |  | $                                 | 0.18    |      | $ | 0.45    | (2)    |  | $ | 0.30    | (2)    |  | $    | 0.27    | (2)    |  | $ | 0.30    | (2)   
|Dividends per share                                                             |  | $                                 | 0.21    |      | $ | 0.16    | (1)(2) |  | $ | 0.16    | (1)(2) |  | $    | 0.16    | (1)(2) |  | $ | 0.16    | (1)(2)

---

|(1) | Represents dividends paid per share of Jefferson Federal common stock to shareholders other
than Jefferson Bancshares, MHC, which waived the receipt of all dividends during the periods presented.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Per share and dividend amounts have been adjusted to reflect the exchange of 4.2661 shares of
Jefferson Bancshares common stock for each share of Jefferson Federal common stock in the conversion.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



20



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##### Table of Contents

|                                                                        |  |                                   |   |  |        |   |  |        |   |  |        |   |  |        |  
|----------------------------------------------------------------------- |  | --------------------------------- | - |  | ------ | - |  | ------ | - |  | ------ | - |  | ------ | -
|                                                                        |  | At or For the Year Ended June 30, |  
|                                                                        |  | 2004                              |   |  | 2003   |   |  | 2002   |   |  | 2001   |   |  | 2000   |  
|Performance Ratios:                                                     |  |                                   |   |  |        |   |  |        |   |  |        |   |  |        |  
|Return on average assets                                                |  | 0.44                              | % |  | 1.32   | % |  | 0.91   | % |  | 0.90   | % |  | 1.05   | %
|Return on average equity                                                |  | 1.46                              |   |  | 10.25  |   |  | 7.68   |   |  | 7.60   |   |  | 9.19   |  
|Interest rate spread(1)                                                 |  | 3.08                              |   |  | 3.66   |   |  | 3.02   |   |  | 2.56   |   |  | 2.92   |  
|Net interest margin(2)                                                  |  | 3.76                              |   |  | 4.10   |   |  | 3.53   |   |  | 3.20   |   |  | 3.47   |  
|Noninterest expense to average assets                                   |  | 3.28                              |   |  | 1.94   |   |  | 1.90   |   |  | 1.65   |   |  | 1.64   |  
|Efficiency ratio(3)                                                     |  | 83.21                             |   |  | 45.30  |   |  | 50.73  |   |  | 47.46  |   |  | 42.36  |  
|Average interest-earning assets to average interest-bearing liabilities |  | 143.13                            |   |  | 117.67 |   |  | 112.77 |   |  | 112.70 |   |  | 111.80 |  
|Dividend payout ratio(4)                                                |  | 1.17                              |   |  | 36.46  |   |  | 53.79  |   |  | 59.62  |   |  | 54.72  |  
|Capital Ratios:                                                         |  |                                   |   |  |        |   |  |        |   |  |        |   |  |        |  
|Tangible capital                                                        |  | 22.21                             |   |  | 9.75   |   |  | 12.00  |   |  | 11.50  |   |  | 11.60  |  
|Core capital                                                            |  | 22.21                             |   |  | 9.75   |   |  | 12.00  |   |  | 11.50  |   |  | 11.60  |  
|Risk-based capital                                                      |  | 38.78                             |   |  | 21.06  |   |  | 21.10  |   |  | 20.20  |   |  | 20.30  |  
|Average equity to average assets                                        |  | 30.40                             |   |  | 12.90  |   |  | 11.87  |   |  | 11.87  |   |  | 11.41  |  
|Asset Quality Ratios:                                                   |  |                                   |   |  |        |   |  |        |   |  |        |   |  |        |  
|Allowance for loan losses as a percent of total gross loans             |  | 1.31                              |   |  | 1.54   |   |  | 1.37   |   |  | 1.17   |   |  | 1.15   |  
|Allowance for loan losses as a percent of nonperforming loans           |  | 228.90                            |   |  | 161.79 |   |  | 130.40 |   |  | 80.10  |   |  | 49.10  |  
|Net charge-offs to average outstanding loans during the period          |  | 0.19                              |   |  | 0.34   |   |  | 0.38   |   |  | 0.43   |   |  | 0.71   |  
|Nonperforming loans as a percent of total loans                         |  | 0.58                              |   |  | 0.95   |   |  | 1.09   |   |  | 1.52   |   |  | 2.43   |  
|Nonperforming assets as a percent of total assets                       |  | 0.54                              |   |  | 0.82   |   |  | 1.16   |   |  | 1.54   |   |  | 1.91   |  

---

|(1) | Represents the difference between the weighted average yield on average interest-earning
assets and the weighted average cost of interest-bearing liabilities.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Represents net interest income as a percent of average interest-earning assets.
|--- | -------------------------------------------------------------------------------



|(3) | Represents noninterest expense divided by the sum of net interest income and noninterest
income, excluding gains or losses on the sale of securities. Excluding the $4.0 million contribution to the Charitable Foundation, the efficiency ratio for 2004 would be 50.78.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Reflects dividends per share declared in the period divided by earnings per share for the period.
|--- | -------------------------------------------------------------------------------------------------



21



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##### Table of Contents

|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
|------- | ------------------------------------------------------------------------------------



The objective of this section is to help shareholders and potential investors understand our views on our results of
operations and financial condition. You should read this discussion in conjunction with the financial statements and notes to the financial statements that appear elsewhere in this report.



Overview



Income



We have two primary sources of pre-tax income. The first is net interest income. Net interest income is the difference between interest income 
which is the income that we earn on our loans and investments  and interest expense  which is the interest that we pay on our deposits and borrowings.



Our second principal source of pre-tax income is fee income  the compensation we receive from providing products and
services. Most of our fee income comes from service charges on NOW accounts and fees for late loan payments. We also earn fee income from ATM charges, insurance commissions, safe deposit box rentals and other fees and charges.



We occasionally recognize gains or losses as a result of sales of investment
securities or foreclosed real estate. These gains and losses are not a regular part of our income.



Expenses



The expenses we incur in operating our business consist of compensation and benefits expenses, occupancy expenses, equipment and data processing expense,
deposit insurance premiums, advertising expenses, expenses for foreclosed real estate and other miscellaneous expenses.



Compensation and benefits consist primarily of the salaries and wages paid to our employees, fees paid to our directors and expenses for retirement and
other employee benefits.



Occupancy expenses, which are the
fixed and variable costs of building and equipment, consist primarily of lease payments, real estate taxes, depreciation charges, maintenance and costs of utilities.



Equipment and data processing expense includes fees paid to our third-party data processing service and expenses and
depreciation charges related to office and banking equipment. Depreciation of premises and equipment is computed using the straight-line and accelerated methods based on the useful lives of the related assets. Estimated lives are five to 40 years
for building and improvements, and three to 10 years for furniture and equipment.



Deposit insurance premiums are payments we make to the Federal Deposit Insurance Corporation for insurance of our deposit accounts.



Expenses for foreclosed real estate include maintenance and repairs on foreclosed properties prior to sale.



Other expenses include expenses for attorneys, accountants and consultants,
payroll taxes, franchise taxes, charitable contributions, insurance, office supplies, postage, telephone and other miscellaneous operating expenses.



Critical Accounting Policies



We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying
value of certain assets or on income to be critical



22



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##### Table of Contents

accounting policies. We consider the following to be our critical accounting policies: allowance for loan losses and deferred income taxes.



Allowance for Loan Losses. Determining the amount of the
allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a monthly basis and establishes the provision for loan losses based on the composition of the loan portfolio, delinquency
levels, loss experience, economic condition and other factors related to the collectibility of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the
allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically
reviews our allowance for loan losses. Such agency may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination.



Deferred Income Taxes. We use the asset and liability method of
accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets,
including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.



Results of Operations for the Years Ended June 30, 2004, 2003 and 2002



Overview.



|                                |  |  |  |                                               |       |   |      |   |       |      |  |   |                   |     |  |                   |   |  |     
|------------------------------- |  |  |  | --------------------------------------------- | ----- | - | ---- | - | ----- | ---- |  | - | ----------------- | --- |  | ----------------- | - |  | ----
|                                |  |  |  | 2004                                          |       |   | 2003 |   |       | 2002 |  |   | % Change2004/2003 |     |  | % Change2003/2002
|                                |  |  |  | (Dollars in thousands, except per share data)
|Net earnings                    |  |  |  | $                                             | 1,387 |   |      | $ | 3,592 |      |  | $ | 2,426             |     |  | (61.4             | ) |  | 48.1
|Net earnings per share, basic   |  |  |  | $                                             | 0.18  |   |      |   | 0.45  | (1)  |  |   | 0.30              | (1) |  | (60.0             | ) |  | 50.0
|Net earnings per share, diluted |  |  |  | $                                             | 0.18  |   |      |   | 0.45  | (1)  |  |   | 0.30              | (1) |  | (60.0             | ) |  | 50.0
|Return on average assets        |  |  |  |                                               | 0.44  | % |      |   | 1.32  | %    |  |   | 0.91              | %   |  |                   |   |  |     
|Return on average equity        |  |  |  |                                               | 1.46  | % |      |   | 10.25 | %    |  |   | 7.68              | %   |  |                   |   |  |     

---

|(1) | Per share amounts have been adjusted to reflect the exchange of 4.2661 shares of Jefferson Bancshares common stock for each share of Jefferson Federal common stock
in the Conversion.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2004 v. 2003. Net
earnings were $1.4 million for the year ended June 30, 2004 compared to $3.6 million for the year ended June 30, 2003. Net earnings decreased as a result of the nonrecurring expense associated with the $4.0 million contribution to the Jefferson
Federal Charitable Foundation combined with an increase in noninterest expense. This earnings decrease was partially offset by an increase in net interest income and noninterest income combined with a decrease in provision for loan losses.



2003 v. 2002. Net earnings for 2003 were $3.6 million,
representing an increase of $1.2 million, or 48.1%, from net earnings of $2.4 million for 2002. On a diluted per share basis, earnings increased to $0.45 for fiscal 2003 from $0.30 for fiscal 2002. The resulting return on average assets was 1.32%
and the return on average stockholders equity was 10.24%, as compared to 0.91% and 7.68%, respectively, for 2002. The increase in net earnings was primarily attributable to an increase in net interest income accompanied by a decrease in the
provision for loan losses, which more than offset an increase in noninterest expense.



23



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##### Table of Contents

Net Interest Income.



The following table summarizes changes in interest income and expense for the years ended June 30, 2004, 2003 and 2002:



|                           |  |                     |        |          |   |        |  |           |        |  |           |    |  |       |   
|-------------------------- |  | ------------------- | ------ | -------- | - | ------ |  | --------- | ------ |  | --------- | -- |  | ----- | --
|                           |  | Year Ended June 30, |        | % Change |  
|                           |  | 2004                |        | 2003     |   | 2002   |  | 2004/2003 |        |  | 2003/2002 |   
|Interest income:           |  |                     |        |          |   |        |  |           |        |  |           |    |  |       |   
|Loans                      |  | $                   | 12,692 |          | $ | 14,752 |  | $         | 15,988 |  | (14.0     | )% |  | (7.7  | )%
|Investment securities      |  |                     | 2,620  |          |   | 1,292  |  |           | 1,812  |  | 102.8     |    |  | (28.7 | ) 
|Mortgage-backed securities |  |                     | 540    |          |   | 992    |  |           | 1,335  |  | (45.6     | )  |  | (25.7 | ) 
|Municipal securities       |  |                     | 44     |          |   |       |  |           |       |  | NM        |    |  |      |   
|Interest-earning deposits  |  |                     | 109    |          |   | 159    |  |           | 168    |  | (31.4     | )  |  | (5.4  | ) 
|FHLB stock                 |  |                     | 62     |          |   | 64     |  |           | 77     |  | (3.1      | )  |  | (16.9 | ) 
|                           |  |                     |        |          |   |        |  |           |        |  |           |    |  |       |   
|Total interest income      |  |                     | 16,067 |          |   | 17,259 |  |           | 19,380 |  | (6.9      | )  |  | (10.9 | ) 
|                           |  |                     |        |          |   |        |  |           |        |  |           |    |  |       |   
|Interest expense:          |  |                     |        |          |   |        |  |           |        |  |           |    |  |       |   
|Deposits                   |  |                     | 4,670  |          |   | 6,418  |  |           | 10,165 |  | (27.2     | )  |  | (36.9 | ) 
|Borrowings                 |  |                     | 106    |          |   | 100    |  |           | 102    |  | 6.0       |    |  | (2.0  | ) 
|                           |  |                     |        |          |   |        |  |           |        |  |           |    |  |       |   
|Total interest expense     |  |                     | 4,776  |          |   | 6,518  |  |           | 10,267 |  | (26.7     | )  |  | (36.5 | ) 
|                           |  |                     |        |          |   |        |  |           |        |  |           |    |  |       |   
|Net interest income        |  | $                   | 11,291 |          | $ | 10,741 |  | $         | 9,113  |  | 5.1       | %  |  | 17.9  | % 
|                           |  |                     |        |          |   |        |  |           |        |  |           |    |  |       |   



2004 v. 2003.
Net interest income before loan loss provision increased $550,000, or 5.1%, to $11.3 million for the year ended June 30, 2004. This increase was primarily the result of a decrease in interest expense, partially offset by lower interest income. The
net interest margin and interest rate spread were 3.76% and 3.08%, respectively, for the year ended June 30, 2004, compared to 4.10% and 3.66% for the comparable period in 2003. The decline in net interest margin reflects growth in earning assets
with lower yields due to current low market interest rates. The average balance of interest-earning assets increased $38.1 million to $300.0 million, while the average balance of interest-bearing liabilities decreased $13.0 million to $209.6
million. The average rate paid on interest-bearing liabilities decreased 65 basis points to 2.28%, while the average yield on interest-earning assets decreased 123 basis points to 5.36%



Total interest income decreased $1.2 million, or 6.9%, to $16.1 million for the year ended June 30, 2004 compared to $17.3
million for the year ended June 30, 2003. The decrease in interest income was the result of a reduction in the average yield of interest-earning assets more than offsetting an increase in the average balance of interest-earning assets. Interest on
loans decreased as a result of declining rates and a decrease in the average balance. The average yield on loans declined as we originated loans at lower interest rates due to the prevailing low interest rate environment, and loans with variable
rates repriced to lower rates. Interest on investment securities increased due to an increase in the average balance which more than offset a decline in the average yield. The average balance of investments increased as a result of the investment of
Conversion proceeds in short-term securities. The average yield on investment securities decreased 126 basis points to 3.07% for 2004 compared to 4.33% for 2003. Approximately 13% of the investment portfolio is held in mortgage-backed securities
(MBSs). A significant portion of our mortgage-backed securities has adjustable rates and has repriced downward in the current low interest rate environment. Dividends on FHLB stock were $62,000 for fiscal 2004 and $64,000 for fiscal 2003. Dividends
on FHLB stock are paid with additional shares of FHLB stock.



Interest expense decreased $1.7 million, or 26.7%, to $4.8 million for 2004 compared to $6.5 million for 2003 as a result of a decline in both the average balance of deposits and the average rate paid. A decline in the average balance of
certificates of deposit more than offset increases in transaction accounts for the year ended June 30, 2004. The decline in certificates of deposit resulted from our decision not to aggressively compete for higher



24



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##### Table of Contents

costing deposits. The average rate paid on deposits declined for fiscal 2004 due to the current low interest rate environment.



2003 v. 2002. Net interest income for fiscal 2003 increased $1.6
million, or 17.9%, to $10.7 million as a result of a significant decrease in the cost of funds which more than offset a decrease in the average yield on interest earning assets. The interest rate spread increased to 3.66% for 2003 compared to 3.02%
for 2002, while the net interest margin increased to 4.10% for 2003 compared to 3.53% for 2002.



Interest income decreased $2.1 million, or 10.9%, to $17.3 million for 2003 due primarily to a decrease in the average yield on interest-earning assets.
The average yield on interest-earning assets declined 91 basis points to 6.59% for 2003 compared to 7.50% for 2002. The level of average interest-earning assets increased $3.6 million, or 1.4% as an increase in interest-earning deposits more than
offset decreases in the average balances of loans, mortgage-backed securities, and investment securities. Interest on loans decreased $1.2 million, or 7.7%, to $14.8 million for 2003 due to decline in the average yield and the average balance of
loans. The average yield on loans declined as we originated loans at lower interest rates due to the prevailing low interest rate environment. The average balance of loans decreased as a result of heavy refinancing activity and our decision to
tighten underwriting to strengthen asset quality. Interest on mortgage-backed securities decreased $343,000, or 25.7%, to $992,000 for 2003 due to a decline in both the average balance and the average yield. The decrease in the average balance of
mortgage-backed securities is the result of increased principal repayments due to the prevailing low interest rate environment. Interest on investment securities decreased $520,000, or 28.7%, to $1.3 million due to a decline in both the average
balance and the average yield. During 2003, approximately $15.1 million of our investment securities were called, resulting in a lower average balance and lower average yield.



Total interest expense decreased $3.7 million, or 36.5%, to $6.5 million for 2003 as the result of a 157 basis point decline
in the average cost of interest-bearing deposits to 2.91% and a decline in the average balance of deposits of $6.5 million, or 2.8%. The decline in the average cost of deposits was the result of lower market interest rates and a transition of
deposits into lower costing transaction accounts.



25



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##### Table of Contents

Average Balances and Yields. The following table presents information regarding average balances
of assets and liabilities, as well as the total dollar amounts of interest income and dividends from average interest-earning assets and interest expense on average interest-bearing liabilities and the resulting average yields and costs. The yields
and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. For purposes of this table, average balances have been calculated using the
average of month-end balances, and nonaccrual loans are included in average balances; however, accrued interest income has been excluded from these loans.



|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|-------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | -------------------- | - | ----------- | ---- | ---- | -------------- |  | - | ---------------------- | - | ---------- | - | ------ | --------------- | ---- | - | -------------------- | - | ----------- | - |  | - | ------ |  | ---- | -
|                                                                                 |  | Year Ended June 30,    |        
|                                                                                 |  | 2004                   |         |   | 2003                 |   |             | 2002 |     
|                                                                                 |  | AverageBalance         |         |   | InterestandDividends |   | Yield/ Cost |      |      | AverageBalance |  |   | Interest and Dividends |   | Yield/Cost |   |        | Average Balance |      |   | InterestandDividends |   | Yield/ Cost |  
|                                                                                 |  | (Dollars in thousands) |        
|Interest-earning assets:                                                         |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Loans                                                                            |  | $                      | 185,899 |   |                      | $ | 12,692      |      | 6.83 | %              |  | $ | 189,691                |   |            | $ | 14,752 |                 | 7.78 | % |                      | $ | 190,980     |   |  | $ | 15,987 |  | 8.37 | %
|Mortgage-backed securities                                                       |  |                        | 15,218  |   |                      |   | 540         |      | 3.55 |                |  |   | 24,310                 |   |            |   | 992    |                 | 4.08 |   |                      |   | 27,596      |   |  |   | 1,335  |  | 4.84 |  
|Investment securities                                                            |  |                        | 87,335  |   |                      |   | 2,620       |      | 3.00 |                |  |   | 28,407                 |   |            |   | 1,292  |                 | 4.55 |   |                      |   | 31,980      |   |  |   | 1,812  |  | 5.67 |  
|Municipal securities                                                             |  |                        | 1,711   |   |                      |   | 44          |      | 2.57 |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Daily interest deposits                                                          |  |                        | 8,287   |   |                      |   | 109         |      | 1.32 |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Other earning assets                                                             |  |                        | 1,552   |   |                      |   | 62          |      | 3.99 |                |  |   | 19,528                 |   |            |   | 223    |                 | 1.14 |   |                      |   | 7,738       |   |  |   | 245    |  | 3.17 |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Total interest-earning assets                                                    |  |                        | 300,002 |   |                      |   | 16,067      |      | 5.36 |                |  |   | 261,936                |   |            |   | 17,259 |                 | 6.59 |   |                      |   | 258,294     |   |  |   | 19,379 |  | 7.50 |  
|Noninterest-earning assets                                                       |  |                        | 12,881  |   |                      |   |             |      |      |                |  |   | 9,993                  |   |            |   |        |                 |      |   |                      |   | 7,806       |   |  |   |        |  |      |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Total assets                                                                     |  | $                      | 312,883 |   |                      |   |             |      |      |                |  | $ | 271,929                |   |            |   |        |                 |      |   |                      | $ | 266,100     |   |  |   |        |  |      |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Interest-bearing liabilities:                                                    |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Passbook accounts                                                                |  | $                      | 13,994  |   |                      |   | 75          |      | 0.54 |                |  | $ | 15,016                 |   |            |   | 141    |                 | 0.94 | % |                      | $ | 13,241      |   |  |   | 262    |  | 1.98 | %
|NOW accounts                                                                     |  |                        | 15,785  |   |                      |   | 85          |      | 0.54 |                |  |   | 14,673                 |   |            |   | 125    |                 | 0.85 |   |                      |   | 12,325      |   |  |   | 137    |  | 1.11 |  
|Money market accounts                                                            |  |                        | 28,649  |   |                      |   | 358         |      | 1.25 |                |  |   | 23,305                 |   |            |   | 466    |                 | 2.00 |   |                      |   | 10,133      |   |  |   | 237    |  | 2.34 |  
|Certificates of deposit                                                          |  |                        | 148,499 |   |                      |   | 4,152       |      | 2.80 |                |  |   | 167,599                |   |            |   | 5,686  |                 | 3.39 |   |                      |   | 191,350     |   |  |   | 9,528  |  | 4.98 |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Total interest-bearing deposits                                                  |  |                        | 206,927 |   |                      |   | 4,670       |      | 2.26 |                |  |   | 220,593                |   |            |   | 6,418  |                 | 2.91 |   |                      |   | 227,049     |   |  |   | 10,164 |  | 4.48 |  
|Borrowings                                                                       |  |                        | 2,667   |   |                      |   | 106         |      | 3.97 |                |  |   | 2,000                  |   |            |   | 100    |                 | 5.00 |   |                      |   | 2,000       |   |  |   | 102    |  | 5.10 |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Total interest-bearing liabilities                                               |  |                        | 209,594 |   |                      |   | 4,776       |      | 2.28 |                |  |   | 222,593                |   |            |   | 6,518  |                 | 2.93 |   |                      |   | 229,049     |   |  |   | 10,266 |  | 4.48 |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Noninterest-bearing liabilities                                                  |  |                        | 8,177   |   |                      |   |             |      |      |                |  |   | 14,268                 |   |            |   |        |                 |      |   |                      |   | 5,455       |   |  |   |        |  |      |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Total liabilities                                                                |  |                        | 217,771 |   |                      |   |             |      |      |                |  |   | 236,861                |   |            |   |        |                 |      |   |                      |   | 234,504     |   |  |   |        |  |      |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Stockholders equity                                                             |  |                        | 95,112  |   |                      |   |             |      |      |                |  |   | 35,068                 |   |            |   |        |                 |      |   |                      |   | 31,596      |   |  |   |        |  |      |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Total liabilities and retained earnings                                          |  | $                      | 312,883 |   |                      |   |             |      |      |                |  | $ | 271,929                |   |            |   |        |                 |      |   |                      | $ | 266,100     |   |  |   |        |  |      |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Net interest income                                                              |  |                        |         |   |                      | $ | 11,291      |      |      |                |  |   |                        |   |            | $ | 10,741 |                 |      |   |                      |   |             |   |  | $ | 9,113  |  |      |  
|                                                                                 |  |                        |         |   |                      |   |             |      |      |                |  |   |                        |   |            |   |        |                 |      |   |                      |   |             |   |  |   |        |  |      |  
|Interest rate spread                                                             |  |                        |         |   |                      |   |             |      | 3.08 | %              |  |   |                        |   |            |   |        |                 | 3.66 | % |                      |   |             |   |  |   |        |  | 3.02 | %
|Net interest margin                                                              |  |                        |         |   |                      |   |             |      | 3.76 | %              |  |   |                        |   |            |   |        |                 | 4.10 | % |                      |   |             |   |  |   |        |  | 3.53 | %
|Ratio of average interest-earning assets to average interest-bearing liabilities |  |                        | 143.13  | % |                      |   |             |      |      |                |  |   | 117.67                 | % |            |   |        |                 |      |   |                      |   | 112.77      | % |  |   |        |  |      |  



26



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##### Table of Contents

Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on
our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior
rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the
changes due to volume.



|                                                                  |  |                            |       |   |                       |   |        |                            |  |   |        |   |  |      |      |   |     |   |        |   |  |   |        |  
|----------------------------------------------------------------- |  | -------------------------- | ----- | - | --------------------- | - | ------ | -------------------------- |  | - | ------ | - |  | ---- | ---- | - | --- | - | ------ | - |  | - | ------ | -
|                                                                  |  | 2004 Compared to 2003      |       |   | 2003 Compared to 2002 |  
|                                                                  |  | Increase (Decrease) Due to |       |   |                       |   |        | Increase (Decrease) Due to |  |   |        |  
|                                                                  |  | Volume                     |       |   | Rate                  |   |        | Net                        |  |   | Volume |   |  | Rate |      |   | Net |  
|                                                                  |  | (In Thousands)             |      
|Interest income:                                                  |  |                            |       |   |                       |   |        |                            |  |   |        |   |  |      |      |   |     |   |        |   |  |   |        |  
|Loans receivable                                                  |  | $                          | (290  | ) |                       | $ | (1,770 | )                          |  | $ | (2,060 | ) |  | $    | (107 | ) |     | $ | (1,128 | ) |  | $ | (1,235 | )
|Mortgage-backed securities                                        |  |                            | (335  | ) |                       |   | (117   | )                          |  |   | (452   | ) |  |      | (148 | ) |     |   | (195   | ) |  |   | (343   | )
|Investment securities                                             |  |                            | 1,589 |   |                       |   | (261   | )                          |  |   | 1,328  |   |  |      | (188 | ) |     |   | (332   | ) |  |   | (520   | )
|Municipals                                                        |  |                            | 44    |   |                       |   |       |                            |  |   | 44     |   |  |      |      |   |     |   |        |   |  |   |        |  
|Daily interest-bearing deposits and other interest-earning assets |  |                            | (65   | ) |                       |   | 13     |                            |  |   | (52    | ) |  |      | 167  |   |     |   | (189   | ) |  |   | (22    | )
|                                                                  |  |                            |       |   |                       |   |        |                            |  |   |        |   |  |      |      |   |     |   |        |   |  |   |        |  
|Total interest-earning assets                                     |  |                            | 943   |   |                       |   | (2,135 | )                          |  |   | (1,192 | ) |  |      | (276 | ) |     |   | (1,844 | ) |  |   | (2,120 | )
|                                                                  |  |                            |       |   |                       |   |        |                            |  |   |        |   |  |      |      |   |     |   |        |   |  |   |        |  
|Interest expense:                                                 |  |                            |       |   |                       |   |        |                            |  |   |        |   |  |      |      |   |     |   |        |   |  |   |        |  
|Deposits                                                          |  |                            | (379  | ) |                       |   | (1,369 | )                          |  |   | (1,748 | ) |  |      | (281 | ) |     |   | (3,465 | ) |  |   | (3,746 | )
|Borrowings                                                        |  |                            | 16    |   |                       |   | (10    | )                          |  |   | 6      |   |  |      |     |   |     |   | (2     | ) |  |   | (2     | )
|                                                                  |  |                            |       |   |                       |   |        |                            |  |   |        |   |  |      |      |   |     |   |        |   |  |   |        |  
|Total interest-bearing liabilities                                |  |                            | (363  | ) |                       |   | (1,379 | )                          |  |   | (1,742 | ) |  |      | (281 | ) |     |   | (3,467 | ) |  |   | (3,748 | )
|                                                                  |  |                            |       |   |                       |   |        |                            |  |   |        |   |  |      |      |   |     |   |        |   |  |   |        |  
|Net change in interest income                                     |  | $                          | 1,306 |   |                       | $ | (756   | )                          |  | $ | 550    |   |  | $    | 5    |   |     | $ | 1,623  |   |  | $ | 1,628  |  
|                                                                  |  |                            |       |   |                       |   |        |                            |  |   |        |   |  |      |      |   |     |   |        |   |  |   |        |  



Provision for
Loan Losses



We review the level of the allowance on a
monthly basis and establish the provision for loan losses based on the level of subprime loans in the loan portfolio, delinquency levels, loss experience, economic conditions, and other factors related to the collectibility of the loan portfolio. We
use Beacon credit scores to predict the likelihood that an existing borrower will become a credit risk. We consider loans to borrowers with a Beacon credit score below 600 to be subprime.



2004 v. 2003. Provision for loan losses decreased $787,000 for the
year ended June 30, 2004 compared to the same period in 2003. There were no additions to the allowance for loan losses during fiscal 2004 due to lower estimated losses in the loan portfolio. Net charge-offs were $362,000 for 2004 compared to
$642,000 for 2003. Nonaccrual loans were $1.1 million at June 30, 2004 compared to $1.8 million at June 30, 2003.



2003 v. 2002. Provision for loan losses decreased $434,000, or 35.5%, to $787,000 for the year ended June 30, 2003. Net charge-offs for 2003 were
$642,000, compared to $734,000 for 2002. The provision for loan losses was suspended in the fourth quarter of 2003 due to improvements in the quality of the loan portfolio and our assessment of the adequacy of the allowance for loan losses. The
level of subprime loans decreased approximately $8.5 million, or 22.8%, to $28.8 million at June 30, 2003. In addition, nonaccrual loans decreased $312,000 to $1.8 million at June 30, 2003.



An analysis of the changes in the allowance for loan losses is presented
under Allowance for Loan Losses and Asset Quality.



27



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##### Table of Contents

Noninterest Income.The following table shows the components of noninterest income and the
percentage changes from 2004 to 2003 and from 2003 to 2002.



|                                       |  |                        |       |      |   |      |  |                   |       |  |                    |   |  |       |  
|-------------------------------------- |  | ---------------------- | ----- | ---- | - | ---- |  | ----------------- | ----- |  | ------------------ | - |  | ----- | -
|                                       |  | 2004                   |       | 2003 |   | 2002 |  | % Change2004/2003 |       |  | % Change 2003/2002 |  
|                                       |  | (Dollars in Thousands) |      
|Dividends from investments             |  | $                      | 48    |      | $ | 25   |  | $                 |      |  | 92.0               | % |  | NM    |  
|Service charges and fees               |  |                        | 625   |      |   | 674  |  |                   | 669   |  | (7.3               | ) |  | 0.7   | %
|Gain on sale of fixed assets           |  |                        | 1     |      |   |     |  |                   |      |  | NM                 |   |  |      |  
|Gain on sale of foreclosed real estate |  |                        | 152   |      |   | 47   |  |                   | 45    |  | 223.4              |   |  | 4.4   |  
|Gain on sale of investments            |  |                        | 22    |      |   | 81   |  |                   | 141   |  | (72.8              | ) |  | (42.6 | )
|Other                                  |  |                        | 219   |      |   | 152  |  |                   | 166   |  | 23.7               |   |  | (8.4  | )
|                                       |  |                        |       |      |   |      |  |                   |       |  |                    |   |  |       |  
|Total                                  |  | $                      | 1,067 |      | $ | 979  |  | $                 | 1,021 |  | 9.0                |   |  | (4.1  | )
|                                       |  |                        |       |      |   |      |  |                   |       |  |                    |   |  |       |  



2004 v. 2003.
Noninterest income increased $88,000, or 9.0%, to $1.1 million for the year ended June 30, 2004 due to a combination of factors, including an increase in gain on sale of foreclosed property more than offsetting a decrease in service charges and fees
and a decrease in gain on sale of investments. In addition, the cash surrender value of life insurance, which was purchased during the last six months of fiscal 2004, increased $80,000.



2003 v. 2002. Noninterest income decreased $42,000, or 4.1%, to $979,000 for 2003. The decrease in noninterest income
was primarily attributable to a decrease in gain on sale of investments.



Noninterest Expense.The following table shows the components of noninterest expense and the percentage changes from 2004 to 2003 and from 2003 to 2002.



|                                                            |  |                        |        |      |   |       |  |                   |       |  |                    |   |  |      |  
|----------------------------------------------------------- |  | ---------------------- | ------ | ---- | - | ----- |  | ----------------- | ----- |  | ------------------ | - |  | ---- | -
|                                                            |  | 2004                   |        | 2003 |   | 2002  |  | % Change2004/2003 |       |  | % Change 2003/2002 |  
|                                                            |  | (Dollars in Thousands) |       
|Compensation and benefits                                   |  | $                      | 3,175  |      | $ | 2,451 |  | $                 | 2,351 |  | 29.5               | % |  | 4.3  | %
|Occupancy                                                   |  |                        | 257    |      |   | 263   |  |                   | 244   |  | (2.3               | ) |  | 7.8  |  
|Equipment and data processing                               |  |                        | 974    |      |   | 864   |  |                   | 832   |  | 12.7               |   |  | 3.8  |  
|SAIF deposit insurance premiums                             |  |                        | 37     |      |   | 38    |  |                   | 41    |  | (2.6               | ) |  | (7.3 | )
|REO expense                                                 |  |                        | 209    |      |   | 353   |  |                   | 285   |  | (40.8              | ) |  | 23.9 |  
|Advertising                                                 |  |                        | 213    |      |   | 147   |  |                   | 130   |  | 44.9               |   |  | 13.1 |  
|Contribution to the Jefferson Federal Charitable Foundation |  |                        | 4,000  |      |   |      |  |                   |      |  | NM                 |   |  |     |  
|Other                                                       |  |                        | 1,400  |      |   | 1,157 |  |                   | 1,186 |  | 21.0               |   |  | (2.4 | )
|                                                            |  |                        |        |      |   |       |  |                   |       |  |                    |   |  |      |  
|Total noninterest expense                                   |  | $                      | 10,265 |      | $ | 5,273 |  | $                 | 5,069 |  | 94.7               |   |  | 4.0  |  
|                                                            |  |                        |        |      |   |       |  |                   |       |  |                    |   |  |      |  



2004 v. 2003.
Noninterest expense increased $5.0 million to $10.3 million for the year ended June 30, 2004 due primarily to the $4.0 million contribution to the Jefferson Federal Charitable Foundation. Compensation and benefits increased $724,000, or 29.5%, due
primarily to expenses related to the Employee Stock Ownership Plan (ESOP) and the Stock Incentive Plan. For 2004, compensation expense related to the ESOP was $590,000 and expense related to the Stock Incentive Plan was $220,000. Prior
to the establishment of the ESOP at the beginning of fiscal 2004, annual contributions were made to a 401(k) Plan. The expense related to the 401(k) Plan for 2003 was approximately $184,000.



2003 v. 2002. Noninterest expense increased $204,000, or 4.0%, to $5.3
million for 2003. The increase was primarily attributable to an increase in compensation and benefits due to salary increases. REO expense increased due to a higher volume of foreclosed property.



28



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##### Table of Contents

Income Taxes



2004 v. 2003. Income tax expense for the year ended June 30, 2004 was $706,000 compared to $2.1 million for the same
period in 2003. The decrease in income tax expense (i.e., current and deferred) for fiscal 2004 was due to the contribution of cash and common stock to the Jefferson Federal Charitable Foundation. The contribution to the Foundation is tax
deductible, subject to a limitation based on 10% of the Companys annual taxable income. Any unused portion of the deduction may be carried forward for five years following the year in which the contribution is made.



2003 v. 2002. Income taxes increased due to a higher level of income.
The effective tax rate for 2003 was 36.5% for 2003, compared to 36.9% for 2002.



Balance Sheet



Loans. Our primary lending activity is the origination of loans secured by real estate. We originate real estate loans secured by one- to four-family homes, commercial real estate, multi-family real estate and land. We also
originate construction loans and home equity loans. At June 30, 2004, real estate loans totaled $170.9 million, or 90.2% of our total loans, compared to $162.4 million, or 88.6% of total loans, at June 30, 2003 and $178.9 million, or 90.9% of total
loans, at June 30, 2002. Mortgage loans increased $8.5 million, or 5.2%, in the year ended June 30, 2004 and declined $14.8 million, or 8.3%, in the year ended June 30, 2003. Loans increased in the year ended June 30, 2004 as a result of an increase
in commercial real estate loans.



The largest segment of our
mortgage loans is one- to four-family loans. At June 30, 2004, one- to four-family loans totaled $84.8 million and represented 49.6% of mortgage loans and 44.8% of total loans. One- to four-family loans were essentially unchanged from June 30, 2003.



Commercial real estate loans is the second largest segment of
our mortgage loan portfolio. We have emphasized this type of lending for several years and have grown this portfolio to $60.0 million as of June 30, 2004. Commercial real estate loans increased $11.0 million, or 22.4%, in the year ended June 30,
2004 and increased $2.3 million, or 5.0%, in the year ended June 30, 2003. We intend to continue to emphasize this type of lending. We hired an experienced commercial loan officer in 2001 and our Chief Executive Officer has significant experience in
this area.



Multi-family real estate loans decreased $4.0
million, or 30.4%, in the year ended June 30, 2004 and grew $66,000, or 0.5%, in the year ended June 30, 2003. Construction loans decreased $583,000, or 16.3%, in the year ended June 30, 2004 and decreased $6.0 million, or 53.1%, in the year ended
June 30, 2003. The decline in construction loans as of June 30, 2004 was primarily due to a decrease in demand and the tightening of our underwriting standards. Land loans increased $563,000 million, or 5.5%, in the year ended June 30, 2004 and
declined $2.8 million, or 21.6%, in the year ended June 30, 2003.



For several years we have maintained a portfolio of commercial business loans. Commercial business loans decreased $832,000, or 6.2%, in the year ended June 30, 2004 and grew $5.7 million, or 73.6%, in the year ended June 30, 2003. Since
January 2002, most of the commercial business loans that we have originated have been tied to prime and, thus, will reprice quickly as interest rates change.



We originate a variety of consumer loans, including loans secured by automobiles, mobile homes, and deposit accounts at Jefferson Federal. Consumer loans
totaled $5.9 million and represented 3.1% of total loans at June 30, 2004, compared to $7.4 million, or 4.0% of total loans, at June 30, 2003 and $10.2 million, or 5.2% of total loans, at June 30, 2002. We have tightened our underwriting standards
and have originated fewer subprime loans in recent periods. In addition, we have experienced low demand for automobile loans as a result of low-cost financing offered through automobile dealers.



29



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##### Table of Contents

The following table sets forth the composition of our loan portfolio at the dates indicated.



|                               |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  
|------------------------------ |  | ---------------------- | ------- | - | ------- | ----- | - | ------ | - | ------- | ------- |  | ----- | ------ |  | - | ------- | - |  | ------ | - |  | ------- | ------- | - | ------ | ----- | - | ------- | - | ------- | - |  | ----- | -
|                               |  | At June 30,            |        
|                               |  | 2004                   |         |   | 2003    |       |   | 2002   |   |         | 2001    |  |       | 2000   | 
|                               |  | Amount                 |         |   | Percent |       |   | Amount |   |         | Percent |  |       | Amount |  |   | Percent |   |  | Amount |   |  | Percent |         |   | Amount |       |   | Percent |  
|                               |  | (Dollars in thousands) |        
|Real estate loans:             |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  
|Residential one-to four-family |  | $                      | 84,784  |   |         | 44.8  | % |        | $ | 84,628  |         |  | 46.2  | %      |  | $ | 94,595  |   |  | 49.0   | % |  | $       | 97,270  |   |        | 52.9  | % |         | $ | 90,742  |   |  | 52.4  | %
|Home equity lines of credit    |  |                        | 3,143   |   |         | 1.7   |   |        |   | 1,736   |         |  | 0.9   |        |  |   | 253     |   |  | 0.1    |   |  |         |        |   |        |      |   |         |   |        |   |  |      |  
|Commercial                     |  |                        | 59,993  |   |         | 31.7  |   |        |   | 49,020  |         |  | 26.7  |        |  |   | 46,672  |   |  | 24.2   |   |  |         | 41,145  |   |        | 22.4  |   |         |   | 37,432  |   |  | 21.6  |  
|Multi-family                   |  |                        | 9,213   |   |         | 4.9   |   |        |   | 13,229  |         |  | 7.2   |        |  |   | 13,163  |   |  | 6.8    |   |  |         | 8,670   |   |        | 4.7   |   |         |   | 8,858   |   |  | 5.1   |  
|Construction                   |  |                        | 3,001   |   |         | 1.6   |   |        |   | 3,584   |         |  | 2.0   |        |  |   | 7,465   |   |  | 3.9    |   |  |         | 4,524   |   |        | 2.5   |   |         |   | 5,151   |   |  | 3.0   |  
|Land                           |  |                        | 10,760  |   |         | 5.7   |   |        |   | 10,197  |         |  | 5.6   |        |  |   | 13,011  |   |  | 6.7    |   |  |         | 12,750  |   |        | 6.9   |   |         |   | 9,643   |   |  | 5.6   |  
|                               |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  
|Total real estate loans        |  |                        | 170,894 |   |         | 90.2  |   |        |   | 162,394 |         |  | 88.6  |        |  |   | 175,159 |   |  | 90.7   |   |  |         | 164,359 |   |        | 89.4  |   |         |   | 151,826 |   |  | 87.6  |  
|Commercial business loans      |  |                        | 12,640  |   |         | 6.7   |   |        |   | 13,472  |         |  | 7.4   |        |  |   | 7,759   |   |  | 4.0    |   |  |         | 6,055   |   |        | 3.3   |   |         |   | 6,959   |   |  | 4.0   |  
|Non-real estate loans:         |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  
|Automobile loans               |  |                        | 2,200   |   |         | 1.2   |   |        |   | 3,081   |         |  | 1.7   |        |  |   | 4,243   |   |  | 2.2    |   |  |         | 6,012   |   |        | 3.3   |   |         |   | 7,059   |   |  | 4.1   |  
|Mobile home loans              |  |                        | 531     |   |         | 0.3   |   |        |   | 719     |         |  | 0.4   |        |  |   | 954     |   |  | 0.5    |   |  |         | 1,384   |   |        | 0.8   |   |         |   | 1,536   |   |  | 0.9   |  
|Loans secured by deposits      |  |                        | 1,084   |   |         | 0.6   |   |        |   | 1,841   |         |  | 1.0   |        |  |   | 2,787   |   |  | 1.4    |   |  |         | 3,818   |   |        | 2.1   |   |         |   | 3,362   |   |  | 1.9   |  
|Other consumer loans           |  |                        | 2,038   |   |         | 1.1   |   |        |   | 1,715   |         |  | 0.9   |        |  |   | 2,249   |   |  | 1.2    |   |  |         | 2,273   |   |        | 1.2   |   |         |   | 2,494   |   |  | 1.4   |  
|                               |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  
|Total non-real estate loans    |  |                        | 5,853   |   |         | 3.1   |   |        |   | 7,356   |         |  | 4.0   |        |  |   | 10,233  |   |  | 5.3    |   |  |         | 13,487  |   |        | 7.3   |   |         |   | 14,451  |   |  | 8.3   |  
|                               |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  
|Total gross loans              |  |                        | 189,387 |   |         | 100.0 | % |        |   | 183,222 |         |  | 100.0 | %      |  |   | 193,151 |   |  | 100.0  | % |  |         | 183,901 |   |        | 100.0 | % |         |   | 173,236 |   |  | 100.0 | %
|                               |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  
|Less:                          |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  
|Unearned discount on loans     |  |                        | (1      | ) |         |       |   |        |   | (5      | )       |  |       |        |  |   | (36     | ) |  |        |   |  |         | (166    | ) |        |       |   |         |   | (736    | ) |  |       |  
|Deferred loan fees, net        |  |                        | (306    | ) |         |       |   |        |   | (366    | )       |  |       |        |  |   | (387    | ) |  |        |   |  |         | (335    | ) |        |       |   |         |   | (298    | ) |  |       |  
|Allowance for losses           |  |                        | (2,479  | ) |         |       |   |        |   | (2,841  | )       |  |       |        |  |   | (2,696  | ) |  |        |   |  |         | (2,209  | ) |        |       |   |         |   | (2,030  | ) |  |       |  
|                               |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  
|Total loans receivable, net    |  | $                      | 186,601 |   |         |       |   |        | $ | 180,010 |         |  |       |        |  | $ | 190,032 |   |  |        |   |  | $       | 181,191 |   |        |       |   |         | $ | 170,172 |   |  |       |  
|                               |  |                        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |         |   |  |       |  



30



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##### Table of Contents

The following table sets forth certain information at June 30, 2004 regarding the dollar amount of
principal repayments becoming due during the periods indicated for loans. The table does not include any estimate of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from
that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.



|                              |  |                  |        |                          |   |               |  |            |       |  |   |        
|----------------------------- |  | ---------------- | ------ | ------------------------ | - | ------------- |  | ---------- | ----- |  | - | -------
|                              |  | Real EstateLoans |        | CommercialBusiness Loans |   | ConsumerLoans |  | TotalLoans
|                              |  |                  |        | (In thousands)           |   |              
|Amounts due in:               |  |                  |        |                          |   |               |  |            |       |  |   |        
|One year or less              |  | $                | 5,386  |                          | $ | 29,809        |  | $          | 3,889 |  | $ | 39,084 
|More than one to three years  |  |                  | 9,491  |                          |   | 12,474        |  |            | 1,544 |  |   | 23,509 
|More than three to five years |  |                  | 10,321 |                          |   | 32,036        |  |            | 285   |  |   | 42,642 
|More than five to 10 years    |  |                  | 27,258 |                          |   | 8,622         |  |            | 131   |  |   | 36,011 
|More than 10 to 15 years      |  |                  | 19,998 |                          |   | 3,820         |  |            | 5     |  |   | 23,823 
|More than 15 years            |  |                  | 22,152 |                          |   | 2,166         |  |            |      |  |   | 24,318 
|                              |  |                  |        |                          |   |               |  |            |       |  |   |        
|Total                         |  | $                | 94,606 |                          | $ | 88,927        |  | $          | 5,854 |  | $ | 189,387
|                              |  |                  |        |                          |   |               |  |            |       |  |   |        



The following table
sets forth the dollar amount of all loans at June 30, 2004 that are due after June 30, 2005 and have either fixed interest rates or floating or adjustable interest rates.



|                            |  |                |        |                             |   |        |  |   |        
|--------------------------- |  | -------------- | ------ | --------------------------- | - | ------ |  | - | -------
|                            |  | Fixed-Rates    |        | Floating orAdjustable-Rates |   | Total 
|                            |  | (In thousands)
|Real estate loans:          |  |                |        |                             |   |        |  |   |        
|One-to four-family          |  | $              | 28,018 |                             | $ | 55,845 |  | $ | 83,863 
|Home equity lines of credit |  |                | 80     |                             |   | 3,063  |  |   | 3,143  
|Commercial                  |  |                | 23,854 |                             |   | 25,547 |  |   | 49,401 
|Multi-family                |  |                | 2,417  |                             |   | 6,168  |  |   | 8,585  
|Construction                |  |                | 115    |                             |   | 2,401  |  |   | 2,516  
|Land                        |  |                | 3,158  |                             |   | 1,227  |  |   | 4,385  
|Commercial business loans   |  |                | 1,919  |                             |   | 5,238  |  |   | 7,157  
|Consumer loans              |  |                | 3,109  |                             |   |       |  |   | 3,109  
|                            |  |                |        |                             |   |        |  |   |        
|Total                       |  | $              | 62,670 |                             | $ | 99,489 |  | $ | 162,159
|                            |  |                |        |                             |   |        |  |   |        



The following table
shows loan origination activity during the periods indicated. We did not purchase or sell any loans during these periods. Subprime loans accounted for $450,000 of the real estate loans originated during the year ended June 30, 2004 and $274,000 of
the consumer loans.



|                                      |  |                     |         |   |      |   |         |      |  |   |         |  
|------------------------------------- |  | ------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                      |  | Year Ended June 30, |        
|                                      |  | 2004                |         |   | 2003 |   |         | 2002 | 
|                                      |  | (In thousands)      |        
|Total loans at beginning of period    |  | $                   | 184,904 |   |      | $ | 196,912 |      |  | $ | 188,231 |  
|                                      |  |                     |         |   |      |   |         |      |  |   |         |  
|Loans originated:                     |  |                     |         |   |      |   |         |      |  |   |         |  
|Real estate                           |  |                     | 55,333  |   |      |   | 39,741  |      |  |   | 58,647  |  
|Commercial business                   |  |                     | 7,772   |   |      |   | 11,213  |      |  |   | 8,593   |  
|Consumer                              |  |                     | 5,122   |   |      |   | 4,943   |      |  |   | 7,559   |  
|                                      |  |                     |         |   |      |   |         |      |  |   |         |  
|Total loans originated                |  |                     | 68,227  |   |      |   | 55,897  |      |  |   | 74,799  |  
|Real estate loan principal repayments |  |                     | (41,485 | ) |      |   | (47,439 | )    |  |   | (32,973 | )
|Other repayments                      |  |                     | (22,259 | ) |      |   | (22,148 | )    |  |   | (36,906 | )
|                                      |  |                     |         |   |      |   |         |      |  |   |         |  
|Net loan activity                     |  |                     | 4,483   |   |      |   | (13,690 | )    |  |   | 4,920   |  
|                                      |  |                     |         |   |      |   |         |      |  |   |         |  
|Total gross loans at end of period    |  | $                   | 189,387 |   |      | $ | 183,222 |      |  | $ | 193,151 |  
|                                      |  |                     |         |   |      |   |         |      |  |   |         |  



31



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##### Table of Contents

Investments. Our investment portfolio consists primarily of federal agency debt securities
with maturities of seven years or less and mortgage-backed securities with stated final maturities of thirty years or less. Investment securities increased $18.6 million, or 24.4%, in the year ended June 30, 2004 due primarily to the investment of
conversion related deposits and the reinvestment of proceeds from sales, calls and prepayments of securities.



The following table sets forth the carrying values of our investment securities portfolio at the dates indicated. All of our investment securities are
classified as available-for-sale.



|                           |  |                        |        |           |   |               |  |           |        |               |   |           |  |   |        |  |   |       
|-------------------------- |  | ---------------------- | ------ | --------- | - | ------------- |  | --------- | ------ | ------------- | - | --------- |  | - | ------ |  | - | ------
|                           |  | At June 30,           
|                           |  | 2004                   |        | 2003      |   | 2002         
|                           |  | AmortizedCost          |        | FairValue |   | AmortizedCost |  | FairValue |        | AmortizedCost |   | FairValue
|                           |  | (Dollars in thousands)
|Federal agency securities  |  | $                      | 80,443 |           | $ | 79,273        |  | $         | 55,646 |               | $ | 56,574    |  | $ | 27,933 |  | $ | 28,464
|Municipals                 |  |                        | 3,425  |           |   | 3,314         |  |           |       |               |   |          |  |   |       |  |   |      
|Mortgage-backed securities |  |                        | 12,422 |           |   | 12,418        |  |           | 19,306 |               |   | 19,826    |  |   | 31,416 |  |   | 31,751
|                           |  |                        |        |           |   |               |  |           |        |               |   |           |  |   |        |  |   |       
|Total                      |  | $                      | 96,290 |           | $ | 95,005        |  | $         | 74,952 |               | $ | 76,400    |  | $ | 59,349 |  | $ | 60,215
|                           |  |                        |        |           |   |               |  |           |        |               |   |           |  |   |        |  |   |       



The following table
sets forth the maturities and weighted average yields of investment securities at June 30, 2004. Certain mortgage-backed securities have interest rates that are adjustable and will reprice annually within the various maturity ranges. These repricing
schedules are not reflected in the table below. At June 30, 2004, mortgage-backed securities with adjustable rates totaled $10.8 million.



|                           |  |                                  |        |                      |                                   |   |               |                     |                      |  |       |                |  |                      |        |  |                |   |                      |   |        |  |      |  
|-------------------------- |  | -------------------------------- | ------ | -------------------- | --------------------------------- | - | ------------- | ------------------- | -------------------- |  | ----- | -------------- |  | -------------------- | ------ |  | -------------- | - | -------------------- | - | ------ |  | ---- | -
|                           |  | More than One Year to Five Years |        |                      | More than Five Years to Ten Years |   |               | More than Ten Years |                      |  | Total |               
|                           |  | Carrying Value                   |        | WeightedAverageYield |                                   |   | CarryingValue |                     | WeightedAverageYield |  |       | Carrying Value |  | WeightedAverageYield |        |  | Carrying Value |   | WeightedAverageYield |  
|Federal agency securities  |  | $                                | 56,427 |                      | 3.19                              | % |               | $                   | 22,846               |  | 3.22  | %              |  | $                    |       |  | 0              | % |                      | $ | 79,273 |  | 3.20 | %
|Municipal securities       |  |                                  | 1,539  |                      | 2.64                              |   |               |                     | 1,258                |  | 2.99  |                |  |                      | 316    |  | 3.57           |   |                      |   | 3,113  |  | 2.87 |  
|Mortgage-backed securities |  |                                  | 89     |                      | 7.00                              |   |               |                     | 416                  |  | 6.21  |                |  |                      | 11,913 |  | 3.30           |   |                      |   | 12,418 |  | 3.42 |  
|                           |  |                                  |        |                      |                                   |   |               |                     |                      |  |       |                |  |                      |        |  |                |   |                      |   |        |  |      |  
|Total                      |  | $                                | 58,055 |                      | 3.18                              | % |               | $                   | 24,520               |  | 3.26  | %              |  | $                    | 12,229 |  | 3.31           | % |                      | $ | 94,804 |  | 3.22 | %
|                           |  |                                  |        |                      |                                   |   |               |                     |                      |  |       |                |  |                      |        |  |                |   |                      |   |        |  |      |  



Deposits. Our primary source of funds is our deposit accounts. The deposit base is comprised of checking, savings, money market and time deposits. These deposits are provided primarily by individuals and businesses within our
market area. We do not use brokered deposits as a source of funding. We have adjusted our pricing strategy to encourage the run-off of higher-rate certificates of deposit and to increase transaction accounts, which has resulted in the loss of some
deposits. In the past, we offered interest rates on certificates of deposit that were substantially above market rates. Our current deposit pricing structure is more consistent with market rates. Although the change in pricing strategy resulted in
the loss of some deposits, we do not expect that we will continue to experience a significant decline in certificates of deposit as a result of our current pricing structure. Total deposits decreased $119.3 million, or 36.8% to $204.9 million at
June 30, 2004. This decrease was primarily attributable to the funds held in the Conversion account at June 30, 2003, for the purchase of Jefferson Bancshares common stock.



|                              |  |                |         |      |   |         |  |   |        
|----------------------------- |  | -------------- | ------- | ---- | - | ------- |  | - | -------
|                              |  | At June 30,   
|                              |  | 2004           |         | 2003 |   | 2002   
|                              |  | (In thousands)
|Noninterest-bearing accounts  |  | $              | 7,958   |      | $ | 99,109  |  | $ | 4,809  
|NOW accounts                  |  |                | 15,220  |      |   | 17,767  |  |   | 13,358 
|Passbook accounts             |  |                | 13,849  |      |   | 19,346  |  |   | 14,375 
|Money market deposit accounts |  |                | 28,930  |      |   | 28,588  |  |   | 16,569 
|Certificates of deposit       |  |                | 138,976 |      |   | 159,437 |  |   | 182,738
|                              |  |                |         |      |   |         |  |   |        
|Total                         |  | $              | 204,933 |      | $ | 324,247 |  | $ | 231,849
|                              |  |                |         |      |   |         |  |   |        



32



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##### Table of Contents

The following table indicates the amount of jumbo certificates of deposit by time remaining until
maturity as of June 30, 2004. Jumbo certificates of deposit require minimum deposits of $100,000.



|                               |  |                          |       
|------------------------------ |  | ------------------------ | ------
|Maturity Period                |  | Certificates of Deposits
|                               |  | (In thousands)          
|Three months or less           |  | $                        | 6,761 
|Over three through six months  |  |                          | 11,976
|Over six through twelve months |  |                          | 7,257 
|Over twelve months             |  |                          | 7,924 
|                               |  |                          |       
|Total                          |  | $                        | 33,918
|                               |  |                          |       



The following table
sets forth the time deposits classified by rates at the dates indicated.



|             |  |                |         |      |   |         |  |   |        
|------------ |  | -------------- | ------- | ---- | - | ------- |  | - | -------
|             |  | At June 30,   
|             |  | 2004           |         | 2003 |   | 2002   
|             |  | (In thousands)
|0.00 - 1.00% |  | $              | 7,442   |      | $ | 302     |  | $ |       
|1.01 - 2.00% |  |                | 35,578  |      |   | 39,547  |  |   |       
|2.01 - 3.00% |  |                | 54,532  |      |   | 59,643  |  |   | 59,947 
|3.01 - 4.00% |  |                | 26,984  |      |   | 27,896  |  |   | 62,599 
|4.01 - 5.00% |  |                | 13,785  |      |   | 22,737  |  |   | 31,452 
|5.01 - 6.00% |  |                | 655     |      |   | 5,132   |  |   | 10,091 
|6.01 - 7.00% |  |                |        |      |   | 4,180   |  |   | 18,649 
|             |  |                |         |      |   |         |  |   |        
|Total        |  | $              | 138,976 |      | $ | 159,437 |  | $ | 182,738
|             |  |                |         |      |   |         |  |   |        



The following table
sets forth the amount and maturities of time deposits at June 30, 2004.



|             |  |                        |         |          |   |           |  |          |        |       |   |                                    |  |   |         |  |       |  
|------------ |  | ---------------------- | ------- | -------- | - | --------- |  | -------- | ------ | ----- | - | ---------------------------------- |  | - | ------- |  | ----- | -
|             |  | Amount Due             |        
|             |  | Less Than One Year     |         | 1-2Years |   | 2-3 Years |  | 3-4Years |        | Total |   | Percent ofTotalCertificateAccounts | 
|             |  | (Dollars in thousands) |        
|0.00 - 1.00% |  | $                      | 7,442   |          | $ |          |  | $        |       |       | $ |                                   |  | $ | 7,442   |  | 5.4   | %
|1.01 - 2.00% |  |                        | 32,878  |          |   | 2,571     |  |          | 129    |       |   |                                   |  |   | 35,578  |  | 25.6  |  
|2.01 - 3.00% |  |                        | 35,356  |          |   | 8,049     |  |          | 10,960 |       |   | 167                                |  |   | 54,532  |  | 39.2  |  
|3.01 - 4.00% |  |                        | 17,661  |          |   | 8,919     |  |          | 404    |       |   |                                   |  |   | 26,984  |  | 19.4  |  
|4.01 - 5.00% |  |                        | 12,892  |          |   | 783       |  |          | 110    |       |   |                                   |  |   | 13,785  |  | 9.9   |  
|5.01 - 6.00% |  |                        | 427     |          |   | 228       |  |          |       |       |   |                                   |  |   | 655     |  | 0.5   |  
|6.01 - 7.00% |  |                        |        |          |   |          |  |          |       |       |   |                                   |  |   |        |  |      |  
|             |  |                        |         |          |   |           |  |          |        |       |   |                                    |  |   |         |  |       |  
|Total        |  | $                      | 106,656 |          | $ | 20,550    |  | $        | 11,603 |       | $ | 167                                |  | $ | 138,976 |  | 100.0 | %
|             |  |                        |         |          |   |           |  |          |        |       |   |                                    |  |   |         |  |       |  



33



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##### Table of Contents

The following table sets forth the savings activities for the periods indicated.



|                                             |  |                     |          |   |      |   |         |  |   |        
|-------------------------------------------- |  | ------------------- | -------- | - | ---- | - | ------- |  | - | -------
|                                             |  | Year Ended June 30,
|                                             |  | 2004                |          |   | 2003 |   | 2002   
|                                             |  | (In thousands)     
|Beginning balance                            |  | $                   | 324,247  |   |      | $ | 231,849 |  | $ | 222,061
|                                             |  |                     |          |   |      |   |         |  |   |        
|Increase (decrease) before interest credited |  |                     | (123,046 | ) |      |   | 87,251  |  |   | 1,576  
|Interest credited                            |  |                     | 3,732    |   |      |   | 5,147   |  |   | 8,212  
|                                             |  |                     |          |   |      |   |         |  |   |        
|Net increase (decrease) in savings deposits  |  |                     | (119,314 | ) |      |   | 92,398  |  |   | 9,788  
|                                             |  |                     |          |   |      |   |         |  |   |        
|Ending balance                               |  | $                   | 204,933  |   |      | $ | 324,247 |  | $ | 231,849
|                                             |  |                     |          |   |      |   |         |  |   |        



Borrowings. We have occasionally relied upon advances from the Federal Home Loan Bank (FHLB) of Cincinnati to supplement our supply of lendable funds and to meet deposit withdrawal requirements. FHLB
advances were $6.0 million at June 30, 2004 compared to $2.0 million at June 30, 2003. The following table presents certain information regarding our use of FHLB advances during the periods and at the dates indicated.



|                                                        |  |                        |       |   |      |   |       |      |  |   |       |  
|------------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                        |  | Year Ended June 30,    |      
|                                                        |  | 2004                   |       |   | 2003 |   |       | 2002 | 
|                                                        |  | (Dollars in thousands) |      
|Maximum amount of advances outstanding at any month end |  | $                      | 6,000 |   |      | $ | 2,000 |      |  | $ | 2,000 |  
|Average advances outstanding                            |  |                        | 2,667 |   |      |   | 2,000 |      |  |   | 2,000 |  
|Weighted average interest rate during the period        |  |                        | 3.97  | % |      |   | 5.00  | %    |  |   | 5.10  | %
|Balance outstanding at end of period                    |  | $                      | 6,000 |   |      | $ | 2,000 |      |  | $ | 2,000 |  
|Weighted average interest rate at end of period         |  |                        | 2.77  | % |      |   | 5.01  | %    |  |   | 5.01  | %



Stockholders equity.Stockholders equity increased $56.8 million to $93.4 million at June 30, 2004 due primarily to $64.5 million in net proceeds from the conversion and increased $3.7 million, or 11.3%, in
the year ended June 30, 2003. Retained earnings, less dividends paid, accounted for $1.4 million and $3.4 million of the increase in the year ended June 30, 2004 and the year ended June 30, 2003, respectively. Unrealized gains and losses, net of
taxes, in the available-for-sale investment portfolio are reflected as an adjustment to stockholders equity. At June 30, 2004, the adjustment to stockholders equity was a net unrealized loss of $793,000 compared to a net unrealized gain
of $898,000 at June 30, 2003. During the year ended June 30, 2004, common stock and paid in capital increased due to the exercise of 9,532 stock options.



Allowance for Loan Losses and Asset Quality



Allowance for Loan Losses.The allowance for loan losses is a valuation allowance for probable
losses inherent in the loan portfolio. We evaluate the need to establish reserves against losses on loans on a monthly basis. When additional reserves are necessary, a provision for loan losses is charged to earnings.



In connection with assessing the allowance, we consider the level of subprime
loans held in the portfolio and delinquency levels and loss experience with respect to subprime and prime loans. In addition, we assess the allowance using factors that cannot be associated with specific credit or loan categories. These factors
include our subjective evaluation of local and national economic and business conditions, portfolio concentration and changes in the character and size of the loan portfolio. The allowance methodology reflects our objective that the overall
allowance appropriately reflects a margin for the imprecision necessarily inherent in estimates of expected credit losses.



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The Office of Thrift Supervision, as an integral part of its examination process, periodically reviews
our allowance for loan losses. The Office of Thrift Supervision may require us to make additional provisions for loan losses based on judgments different from ours.



Due to net charge-offs, the allowance for loan losses decreased $362,000 to $2.5 million at June 30, 2004. There were no
additions to the allowance for loan losses during the 2004 fiscal year. At June 30, 2004, our allowance for loan losses represented 1.31% of total gross loans and 228.9% of nonperforming loans, compared to 1.54% of total gross loans and 161.79% of
nonperforming loans at June 30, 2003.



At June 30, 2003, our
allowance for loan losses represented 1.54% of total gross loans and 161.8% of nonperforming loans, compared to 1.37% of total gross loans and 130.4% of nonperforming loans at June 30, 2002. The allowance for loan losses increased $145,000, or 5.4%,
from June 30, 2002 to June 30, 2003. Between June 30, 2002 and June 30, 2003, the factors that we applied to various loan categories to determine the amount of the allowance were essentially unchanged, other than with respect to subprime consumer
loans. We increased the risk factor with respect to these loans as a result of recent historical loss experience and general economic trends in our market area. The small change in the allowance reflected offsetting changes in loan concentration and
quality that occurred during the period. Specifically, elements of the allowance for loan losses that decreased were those relating to subprime loans, which decreased $6.6 million, or 20.6%, and non-accruing subprime loans, which decreased $913,000,
or 57.9% and subprime loans delinquent 30 to 89 days, which decreased $1.2 million, or 25.3%. Elements of the allowance for loan losses that increased were those relating to substandard loans, which increased $1.8 million, or 174.4% and non-accruing
prime loans, which increased $605,000, or 124.5%.



Although we
believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ
substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that
regulators, in reviewing our loan portfolio, will not request us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the
existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely
affect our financial condition and results of operations.



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##### Table of Contents

Summary of Loan Loss Experience.The following table sets forth an analysis of the
allowance for loan losses for the periods indicated. Where specific loan loss reserves have been established, any difference between the loss reserve and the amount of loss realized has been charged or credited to current income.



|                                                                    |  |                        |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|------------------------------------------------------------------- |  | ---------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                    |  | Year Ended June 30,    |       
|                                                                    |  | 2004                   |        |   | 2003 |   |        | 2002 |  |   | 2001   |   |  | 2000 |       
|                                                                    |  | (Dollars in thousands) |       
|Allowance at beginning of period                                    |  | $                      | 2,841  |   |      | $ | 2,696  |      |  | $ | 2,209  |   |  | $    | 2,030  |   |  | $ | 1,981  |  
|Provision for loan losses                                           |  |                        |       |   |      |   | 787    |      |  |   | 1,221  |   |  |      | 960    |   |  |   | 1,270  |  
|Recoveries:                                                         |  |                        |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Real estate loans                                                   |  |                        | 60     |   |      |   | 5      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Commercial business loans                                           |  |                        | 53     |   |      |   | 171    |      |  |   | 204    |   |  |      | 205    |   |  |   | 140    |  
|Consumer loans                                                      |  |                        | 150    |   |      |   | 259    |      |  |   | 479    |   |  |      | 401    |   |  |   | 616    |  
|                                                                    |  |                        |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total recoveries                                                    |  |                        | 263    |   |      |   | 435    |      |  |   | 683    |   |  |      | 606    |   |  |   | 756    |  
|                                                                    |  |                        |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Charge-offs:                                                        |  |                        |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Real estate loans                                                   |  |                        | (313   | ) |      |   | (397   | )    |  |   | (295   | ) |  |      |       |   |  |   |       |  
|Commercial business loans                                           |  |                        | (82    | ) |      |   | (219   | )    |  |   | (312   | ) |  |      | (624   | ) |  |   | (643   | )
|Consumer loans                                                      |  |                        | (230   | ) |      |   | (461   | )    |  |   | (810   | ) |  |      | (763   | ) |  |   | (1,334 | )
|                                                                    |  |                        |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total charge-offs                                                   |  |                        | (625   | ) |      |   | (1,077 | )    |  |   | (1,417 | ) |  |      | (1,387 | ) |  |   | (1,977 | )
|                                                                    |  |                        |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net charge-offs                                                     |  |                        | (362   | ) |      |   | (642   | )    |  |   | (734   | ) |  |      | (781   | ) |  |   | (1,221 | )
|                                                                    |  |                        |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Allowance at end of period                                          |  | $                      | 2,479  |   |      | $ | 2,841  |      |  | $ | 2,696  |   |  | $    | 2,209  |   |  | $ | 2,030  |  
|                                                                    |  |                        |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Allowance to nonperforming loans                                    |  |                        | 228.90 | % |      |   | 161.79 | %    |  |   | 130.40 | % |  |      | 80.10  | % |  |   | 49.10  | %
|Allowance to total gross loans outstanding at the end of the period |  |                        | 1.31   | % |      |   | 1.54   | %    |  |   | 1.37   | % |  |      | 1.17   | % |  |   | 1.15   | %
|Net charge-offs to average loans outstanding during the period      |  |                        | 0.19   | % |      |   | 0.34   | %    |  |   | 0.38   | % |  |      | 0.43   | % |  |   | 0.71   | %



The following table
sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated.



|                                |  |             |       |                                |       |   |                                       |      |   |        |   |                                |  |       |                                       |  |      |  
|------------------------------- |  | ----------- | ----- | ------------------------------ | ----- | - | ------------------------------------- | ---- | - | ------ | - | ------------------------------ |  | ----- | ------------------------------------- |  | ---- | -
|                                |  | At June 30, |      
|                                |  | 2004        |       |                                | 2003  |  
|                                |  | Amount      |       | % ofAllowanceto TotalAllowance |       |   | % of Loans in Category to Total Loans |      |   | Amount |   | % ofAllowanceto TotalAllowance |  |       | % of Loans in Category to Total Loans | 
|Real estate                     |  | $           | 2,108 |                                | 85.0  | % |                                       | 90.2 | % |        | $ | 2,203                          |  | 77.5  | %                                     |  | 88.7 | %
|Commercial business             |  |             | 193   |                                | 7.8   |   |                                       | 6.7  |   |        |   | 293                            |  | 10.3  |                                       |  | 7.3  |  
|Consumer                        |  |             | 178   |                                | 7.2   |   |                                       | 3.1  |   |        |   | 345                            |  | 12.2  |                                       |  | 4.0  |  
|Unallocated                     |  |             |      |                                |      |   |                                       | N/A  |   |        |   |                               |  |      |                                       |  | N/A  |  
|                                |  |             |       |                                |       |   |                                       |      |   |        |   |                                |  |       |                                       |  |      |  
|Total allowance for loan losses |  | $           | 2,479 |                                | 100.0 | % |                                       |      |   |        | $ | 2,841                          |  | 100.0 | %                                     |  |      |  
|                                |  |             |       |                                |       |   |                                       |      |   |        |   |                                |  |       |                                       |  |      |  



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|                                |  |             |       |                                |       |   |                                       |      |   |        |   |                                   |  |       |                                   |  |      |        |  |                                   |       |  |                                   |   |  |      |  
|------------------------------- |  | ----------- | ----- | ------------------------------ | ----- | - | ------------------------------------- | ---- | - | ------ | - | --------------------------------- |  | ----- | --------------------------------- |  | ---- | ------ |  | --------------------------------- | ----- |  | --------------------------------- | - |  | ---- | -
|                                |  | At June 30, |      
|                                |  | 2002        |       |                                | 2001  |   |                                       | 2000 |  
|                                |  | Amount      |       | % ofAllowanceto TotalAllowance |       |   | % of Loans in Category to Total Loans |      |   | Amount |   | % of Allowance to Total Allowance |  |       | % ofLoans inCategoryto TotalLoans |  |      | Amount |  | % of Allowance to Total Allowance |       |  | % ofLoans inCategoryto TotalLoans |  
|Real estate                     |  | $           | 800   |                                | 29.7  | % |                                       | 90.9 | % |        | $ | 800                               |  | 36.2  | %                                 |  | 89.6 | %      |  | $                                 | 225   |  | 11.1                              | % |  | 87.8 | %
|Commercial business             |  |             | 569   |                                | 21.1  |   |                                       | 3.9  |   |        |   | 564                               |  | 25.5  |                                   |  | 3.2  |        |  |                                   | 541   |  | 26.6                              |   |  | 4.0  |  
|Consumer                        |  |             | 1,327 |                                | 49.2  |   |                                       | 5.2  |   |        |   | 845                               |  | 38.3  |                                   |  | 7.2  |        |  |                                   | 1,264 |  | 62.3                              |   |  | 8.2  |  
|Unallocated                     |  |             |      |                                |      |   |                                       | N/A  |   |        |   |                                  |  |      |                                   |  | N/A  |        |  |                                   |      |  |                                  |   |  | N/A  |  
|                                |  |             |       |                                |       |   |                                       |      |   |        |   |                                   |  |       |                                   |  |      |        |  |                                   |       |  |                                   |   |  |      |  
|Total allowance for loan losses |  | $           | 2,696 |                                | 100.0 | % |                                       |      |   |        | $ | 2,209                             |  | 100.0 | %                                 |  |      |        |  | $                                 | 2,030 |  | 100.0                             | % |  |      |  
|                                |  |             |       |                                |       |   |                                       |      |   |        |   |                                   |  |       |                                   |  |      |        |  |                                   |       |  |                                   |   |  |      |  



Nonperforming
and Classified Assets. When a loan becomes 90 days delinquent, the loan is placed on nonaccrual status at which time the accrual of interest ceases and the reserve for any uncollectible accrued interest is established and charged
against operations. Typically, payments received on a nonaccrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan.



As a community financial institution, we have strived to serve the credit needs of our local communities, which has included
lending to borrowers with marginal credit histories. Consequently, we have experienced a higher level of delinquencies, classified assets and charge-offs. In recent periods, we have taken steps that are intended to help us to continue to serve the
credit needs of the community while improving asset quality. These measures include the use of a credit scoring model that is designed to assist in predicting payment performance for newly originated loans. We now use Beacon credit scores to price
loans according to risk, to monitor loan profitability, to monitor the diversification of the loan portfolio, including subprime loans, and to track loans that are charged off. We believe that these efforts have helped to reduce nonperforming
assets.



We consider repossessed assets and loans that are 90
days or more past due to be nonperforming assets. Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired it is recorded at the lower of
its cost, which is the unpaid balance of the loan plus foreclosure costs, or fair market value at the date of foreclosure. Holding costs and declines in fair value after acquisition of the property result in charges against income.



Nonperforming assets totaled $1.6 million, or 0.54% of total assets, at June
30, 2004, which is a decrease of $1.4 million, or 45.5%, from June 30, 2003. Foreclosed real estate decreased $675,000 to $552,000 at June 30, 2004. At June 30, 2004, foreclosed real estate consisted of 5 single family homes, 4 mobile homes and 3
parcels of real estate. Nonaccrual loans at June 30, 2004 included $1.0 million of residential mortgage loans, $20,000 of commercial real estate loans, $15,000 of commercial business and $21,000 of consumer loans.



Under current accounting guidelines, a loan is defined as impaired when,
based on current information and events, it is probable that a creditor will be unable to collect all amounts due under the contractual terms of the loan agreement. We consider one- to four-family mortgage loans and consumer installment loans to be
homogeneous and, therefore, do not separately evaluate them for impairment. All other loans are evaluated for impairment on an individual basis. At June 30, 2004, we had $265,000 of impaired loans, which consisted of three residential mortgage
loans.



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##### Table of Contents

The following table provides information with respect to our nonperforming assets at the dates indicated.
We did not have any troubled debt restructurings at the dates presented.



|                                                       |  |                        |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|------------------------------------------------------ |  | ---------------------- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | - |  | ---- | ----- | - |  | - | ----- | -
|                                                       |  | At June 30,            |      
|                                                       |  | 2004                   |       |   | 2003 |   |       | 2002 |  |   | 2001  |   |  | 2000 |      
|                                                       |  | (Dollars in thousands) |      
|Nonaccrual loans:                                      |  |                        |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Real estate                                            |  | $                      | 1,047 |   |      | $ | 1,739 |      |  | $ | 1,935 |   |  | $    | 2,692 |   |  | $ | 3,898 |  
|Commercial business                                    |  |                        | 15    |   |      |   |      |      |  |   |      |   |  |      | 17    |   |  |   | 155   |  
|Consumer                                               |  |                        | 21    |   |      |   | 17    |      |  |   | 133   |   |  |      | 50    |   |  |   | 85    |  
|                                                       |  |                        |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total                                                  |  |                        | 1,083 |   |      |   | 1,756 |      |  |   | 2,068 |   |  |      | 2,759 |   |  |   | 4,138 |  
|                                                       |  |                        |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Accruing loans past due 90 days or more                |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total of nonaccrual and 90 days or more past due loans |  |                        | 1,083 |   |      |   | 1,756 |      |  |   | 2,068 |   |  |      | 2,759 |   |  |   | 4,138 |  
|Real estate owned                                      |  |                        | 552   |   |      |   | 1,227 |      |  |   | 978   |   |  |      | 1,070 |   |  |   | 215   |  
|Other nonperforming assets(1)                          |  |                        |      |   |      |   | 16    |      |  |   | 66    |   |  |      | 84    |   |  |   | 47    |  
|                                                       |  |                        |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total nonperforming assets                             |  | $                      | 1,635 |   |      | $ | 2,999 |      |  | $ | 3,112 |   |  | $    | 3,913 |   |  | $ | 4,400 |  
|                                                       |  |                        |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total nonperforming loans to net loans                 |  |                        | 0.58  | % |      |   | 0.98  | %    |  |   | 1.09  | % |  |      | 1.52  | % |  |   | 2.43  | %
|Total nonperforming loans to total assets              |  |                        | 0.35  | % |      |   | 0.48  | %    |  |   | 0.77  | % |  |      | 1.08  | % |  |   | 1.80  | %
|Total nonperforming assets to total assets             |  |                        | 0.54  | % |      |   | 0.82  | %    |  |   | 1.16  | % |  |      | 1.54  | % |  |   | 1.91  | %

---

|(1) | Consists primarily of repossessed automobiles and mobile homes.
|--- | ---------------------------------------------------------------



Interest income that would have been recorded for the year ended June 30, 2004 and the year ended June 30, 2003 had
nonaccruing loans been current according to their original terms amounted to $89,000 and $143,000, respectively. The amount of interest related to these loans included in interest income was $67,000 for the year ended June 30, 2004 and $61,000 for
the year ended June 30, 2003.



We use Beacon
credit scores to predict the likelihood that an existing borrower or potential customer will become a serious credit risk. Beacon credit scores are based on data available in an individuals credit report, such as payment history, outstanding
debt and types of credit in use. Beacon scores range from 400 to 850. We consider loans by borrowers with a Beacon score of less than 600 to be subprime loans. There is no single definition of subprime, and other financial institutions
may use different criteria to identify their subprime loans. For example, Fannie Mae and Freddie Mac generally designate borrowers with a credit bureau score of 660 or below as subprime.



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##### Table of Contents

The following table sets forth the amounts of subprime loans in our loan portfolio at the dates
indicated.



|                           |  |                        |        |                          |      |   |              |      |                            |  |      |              |  |                          |        |  |      |  
|-------------------------- |  | ---------------------- | ------ | ------------------------ | ---- | - | ------------ | ---- | -------------------------- |  | ---- | ------------ |  | ------------------------ | ------ |  | ---- | -
|                           |  | At June 30,            |       
|                           |  | 2004                   |        |                          | 2003 |   |              | 2002 |                           
|                           |  | DollarAmount           |        | As a %of LoansinCategory |      |   | DollarAmount |      | As a % of Loans inCategory |  |      | DollarAmount |  | As a %of LoansinCategory |       
|                           |  | (Dollars in thousands) |       
|Subprime real estate loans |  | $                      | 17,878 |                          | 10.5 | % |              | $    | 27,680                     |  | 16.9 | %            |  | $                        | 35,380 |  | 19.8 | %
|Subprime consumer loans    |  |                        | 649    |                          | 11.1 |   |              |      | 1,100                      |  | 15.0 |              |  |                          | 1,890  |  | 18.5 |  
|                           |  |                        |        |                          |      |   |              |      |                            |  |      |              |  |                          |        |  |      |  
|Total subprime loans       |  | $                      | 18,527 |                          |      |   |              | $    | 28,780                     |  |      |              |  | $                        | 37,270 |  |      |  
|                           |  |                        |        |                          |      |   |              |      |                            |  |      |              |  |                          |        |  |      |  



The amount of the
allowance for loan losses related to subprime loans was $518,000, $820,000 and $1.2 million at June 30, 2004, 2003 and 2002, respectively.



Pursuant to federal regulations, we review and classify our assets on a regular basis. In addition, the Office of Thrift Supervision has the authority to
identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets must have one or more defined weaknesses and are
characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted. The regulations also provide for a special mention category, described as assets which do not currently expose us to a sufficient degree of risk to warrant classification but
do possess credit deficiencies or potential weaknesses deserving our close attention. When we classify an asset as substandard or doubtful we must establish a general allowance for loan losses. If we classify an asset as loss, we must either
establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss or charge off such amount.



The following table shows the aggregate amounts of our classified assets at the dates indicated.



|                        |  |                |       |      |   |       |  |   |      
|----------------------- |  | -------------- | ----- | ---- | - | ----- |  | - | -----
|                        |  | At June 30,   
|                        |  | 2004           |       | 2003 |   | 2002 
|                        |  | (In thousands)
|Substandard assets      |  | $              | 5,592 |      | $ | 5,897 |  | $ | 4,106
|Doubtful assets         |  |                |      |      |   |      |  |   |     
|Loss assets             |  |                |      |      |   |      |  |   | 15   
|                        |  |                |       |      |   |       |  |   |      
|Total classified assets |  | $              | 5,592 |      | $ | 5,897 |  | $ | 4,121
|                        |  |                |       |      |   |       |  |   |      



At each of the dates
in the above table, substandard assets consisted of all nonperforming assets plus other loans that we believed exhibited weakness. These substandard but performing loans totaled $4.0 million, $2.9 million and $995,000 at June 30, 2004, 2003 and
2002, respectively. At each date, substandard but performing loans included a commercial real estate loan that at June 30, 2004 had a balance of $801,000. At June 30, 2004 we included $881,000 of other loans by the same borrower or related persons,
for a total of $1.7 million of substandard but performing loans to one borrower and related persons. The corporate borrower has been in bankruptcy, but has kept all loans current, with the exception of one commercial loan that is 30-59 days past
due. At June 30, 2004, we also had $10.8 million of loans that we were monitoring because of concerns about the borrowers ability to continue to make payments in the future, none of which were nonperforming or classified as substandard. At
that date, $477,000 of the allowance for loan losses related to those loans.



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##### Table of Contents

Delinquencies.The following table provides information about delinquencies in our
loan portfolio at the dates indicated.



|                          |  |                   |       |                   |   |                   |  |                   |       |                   |   |                    |  |   |       |  |   |      
|------------------------- |  | ----------------- | ----- | ----------------- | - | ----------------- |  | ----------------- | ----- | ----------------- | - | ------------------ |  | - | ----- |  | - | -----
|                          |  | At June 30,      
|                          |  | 2004              |       | 2003              |   | 2002             
|                          |  | 30-59DaysPast Due |       | 60-89DaysPast Due |   | 30-59DaysPast Due |  | 60-89DaysPast Due |       | 30-59DaysPast Due |   | 60-89Days Past Due
|                          |  | (In thousands)   
|Real estate loans:        |  |                   |       |                   |   |                   |  |                   |       |                   |   |                    |  |   |       |  |   |      
|Prime loans               |  | $                 | 2,069 |                   | $ | 354               |  | $                 | 2,326 |                   | $ | 250                |  | $ | 3,259 |  | $ | 621  
|Subprime loans            |  |                   | 2,704 |                   |   | 788               |  |                   | 2,388 |                   |   | 796                |  |   | 3,941 |  |   | 997  
|                          |  |                   |       |                   |   |                   |  |                   |       |                   |   |                    |  |   |       |  |   |      
|Total real estate loans   |  |                   | 4,773 |                   |   | 1,142             |  |                   | 4,714 |                   |   | 1,046              |  |   | 7,200 |  |   | 1,618
|                          |  |                   |       |                   |   |                   |  |                   |       |                   |   |                    |  |   |       |  |   |      
|Commercial business loans |  |                   | 1,176 |                   |   | 15                |  |                   | 150   |                   |   | 66                 |  |   | 76    |  |   |     
|                          |  |                   |       |                   |   |                   |  |                   |       |                   |   |                    |  |   |       |  |   |      
|Consumer loans:           |  |                   |       |                   |   |                   |  |                   |       |                   |   |                    |  |   |       |  |   |      
|Prime loans               |  |                   | 138   |                   |   | 42                |  |                   | 89    |                   |   | 60                 |  |   | 157   |  |   | 73   
|Subprime loans            |  |                   | 93    |                   |   | 42                |  |                   | 149   |                   |   | 33                 |  |   | 203   |  |   | 71   
|                          |  |                   |       |                   |   |                   |  |                   |       |                   |   |                    |  |   |       |  |   |      
|Total consumer loans      |  |                   | 231   |                   |   | 84                |  |                   | 238   |                   |   | 93                 |  |   | 360   |  |   | 144  
|                          |  |                   |       |                   |   |                   |  |                   |       |                   |   |                    |  |   |       |  |   |      
|Total                     |  | $                 | 6,180 |                   | $ | 1,241             |  | $                 | 5,102 |                   | $ | 1,205              |  | $ | 7,636 |  | $ | 1,762
|                          |  |                   |       |                   |   |                   |  |                   |       |                   |   |                    |  |   |       |  |   |      



At each of the dates
in the above table, delinquent real estate loans consisted primarily of loans secured by residential real estate.



Liquidity and Capital Resources



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



We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields
available on interest-earning deposits and securities and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term U.S. Government agency
obligations.



Our most liquid assets are cash and cash
equivalents and interest-bearing deposits. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At June 30, 2004, cash and cash equivalents totaled $3.8 million and
interest-bearing deposits totaled $2.6 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $95.0 million at June 30, 2004. In addition, at June 30, 2004, we had arranged the ability to borrow
a total of approximately $61.9 million from the Federal Home Loan Bank of Cincinnati. On that date, we had advances outstanding of $6.0 million.



At June 30, 2004, we had $5.1 million in loan commitments outstanding. In addition to commitments to originate loans, we had $6.4 million in
loans-in-process primarily to fund undisbursed proceeds of construction loans, $141,000 in unused standby letters of credit and $6.7 million in unused lines of credit. Certificates of deposit due within one year of June 30, 2004 totaled $106.7
million. We believe, based on past experience, that a significant portion of those deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.



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The following table presents certain of our contractual obligations as of June 30, 2004.



|                                                           |  |                |       |                        |   |            |  |           |     |                  |   |     |  |   |      
|---------------------------------------------------------- |  | -------------- | ----- | ---------------------- | - | ---------- |  | --------- | --- | ---------------- | - | --- |  | - | -----
|                                                           |  |                |       | Payments due by period
|Contractual Obligations                                    |  | Total          |       | Less than1 year        |   | 1 -3 years |  | 3-5 years |     | More than5 years
|                                                           |  | (In thousands)
|Long-term debt obligations(1)                              |  | $              | 6,000 |                        | $ | 4,000      |  | $         |    |                  | $ |    |  | $ | 2,000
|Capital lease obligations                                  |  |                |      |                        |   |           |  |           |    |                  |   |    |  |   |     
|Operating lease obligations(2)                             |  |                | 32    |                        |   | 16         |  |           | 16  |                  |   |    |  |   |     
|Purchase obligations(3)                                    |  |                | 1,144 |                        |   | 142        |  |           | 498 |                  |   | 504 |  |   |     
|Other long-term liabilities reflected on the balance sheet |  |                |      |                        |   |           |  |           |    |                  |   |    |  |   |     
|                                                           |  |                |       |                        |   |            |  |           |     |                  |   |     |  |   |      
|Total                                                      |  | $              | 7,176 |                        | $ | 4,158      |  | $         | 514 |                  | $ | 504 |  | $ | 2,000
|                                                           |  |                |       |                        |   |            |  |           |     |                  |   |     |  |   |      

---

|(1) | $1.0 million of this amount is callable on September 9, 2004 and $1.0 million is callable on March 9, 2006.
|--- | -----------------------------------------------------------------------------------------------------------



|(2) | Payments are for lease of real property. The lease expires in 2007, with an option to extend
for an additional five years.
|--- | --------------------------------------------------------------------------------------------------------------------------



|(3) | Payments are minimum payments for data processing services. Actual payments may be higher, depending on usage.
|--- | --------------------------------------------------------------------------------------------------------------



Our primary investing activities are the origination of loans and the
purchase of securities. In the year ended June 30, 2004, we originated $68.2 million of loans and purchased $75.6 million in securities. In fiscal 2003, we originated $57.6 million of loans and purchased $42.8 million of securities. In fiscal 2002,
we originated $78.6 million of loans and purchased $45.0 million of securities.



Financing activities consist primarily of activity in deposit accounts and Federal Home Loan Bank advances. We experienced a net decrease in total deposits of $119.3 million in the year ended June 30, 2004 and a net
increase in total deposits of $92.4 million and $9.8 million for the years ended June 30, 2003 and 2002, respectively. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local
competitors and other factors. We generally manage the pricing of our deposits to be competitive and to increase core deposit relationships. Occasionally, we offer promotional rates on certain deposit products in order to attract deposits. Federal
Home Loan Bank advances were $6.0 million at June 30, 2004. During fiscal 2003, Federal Home Loan Bank advances were unchanged. During fiscal 2002, we began and ended the year with $2.0 million in advances outstanding.



We are subject to various regulatory capital requirements administered by the
Office of Thrift Supervision, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet
items to broad risk categories. At June 30, 2004, we exceeded all of our regulatory capital requirements. We are considered well capitalized under regulatory guidelines. See Regulation and SupervisionFederal Savings
Institution RegulationCapital Requirements.



The capital from the Conversion significantly increased our liquidity and capital resources. Over time, the initial level of liquidity will be reduced as net proceeds from the stock offering are used for general corporate purposes,
including the funding of lending activities. We intend to use share repurchases and cash dividends to help manage our capital levels.



Off-Balance Sheet Arrangements



In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles,
are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers requests for funding and take the
form of loan commitments, unused lines of



41



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credit, amounts due mortgagors on construction loans, amounts due on commercial loans and commercial letters of credit.



For the three months and year ended June 30, 2004, we engaged in no
off-balance-sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.



Impact of Recent Accounting Pronouncements



In November 2002, the Financial Accounting Standards Board issued Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. Interpretation No. 45 requires a guarantor entity at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the
fair value of the obligation undertaken in issuing the guarantee. In addition, Interpretation No. 45 elaborates on previously existing disclosure requirements for most guarantees, including loan guarantees such a standby letters of credit. The
recognition and measurement provisions of Interpretation No. 45 were effective on a prospective basis after December 31, 2002, and its adoption on January 1, 2003 has not had a significant effect on our consolidated financial statements.



In December 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure  an amendment of FASB Statement No. 123. This statement provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We have not completed an analysis of the potential effects of this statement on our financial
statements.



In January 2003, the Financial Accounting
Standards Board issued Interpretation No. 46, Consolidation of Variable Interest Entities. Interpretation No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of
loss from the variable interest entitys activities or is entitled to receive a majority of the entitys residual returns, or both. Interpretation No. 46 also requires disclosures about variable interest entities that a company is not
required to consolidate, but in which it has a significant variable interest. On December 17, 2003, the Financial Accounting Standards Board revised Interpretation No. 46 and deferred the effective date of Interpretation No. 46 to no later than the
end of the first reporting period that ends after March 15, 2004. For special-purpose entities, however, Interpretation No. 46 would be required to be applied as of December 31, 2003. We have not established any variable interest entities. The
adoption of Interpretation No. 46 and Interpretation No. 46R did not have an effect on our financial statements.



In April 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities which clarifies certain implementation issues raised by constituents and amends Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities, to include the conclusions reached by the Financial Accounting Standards Board on certain Financial Accounting Standards Board Staff Implementation Issues that, while inconsistent with Statement 133's discussion of financial
guarantee contracts and the application of the shortcut method to an interest rate swap agreement that includes an embedded option and amends other pronouncements. The guidance in Statement 149 is effective for new contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after that date, except for the following: guidance incorporated from FASB Staff Implementation Issues that was effective for periods beginning before June 15, 2003 should continue to be
applied according to the effective dates in those issues; and guidance relating to forward purchase and sale agreements involving when-issued securities should be applied to both existing contracts and new contracts entered into after
June 30, 2003. The adoption of Statement of Financial Accounting Standards No.149 did not have a material effect on our financial statements.



42



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In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards
No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which changes the classification in the statement of financial position of certain common financial instruments from either equity
or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in fair value or redemption amount, as applicable, in earnings. Statement of Financial Accounting Standards No. 150 requires an issuer
to classify certain financial instruments as liabilities, including mandatorily redeemable preferred and common stocks. Statement of Financial Accounting Standards No. 150 is effective for financial instruments entered into or modified after May 31,
2003 and, with one exception, is effective at the beginning of the first interim period beginning after June 15, 2003 (July 1, 2003 as to Jefferson Federal). The adoption of Statement of Financial Accounting Standards No. 150 did not have a material
effect on our financial statements.



Effect of Inflation and Changing Prices



The financial statements and related financial data
presented in this prospectus have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in
the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial
institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institutions performance than do general levels of inflation. Interest rates do not necessarily move in the same direction
or to the same extent as the prices of goods and services.



|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------



Qualitative Aspects of Market Risk. Our most significant form of market risk is interest rate risk. We manage the interest rate sensitivity
of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage
loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings. To reduce the potential volatility of our
earnings, we have sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Pursuant to this strategy, we actively originate adjustable-rate mortgage loans for retention in
our loan portfolio. These loans generally reprice beginning after five years and annually thereafter. Most of our residential adjustable-rate mortgage loans may not adjust downward below their initial interest rate. Although historically we have
been successful in originating adjustable-rate mortgage loans, the ability to originate such loans depends to a great extent on market interest rates and borrowers preferences. As an alternative to adjustable-rate mortgage loans, we offer
fixed-rate mortgage loans with maturities of fifteen years or less. This product enables us to compete in the fixed-rate mortgage market while maintaining a shorter maturity. Fixed-rate mortgage loans typically have an adverse effect on interest
rate sensitivity compared to adjustable-rate loans. In recent years, we have used investment securities with terms of seven years or less and adjustable-rate mortgage-backed securities to help manage interest rate risk. We currently do not
participate in hedging programs, interest rate swaps or other activities involving the use of off-balance sheet derivative financial instruments.



We have established an Asset/Liability Committee to communicate, coordinate and control all aspects involving asset/liability management. The committee
establishes and monitors the volume and mix of assets and funding sources with the objective of managing assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk limits and profitability goals.



Quantitative Aspects of Market Risk. We use an
interest rate sensitivity analysis prepared by the Office of Thrift Supervision to review our level of interest rate risk. This analysis measures interest rate risk by computing changes in net portfolio value of our cash flows from assets,
liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. Net portfolio value represents the market value of portfolio equity and is equal to the market value of assets minus the market value of
liabilities, with



43



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adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and
sustained 100 to 300 basis point increase or 100 basis point decrease in market interest rates with no effect given to any steps that we might take to counter the effect of that interest rate movement. Because of the low level of market interest
rates, this analysis is not performed for decreases of more than 100 basis points. We measure interest rate risk by modeling the changes in net portfolio value over a variety of interest rate scenarios.



The following table, which is based on information that we provide to the
Office of Thrift Supervision, presents the change in our net portfolio value at June 30, 2004 that would occur in the event of an immediate change in interest rates based on Office of Thrift Supervision assumptions, with no effect given to any steps
that we might take to counteract that change.



|                                   |  |                                            |  |          |                                                       |  |          |    |  |           |   |  |        |    
|---------------------------------- |  | ------------------------------------------ |  | -------- | ----------------------------------------------------- |  | -------- | -- |  | --------- | - |  | ------ | ---
|                                   |  | Net Portfolio Value (Dollars in thousands) |  |          | Net Portfolio Value as % of Portfolio Value of Assets | 
|Basis Point (bp) Change in
Rates |  | $ Amount                                   |  | $ Change |                                                       |  | % Change |    |  | NPV Ratio |   |  | Change |    
|300 bp                             |  | 58,980                                     |  | (12,838  | )                                                     |  | (18      | %) |  | 21.55     | % |  | (318   | )bp
|200                                |  | 63,364                                     |  | (8,455   | )                                                     |  | (12      | )  |  | 22.69     |   |  | (205   | )  
|100                                |  | 67,356                                     |  | (4,462   | )                                                     |  | (6       | )  |  | 23.66     |   |  | (107   | )  
|0                                  |  | 71,819                                     |  |          |                                                       |  |          |    |  | 24.74     |   |  |        |    
|(100)                              |  | 72,829                                     |  | 1,011    |                                                       |  | 1        |    |  | 24.86     |   |  | 12     |    



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



|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------



The financial statements required by this Item are incorporated by reference to the Companys Audited Financial Statements found on pages F-1 through
F-28 hereto.



|ITEM 9. | CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | -----------------------------------------------------------------------------------



None.



|ITEM 9A. | CONTROLS AND PROCEDURES
|-------- | -----------------------



The Companys management, including the Companys principal executive officer and principal financial officer, have evaluated the effectiveness
of the Companys disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon their evaluation, the
principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Companys disclosure controls and



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procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under
the Exchange Act with the Securities and Exchange Commission (the SEC) (1) is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and (2) is accumulated and communicated to
the Companys management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.



PART III



|ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
|-------- | --------------------------------------------------



The information relating to the directors and officers of Jefferson Bancshares and information regarding compliance with Section 16(a) of the Exchange Act
is incorporated herein by reference to Jefferson Bancshares Proxy Statement for the 2004 Annual Meeting of Stockholders and to Part I, Item 1, Description of Business  Executive Officers of the Registrant.



Code of Ethics



We have adopted a written code of ethics, which applies to our senior financial officers. We intend to disclose any changes
or waivers from our Code of Ethics applicable to any senior financial officers on our website at http://www.jeffersonfederal.com or in a report on Form 8-K. A copy of the Code of Ethics is available, without charge, upon written request to Jane P.
Hutton, Corporate Secretary, Jefferson Bancshares, Inc., 120 Evans Avenue, Morristown, Tennessee 37814.



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------



The information contained under the sections captioned Executive Compensation and Director Compensation in the Proxy Statement is
incorporated herein by reference.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
|-------- | -----------------------------------------------------------------------------------------------



| | (a) | Security Ownership of Certain Beneficial Owners. The information required by this item is incorporated herein by reference to the section captioned Stock
Ownership in the Proxy Statement.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Security Ownership of Management. The information required by this item is incorporated herein by reference to the section captioned Stock Ownership in the Proxy
Statement.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | Changes in Control. Management of Jefferson Bancshares knows of no arrangements, including any pledge by any person of securities of Jefferson Bancshares, the operation of
which may at a subsequent date result in a change in control of the registrant.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | Equity Compensation Plan Information.
| | --- | -------------------------------------



The following table provides information as of June 30, 2004 for compensation plans under which equity securities may be issued. The data included in this
table has been adjusted to reflect the exchange of 4.2661 shares of Jefferson Bancshares common stock for each share of Jefferson Federal common stock in connection with the Conversion. Jefferson Bancshares does not maintain any equity compensation
plans that have not been approved by security holders.



45



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##### Table of Contents

|                                                           |  |                                                                                             |  |                                                                                 |  |                                                                                                                                          
|---------------------------------------------------------- |  | ------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|Plan category                                              |  | Number of securitiesto be issued uponexercise of outstandingoptions, warrantsand
rights (a) |  | Weighted-averageexercise price ofoutstanding options,warrants and rights (b)(1) |  | Number of securitiesremaining available forfuture issuance underequity compensationplans
(excludingsecurities reflectedin column (a)) (c)
|Equity compensation plans approved by security holders     |  | 462,635                                                                                     |  | 12.44                                                                           |  | 415,761                                                                                                                                  
|                                                           |  |                                                                                             | 
|Equity compensation plans not approved by security holders |  |                                                                                             |  |                                                                                 |  |                                                                                                                                          
|                                                           |  |                                                                                             | 
|Total                                                      |  | 462,635                                                                                     |  | 12.44                                                                           |  | 415,761                                                                                                                                  



|(1) | The information contained under this column of the Equity Compensation Plan table has been adjusted to reflect the exchange of 4.2661 shares of Jefferson Bancshares
common stock for each share of Jefferson Federal common stock.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|-------- | ----------------------------------------------



The information required by this item is incorporated herein by reference to the section captioned Transactions with Management in the Proxy
Statement.



|ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------



The information required by this item is incorporated herein by reference to the section captioned Proposal 2  Ratification of Independent
Auditors in the Proxy Statement.



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PART IV



|ITEM 15. | EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K.
|-------- | -----------------------------------------------------------------



| | (a)(1) | The exhibits and financial statement schedules filed as a part of this report are as follows:
| | ------ | ---------------------------------------------------------------------------------------------



| |  | Report of Independent Auditors
| | - | ------------------------------



| |  | Balance Sheets for the Years Ended June 30, 2004 and 2003.
| | - | ----------------------------------------------------------



| |  | Statements of Earnings for the Years Ended June 30, 2004, 2003 and 2002.
| | - | ------------------------------------------------------------------------



| |  | Statements of Changes in Stockholders Equity for the Years Ended June 30, 2004, 2003 and 2002.
| | - | -----------------------------------------------------------------------------------------------



| |  | Statements of Cash Flows for the Years Ended June 30, 2004, 2003 and 2002.
| | - | --------------------------------------------------------------------------



| |  | Notes to Financial Statements
| | - | -----------------------------



| | (2) | All schedules are omitted as the required information either is not applicable or is included in the financial statements or related notes.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------



| | (3) | Exhibits
| | --- | --------



|     |  |                                                                                                                   
|---- |  | ------------------------------------------------------------------------------------------------------------------
|     | 
|3.1  |  | Charter of Jefferson Bancshares, Inc. (1)                                                                         
|     | 
|3.2  |  | Bylaws of Jefferson Bancshares, Inc. (1)                                                                          
|     | 
|4.1  |  | Specimen Stock Certificate of Jefferson Bancshares, Inc. (1)                                                      
|     | 
|10.1 |  | Employment Agreement between Anderson L. Smith, Jefferson Bancshares, Inc. and Jefferson Federal Bank (2)         
|     | 
|10.2 |  | Amendment to Employment Agreement between Anderson L. Smith, Jefferson Bancshares, Inc. and Jefferson Federal Bank
|     | 
|10.3 |  | Jefferson Federal Savings and Loan Association of Morristown Employee Severance Compensation Plan (1)             
|     | 
|10.4 |  | 1995 Jefferson Federal Savings and Loan Association of Morristown Stock Option Plan (1)                           
|     | 
|10.5 |  | 1995 Jefferson Federal Savings and Loan Association of Morristown Management Recognition and Development Plan (1) 
|     | 
|10.6 |  | Jefferson Federal Bank Supplemental Executive Retirement Plan (1)                                                 
|     | 
|10.7 |  | Jefferson Bancshares, Inc. 2004 Stock-Based Incentive Plan (3)                                                    
|     | 
|11.0 |  | Statement re: computation of per share earnings (4)                                                               
|     | 
|21.0 |  | List of Subsidiaries                                                                                              
|     | 
|23.0 |  | Consent of Craine, Thompson & Jones, P.C.                                                                         
|     | 
|31.1 |  | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer                                                 
|     | 
|31.2 |  | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer                                                 
|     | 
|32.0 |  | Section 1350 Certifications                                                                                       

---

|(1) | Incorporated herein by reference from the Exhibits to Form S-1, Registration Statement and amendments thereto, initially filed on March 21, 2003, Registration No. 333-103961.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Incorporated herein by reference from the Exhibits to the Annual Report on Form 10-K, filed on September 29, 2003.
|--- | ------------------------------------------------------------------------------------------------------------------



|(3) | Incorporated herein by reference from Appendix A to the Companys definitive proxy statement filed on December 1, 2003.
|--- | -----------------------------------------------------------------------------------------------------------------------



|(4) | Incorporated herein by reference to Note 3 to the Companys Audited Financial Statements found on page F-12.
|--- | ------------------------------------------------------------------------------------------------------------



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(b) Reports on Form 8-K



On April 23, 2004, the Company furnished a Form 8-K in which it reported under Item 12 its financial results for the quarter
ended March 31, 2004.



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SIGNATURES



In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



|                        |  |  |  |                            |  |                       |  |                                               
|----------------------- |  |  |  | -------------------------- |  | --------------------- |  | ----------------------------------------------
|                        |  |  |  | JEFFERSON BANCSHARES, INC.
|                        |  |  | 
|Date: September 3, 2004 |  |  |  | By:                        |  | /s/ Anderson L. Smith
|                        |  |  |  |                            |  |                       |  | Anderson L. Smith                             
|                        |  |  |  |                            |  |                       |  | President, Chief Executive Officerand Director



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



|                                             |  |                                                                                               |  |                  
|-------------------------------------------- |  | --------------------------------------------------------------------------------------------- |  | -----------------
|Name                                         |  | Title                                                                                         |  | Date             
|                                             |  |                                                                                              
|/s/ Anderson L. SmithAnderson L. Smith       |  | President, Chief Executive Officer and
Director (principal executive officer)                 |  | September 3, 2004
|                                             |  |                                                                                              
|/s/ Jane P. HuttonJane P. Hutton             |  | Chief Financial Officer, Treasurer and
Secretary (principal financial and accounting
officer) |  | September 3, 2004
|                                             |  |                                                                                              
|/s/ John F. McCrary, Jr.John F. McCrary, Jr. |  | Director                                                                                      |  | September 3, 2004
|                                             |  |                                                                                              
|/s/ H. Scott ReamsH. Scott Reams             |  | Director                                                                                      |  | September 3, 2004
|                                             |  |                                                                                              
|/s/ Dr. Jack E. CampbellDr. Jack E. Campbell |  | Director                                                                                      |  | September 3, 2004
|                                             |  |                                                                                              
|/s/ Dr. Terry M. BrimerDr. Terry M. Brimer   |  | Director                                                                                      |  | September 3, 2004
|                                             |  |                                                                                              
|/s/ William F. YoungWilliam F. Young         |  | Director                                                                                      |  | September 3, 2004
|                                             |  |                                                                                              
|/s/ William T. HaleWilliam T. Hale           |  | Director                                                                                      |  | September 3, 2004





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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Table of Contents



|                                                                                               |  |           
|---------------------------------------------------------------------------------------------- |  | ----------
|Report of Independent Auditors                                                                 |  | F-1       
|                                                                                               | 
|Balance Sheets as of June 30, 2004 and 2003                                                    |  | F-2       
|                                                                                               | 
|Statements of Earnings for the Years Ended June 30, 2004, 2003 and 2002                        |  | F-3       
|                                                                                               | 
|Statements of Changes in Stockholders Equity for the Years Ended June 30, 2004, 2003 and 2002 |  | F-4 - F-5 
|                                                                                               | 
|Statements of Cash Flows for the Years Ended June 30, 2004, 2003 and 2002                      |  | F-6 - F-7 
|                                                                                               | 
|Notes to Consolidated Financial Statements                                                     |  | F-8 - F-28





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##### Table of Contents

[LETTER HEAD OF CRAINE, THOMPSON & JONES, P.C.]



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Board of Directors

Jefferson Bancshares, Inc. and Subsidiary

Morristown, Tennessee



We have audited the accompanying consolidated balance sheets of Jefferson Bancshares, Inc.
and Subsidiary as of June 30, 2004 and 2003, and the related consolidated statements of earnings, changes in stockholders equity and cash flows for each of the three years in the period ended June 30, 2004. These consolidated financial
statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



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



In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects, the financial position of Jefferson Bancshares, Inc. and Subsidiary as of June 30, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the
period ended June 30, 2004, in conformity with accounting principles generally accepted in the United States of America.



/s/  Craine, Thompson & Jones, P.C.



Morristown, Tennessee

August 27, 2004



F-1



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Consolidated Balance Sheets



(Dollars in Thousands)



|                                                                                                     |  |          |         |   |      |   |        
|---------------------------------------------------------------------------------------------------- |  | -------- | ------- | - | ---- | - | -------
|                                                                                                     |  | June 30,
|                                                                                                     |  | 2004     |         |   | 2003
|Assets                                                                                               |  |          |         |   |      |   |        
|Cash and cash equivalents                                                                            |  | $        | 3,803   |   |      | $ | 7,597  
|Interest-bearing deposits                                                                            |  |          | 2,608   |   |      |   | 88,946 
|Investment securities classified as available for sale, net                                          |  |          | 95,005  |   |      |   | 76,400 
|Federal Home Loan Bank stock                                                                         |  |          | 1,580   |   |      |   | 1,518  
|Bank owned life insurance                                                                            |  |          | 5,080   |   |      |   |       
|Loans receivable, net                                                                                |  |          | 186,601 |   |      |   | 180,010
|Premises and equipment, net                                                                          |  |          | 5,120   |   |      |   | 4,168  
|Foreclosed real estate, net                                                                          |  |          | 552     |   |      |   | 1,227  
|Accrued interest receivable:                                                                         |  |          |         |   |      |   |        
|Investments                                                                                          |  |          | 870     |   |      |   | 368    
|Loans receivable, net                                                                                |  |          | 956     |   |      |   | 1,566  
|Deferred tax asset                                                                                   |  |          | 2,502   |   |      |   | 472    
|Other assets                                                                                         |  |          | 797     |   |      |   | 1,506  
|                                                                                                     |  |          |         |   |      |   |        
|Total assets                                                                                         |  | $        | 305,474 |   |      | $ | 363,778
|                                                                                                     |  |          |         |   |      |   |        
|Liabilities and Stockholders Equity                                                                 |  |          |         |   |      |   |        
|Deposits                                                                                             |  | $        | 204,933 |   |      | $ | 324,247
|Federal Home Loan Bank advances                                                                      |  |          | 6,000   |   |      |   | 2,000  
|Other liabilities                                                                                    |  |          | 1,084   |   |      |   | 746    
|Accrued income taxes                                                                                 |  |          | 74      |   |      |   | 160    
|                                                                                                     |  |          |         |   |      |   |        
|Total liabilities                                                                                    |  |          | 212,091 |   |      |   | 327,153
|                                                                                                     |  |          |         |   |      |   |        
|Commitments and contingent liabilities                                                               |  |          |        |   |      |   |       
|Stockholders equity:                                                                                |  |          |         |   |      |   |        
|Preferred stock, $0.01 par value; 10,000,000 shares authorized; shares issued and outstanding - none |  |          |        |   |      |   |       
|Common stock, $0.01 par value; 30,000,000 shares authorized; 8,385,517 shares issued and outstanding |  |          | 84      |   |      |   | 1,876  
|Additional paid-in capital                                                                           |  |          | 71,496  |   |      |   | 1,167  
|Unearned ESOP shares                                                                                 |  |          | (6,265  | ) |      |   |       
|Unearned compensation                                                                                |  |          | (3,488  | ) |      |   |       
|Accumulated other comprehensive income                                                               |  |          | (793    | ) |      |   | 898    
|Retained earnings                                                                                    |  |          | 32,349  |   |      |   | 32,684 
|                                                                                                     |  |          |         |   |      |   |        
|Total stockholders equity                                                                           |  |          | 93,383  |   |      |   | 36,625 
|                                                                                                     |  |          |         |   |      |   |        
|Total liabilities and stockholders equity                                                           |  | $        | 305,474 |   |      | $ | 363,778
|                                                                                                     |  |          |         |   |      |   |        



F-2



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Consolidated Statements of Earnings



(Dollars in Thousands Except Per Share Amounts)



|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|--------------------------------------------------- |  | -------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                    |  | Years Ended June 30, |       
|                                                    |  | 2004                 |        |   | 2003 |   |        | 2002 | 
|Interest income:                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Interest on loans receivable                        |  | $                    | 12,692 |   |      | $ | 14,752 |      |  | $ | 15,988 |  
|Interest on investment securities                   |  |                      | 3,204  |   |      |   | 2,284  |      |  |   | 3,147  |  
|Other interest                                      |  |                      | 171    |   |      |   | 223    |      |  |   | 245    |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Total interest income                               |  |                      | 16,067 |   |      |   | 17,259 |      |  |   | 19,380 |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Interest expense:                                   |  |                      |        |   |      |   |        |      |  |   |        |  
|Deposits                                            |  |                      | 4,670  |   |      |   | 6,418  |      |  |   | 10,165 |  
|Advances from FHLB                                  |  |                      | 106    |   |      |   | 100    |      |  |   | 102    |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Total interest expense                              |  |                      | 4,776  |   |      |   | 6,518  |      |  |   | 10,267 |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Net interest income                                 |  |                      | 11,291 |   |      |   | 10,741 |      |  |   | 9,113  |  
|Provision for loan losses                           |  |                      |       |   |      |   | 787    |      |  |   | 1,221  |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Net interest income after provision for loan losses |  |                      | 11,291 |   |      |   | 9,954  |      |  |   | 7,892  |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Noninterest income:                                 |  |                      |        |   |      |   |        |      |  |   |        |  
|Dividends                                           |  |                      | 48     |   |      |   | 25     |      |  |   |       |  
|Service charges and fees                            |  |                      | 625    |   |      |   | 674    |      |  |   | 669    |  
|Gain on sale of securities, net                     |  |                      | 22     |   |      |   | 81     |      |  |   | 141    |  
|Gain (loss) on sale of foreclosed real estate, net  |  |                      | 152    |   |      |   | 47     |      |  |   | 45     |  
|Gain on sale of fixed assets                        |  |                      | 1      |   |      |   |       |      |  |   |       |  
|Other                                               |  |                      | 219    |   |      |   | 152    |      |  |   | 166    |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Total noninterest income                            |  |                      | 1,067  |   |      |   | 979    |      |  |   | 1,021  |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Noninterest expense:                                |  |                      |        |   |      |   |        |      |  |   |        |  
|Compensation and benefits                           |  |                      | 3,175  |   |      |   | 2,451  |      |  |   | 2,351  |  
|Occupancy expense                                   |  |                      | 257    |   |      |   | 263    |      |  |   | 244    |  
|Equipment and data processing expenses              |  |                      | 974    |   |      |   | 864    |      |  |   | 832    |  
|SAIF deposit insurance premium                      |  |                      | 37     |   |      |   | 38     |      |  |   | 41     |  
|Advertising                                         |  |                      | 213    |   |      |   | 147    |      |  |   | 130    |  
|REO expense                                         |  |                      | 209    |   |      |   | 353    |      |  |   | 285    |  
|Charitable contributions                            |  |                      | 4,000  |   |      |   |       |      |  |   |       |  
|Other                                               |  |                      | 1,400  |   |      |   | 1,157  |      |  |   | 1,186  |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Total noninterest expense                           |  |                      | 10,265 |   |      |   | 5,273  |      |  |   | 5,069  |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Earnings before income taxes                        |  |                      | 2,093  |   |      |   | 5,660  |      |  |   | 3,844  |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Income taxes (benefits):                            |  |                      |        |   |      |   |        |      |  |   |        |  
|Current                                             |  |                      | 1,694  |   |      |   | 2,145  |      |  |   | 1,702  |  
|Deferred                                            |  |                      | (988   | ) |      |   | (77    | )    |  |   | (284   | )
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Total income taxes                                  |  |                      | 706    |   |      |   | 2,068  |      |  |   | 1,418  |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Net earnings                                        |  | $                    | 1,387  |   |      | $ | 3,592  |      |  | $ | 2,426  |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Net earnings per common share - basic               |  | $                    | 0.18   |   |      | $ | 0.45   |      |  | $ | 0.30   |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  
|Net earnings per common share - diluted             |  | $                    | 0.18   |   |      | $ | 0.45   |      |  | $ | 0.30   |  
|                                                    |  |                      |        |   |      |   |        |      |  |   |        |  



The
accompanying notes are an integral part of these consolidated financial statements.



F-3



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Consolidated Statements of Changes in Stockholders Equity



(Dollars in Thousands)



|                                                                                             |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  
|-------------------------------------------------------------------------------------------- |  | ----------- | ----- | ------------------------ | - | ----------------------------- |  | -------------------- | - |  | ----------------------------------- | --- | - | ---------------- | - | --- | ------------------------ |  | - | ------ | - |  | - | ------ | -
|                                                                                             |  | CommonStock |       | AdditionalPaid-inCapital |   | UnallocatedCommonStock inESOP |  | UnearnedCompensation |   |  | AccumulatedOtherComprehensiveIncome |     |   | RetainedEarnings |   |     | TotalStockholders'Equity | 
|Balance at June 30, 2001                                                                     |  | $           | 1,864 |                          | $ | 982                           |  | $                    |  |  | $                                   | (24 | ) |                  | $ | (49 | )                        |  | $ | 27,119 |   |  | $ | 29,892 |  
|                                                                                             |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  
|Comprehensive income:                                                                        |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  
|Net earnings                                                                                 |  |             |      |                          |   |                              |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   | 2,426  |   |  |   | 2,426  |  
|Change in net unrealized gain (loss) on securities available for sale, net of taxes of $ 358 |  |             |      |                          |   |                              |  |                      |  |  |                                     |    |   |                  |   | 586 |                          |  |   |       |   |  |   | 586    |  
|                                                                                             |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  
|Total comprehensive income                                                                   |  |             |      |                          |   |                              |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   |       |   |  |   | 3,012  |  
|Dividends                                                                                    |  |             |      |                          |   |                              |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   | (224   | ) |  |   | (224   | )
|Award of MRP shares                                                                          |  |             | 1     |                          |   | 11                            |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   |       |   |  |   | 12     |  
|Earned portion of MRP                                                                        |  |             |      |                          |   |                              |  |                      |  |  |                                     | 24  |   |                  |   |    |                          |  |   |       |   |  |   | 24     |  
|Tax benefit from vesting of MRP shares                                                       |  |             |      |                          |   | 10                            |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   |       |   |  |   | 10     |  
|Tax benefit from exercise of nonqualified stock options                                      |  |             |      |                          |   | 2                             |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   |       |   |  |   | 2      |  
|Stock options exercised                                                                      |  |             | 11    |                          |   | 162                           |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   |       |   |  |   | 173    |  
|                                                                                             |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  
|Balance at June 30, 2002                                                                     |  |             | 1,876 |                          |   | 1,167                         |  |                      |  |  |                                     |    |   |                  |   | 537 |                          |  |   | 29,321 |   |  |   | 32,901 |  
|                                                                                             |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  
|Comprehensive income:                                                                        |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  
|Net earnings                                                                                 |  |             |      |                          |   |                              |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   | 3,592  |   |  |   | 3,592  |  
|Change in net unrealized gain (loss) on securities available for sale, net of taxes of $ 221 |  |             |      |                          |   |                              |  |                      |  |  |                                     |    |   |                  |   | 361 |                          |  |   |       |   |  |   | 361    |  
|                                                                                             |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  
|Total comprehensive income                                                                   |  |             |      |                          |   |                              |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   |       |   |  |   | 3,953  |  
|Dividends                                                                                    |  |             |      |                          |   |                              |  |                      |  |  |                                     |    |   |                  |   |    |                          |  |   | (229   | ) |  |   | (229   | )
|                                                                                             |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  
|Balance at June 30, 2003                                                                     |  | $           | 1,876 |                          | $ | 1,167                         |  | $                    |  |  | $                                   |    |   |                  | $ | 898 |                          |  | $ | 32,684 |   |  | $ | 36,625 |  
|                                                                                             |  |             |       |                          |   |                               |  |                      |   |  |                                     |     |   |                  |   |     |                          |  |   |        |   |  |   |        |  



(Continued)



F-4



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Consolidated Statements of Changes in Stockholders Equity



(Dollars in Thousands)



(Continued)



|                                                                                               |  |             |        |   |                          |   |        |                               |  |   |                      |   |  |                                      |        |   |                  |   |        |                          |  |   |        |   |  |   |        |  
|---------------------------------------------------------------------------------------------- |  | ----------- | ------ | - | ------------------------ | - | ------ | ----------------------------- |  | - | -------------------- | - |  | ------------------------------------ | ------ | - | ---------------- | - | ------ | ------------------------ |  | - | ------ | - |  | - | ------ | -
|                                                                                               |  | CommonStock |        |   | AdditionalPaid-inCapital |   |        | UnallocatedCommonStock inESOP |  |   | UnearnedCompensation |   |  | AccumulatedOther ComprehensiveIncome |        |   | RetainedEarnings |   |        | TotalStockholdersEquity | 
|Balance at June 30, 2003                                                                       |  | $           | 1,876  |   |                          | $ | 1,167  |                               |  | $ |                     |   |  | $                                    |       |   |                  | $ | 898    |                          |  | $ | 32,684 |   |  | $ | 36,625 |  
|Comprehensive income:                                                                          |  |             |        |   |                          |   |        |                               |  |   |                      |   |  |                                      |        |   |                  |   |        |                          |  |   |        |   |  |   |        |  
|Net earnings                                                                                   |  |             |       |   |                          |   |       |                               |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   | 1,387  |   |  |   | 1,387  |  
|Change in net unrealized gain (loss) on securities available for sale, net of taxes of $ 1,043 |  |             |       |   |                          |   |       |                               |  |   |                     |   |  |                                      |       |   |                  |   | (1,691 | )                        |  |   |       |   |  |   | (1,691 | )
|                                                                                               |  |             |        |   |                          |   |        |                               |  |   |                      |   |  |                                      |        |   |                  |   |        |                          |  |   |        |   |  |   |        |  
|Total comprehensive income                                                                     |  |             |       |   |                          |   |       |                               |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   |       |   |  |   | (304   | )
|Dividends                                                                                      |  |             |       |   |                          |   |       |                               |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   | (1,733 | ) |  |   | (1,733 | )
|Merger of MHC into Jefferson Bancshares                                                        |  |             |       |   |                          |   | 100    |                               |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   | 11     |   |  |   | 111    |  
|Proceeds of stock conversion, net                                                              |  |             | 66     |   |                          |   | 64,406 |                               |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   |       |   |  |   | 64,472 |  
|Conversion of shares held under MHC structure                                                  |  |             | (1,876 | ) |                          |   | 1,876  |                               |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   |       |   |  |   |       |  
|Shares issued in exchange for shares held under MHC structure                                  |  |             | 14     |   |                          |   | (14    | )                             |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   |       |   |  |   |       |  
|Contribution of stock to the Jefferson Federal Charitable Foundation                           |  |             | 4      |   |                          |   | 3,746  |                               |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   |       |   |  |   | 3,750  |  
|Common stock acquired by employee stock ownership plan                                         |  |             |       |   |                          |   |       |                               |  |   | (6,701               | ) |  |                                      |       |   |                  |   |       |                          |  |   |       |   |  |   | (6,701 | )
|Shares committed to be released by the employee stock ownership plan                           |  |             |       |   |                          |   | 154    |                               |  |   | 436                  |   |  |                                      |       |   |                  |   |       |                          |  |   |       |   |  |   | 590    |  
|Stock options exercised                                                                        |  |             |       |   |                          |   | 33     |                               |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   |       |   |  |   | 33     |  
|Tax benefit from exercise of nonqualifying stock options                                       |  |             |       |   |                          |   | 28     |                               |  |   |                     |   |  |                                      |       |   |                  |   |       |                          |  |   |       |   |  |   | 28     |  
|Stock grants under the 2004 Stock Incentive Plan                                               |  |             |       |   |                          |   |       |                               |  |   |                     |   |  |                                      | (3,527 | ) |                  |   |       |                          |  |   |       |   |  |   | (3,527 | )
|Earned portion of stock grants                                                                 |  |             |       |   |                          |   |       |                               |  |   |                     |   |  |                                      | 220    |   |                  |   |       |                          |  |   |       |   |  |   | 220    |  
|Purchase of stock for the 2004 Stock Incentive Plan                                            |  |             |       |   |                          |   |       |                               |  |   |                     |   |  |                                      | (181   | ) |                  |   |       |                          |  |   |       |   |  |   | (181   | )
|                                                                                               |  |             |        |   |                          |   |        |                               |  |   |                      |   |  |                                      |        |   |                  |   |        |                          |  |   |        |   |  |   |        |  
|Balance at June 30, 2004                                                                       |  | $           | 84     |   |                          | $ | 71,496 |                               |  | $ | (6,265               | ) |  | $                                    | (3,488 | ) |                  | $ | (793   | )                        |  | $ | 32,349 |   |  | $ | 93,383 |  
|                                                                                               |  |             |        |   |                          |   |        |                               |  |   |                      |   |  |                                      |        |   |                  |   |        |                          |  |   |        |   |  |   |        |  



The accompanying notes are an integral
part of these consolidated financial statements.



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Consolidated Statements of Cash Flows



(Dollars in Thousands)



|                                                                                               |  |                      |          |   |      |   |         |      |  |   |         |  
|---------------------------------------------------------------------------------------------- |  | -------------------- | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                               |  | Years Ended June 30, |         
|                                                                                               |  | 2004                 |          |   | 2003 |   |         | 2002 | 
|Cash flows from operating activities:                                                          |  |                      |          |   |      |   |         |      |  |   |         |  
|Net earnings                                                                                   |  | $                    | 1,387    |   |      | $ | 3,592   |      |  | $ | 2,426   |  
|Adjustments to reconcile net earnings to net cash provided by (used for) operating activities: |  |                      |          |   |      |   |         |      |  |   |         |  
|Stock contributed to the Jefferson Federal Charitable Foundation                               |  |                      | 3,750    |   |      |   |        |      |  |   |        |  
|Allocated ESOP shares                                                                          |  |                      | 590      |   |      |   |        |      |  |   |        |  
|Depreciation and amortization expense                                                          |  |                      | 288      |   |      |   | 306     |      |  |   | 289     |  
|Amortization of premiums (discounts), net investment securities                                |  |                      | 1        |   |      |   | 136     |      |  |   | 106     |  
|Provision for loan losses                                                                      |  |                      |         |   |      |   | 787     |      |  |   | 1,221   |  
|Gain on sale of fixed assets                                                                   |  |                      | 1        |   |      |   |        |      |  |   |        |  
|Gain (loss) on sale of investment securities, net                                              |  |                      | (22      | ) |      |   | (81     | )    |  |   | (141    | )
|FHLB stock dividends                                                                           |  |                      | (62      | ) |      |   | (63     | )    |  |   | (76     | )
|Amortization of deferred loan fees, net                                                        |  |                      | (175     | ) |      |   | (164    | )    |  |   | (138    | )
|Loss (gain) on foreclosed real estate, net                                                     |  |                      | (152     | ) |      |   | (47     | )    |  |   | (45     | )
|Deferred tax benefit                                                                           |  |                      | (988     | ) |      |   | (77     | )    |  |   | (284    | )
|Earned portion of MRP                                                                          |  |                      | 220      |   |      |   |        |      |  |   | 24      |  
|Increase in cash value of life insurance                                                       |  |                      | (80      | ) |      |   |        |      |  |   |        |  
|Tax benefits from stock options and MRP                                                        |  |                      |         |   |      |   |        |      |  |   | (12     | )
|Decrease (increase) in:                                                                        |  |                      |          |   |      |   |         |      |  |   |         |  
|Accrued interest receivable                                                                    |  |                      | 108      |   |      |   | 182     |      |  |   | 143     |  
|Other assets                                                                                   |  |                      | 533      |   |      |   | (585    | )    |  |   | 95      |  
|Increase (decrease) in other liabilities                                                       |  |                      | (220     | ) |      |   | 140     |      |  |   | 79      |  
|                                                                                               |  |                      |          |   |      |   |         |      |  |   |         |  
|Net cash provided by (used for) operating activities                                           |  |                      | 5,179    |   |      |   | 4,126   |      |  |   | 3,687   |  
|                                                                                               |  |                      |          |   |      |   |         |      |  |   |         |  
|Cash flows from investing activities:                                                          |  |                      |          |   |      |   |         |      |  |   |         |  
|Loan originations, net of principal collections                                                |  |                      | (6,332   | ) |      |   | 8,475   |      |  |   | (9,309  | )
|Purchase of available-for-sale securities                                                      |  |                      | (75,590  | ) |      |   | (42,822 | )    |  |   | (44,977 | )
|Proceeds from sale of available-for-sale securities                                            |  |                      | 24,914   |   |      |   | 3,725   |      |  |   | 22,013  |  
|Proceeds from maturities, calls, and prepayments                                               |  |                      | 29,361   |   |      |   | 23,439  |      |  |   | 17,380  |  
|Purchase of bank owned life insurance                                                          |  |                      | (5,000   | ) |      |   |        |      |  |   |        |  
|Proceeds from sale of premises and equipment                                                   |  |                      | 7        |   |      |   |        |      |  |   |        |  
|Purchase of premises and equipment                                                             |  |                      | (1,246   | ) |      |   | (273    | )    |  |   | (511    | )
|Proceeds from sale of (additions to) foreclosed real estate, net                               |  |                      | 792      |   |      |   | 721     |      |  |   | 34      |  
|                                                                                               |  |                      |          |   |      |   |         |      |  |   |         |  
|Net cash provided by (used for) investing activities                                           |  |                      | (33,094  | ) |      |   | (6,735  | )    |  |   | (15,370 | )
|                                                                                               |  |                      |          |   |      |   |         |      |  |   |         |  
|Cash flows from financing activities:                                                          |  |                      |          |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in deposits                                                            |  |                      | (119,314 | ) |      |   | 92,398  |      |  |   | 9,308   |  
|Proceeds from stock conversion, net                                                            |  |                      | 57,771   |   |      |   |        |      |  |   |        |  
|Merger of MHC into Jefferson Bancshares                                                        |  |                      | 111      |   |      |   |        |      |  |   |        |  
|Proceeds from advances from FHLB                                                               |  |                      | 14,500   |   |      |   |        |      |  |   |        |  
|Repayment of FHLB advances                                                                     |  |                      | (10,500  | ) |      |   |        |      |  |   | (4,000  | )
|Purchase of company stock for stock based incentive plan                                       |  |                      | (3,708   | ) |      |   |        |      |  |   |        |  
|Proceeds from advances from FHLB                                                               |  |                      |         |   |      |   |        |      |  |   | 4,000   |  
|Proceeds from exercise of stock options                                                        |  |                      | 34       |   |      |   |        |      |  |   | 173     |  
|Dividends paid                                                                                 |  |                      | (1,111   | ) |      |   | (229    | )    |  |   | (220    | )
|                                                                                               |  |                      |          |   |      |   |         |      |  |   |         |  
|Net cash provided by (used for) financing activities                                           |  |                      | (62,217  | ) |      |   | 92,169  |      |  |   | 9,261   |  
|                                                                                               |  |                      |          |   |      |   |         |      |  |   |         |  



(Continued)



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Consolidated Statements of Cash Flows



(Dollars in Thousands)



(Continued)



|                                                                                    |  |                      |         |   |      |   |        |  |   |        |  
|----------------------------------------------------------------------------------- |  | -------------------- | ------- | - | ---- | - | ------ |  | - | ------ | -
|                                                                                    |  | Years Ended June 30, |        
|                                                                                    |  | 2004                 |         |   | 2003 |   | 2002   | 
|Net increase (decrease) in cash and cash equivalents, and interest-bearing deposits |  |                      | (90,132 | ) |      |   | 89,560 |  |   | (2,422 | )
|Cash, cash equivalents, and interest-bearing deposits at beginning of period        |  |                      | 96,543  |   |      |   | 6,983  |  |   | 9,405  |  
|                                                                                    |  |                      |         |   |      |   |        |  |   |        |  
|Cash and cash equivalents at end of year                                            |  | $                    | 6,411   |   |      | $ | 96,543 |  | $ | 6,983  |  
|                                                                                    |  |                      |         |   |      |   |        |  |   |        |  
|Supplemental disclosures of cash flow information:                                  |  |                      |         |   |      |   |        |  |   |        |  
|Cash paid during the year for:                                                      |  |                      |         |   |      |   |        |  |   |        |  
|Interest on deposits and advances                                                   |  | $                    | 4,776   |   |      | $ | 6,518  |  | $ | 10,285 |  
|Income taxes                                                                        |  | $                    | 2,052   |   |      | $ | 1,923  |  | $ | 1,615  |  
|Real estate acquired in settlement of loans                                         |  | $                    | 1,826   |   |      | $ | 1,865  |  | $ | 2,418  |  



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements



June 30, 2004, 2003 and 2002



(Dollars in
Thousands)



NOTE 1  NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES



On July 1, 2003, Jefferson Bancshares, M.H.C. (the
M.H.C.) and Jefferson Federal Savings and Loan Association of Morristown (the Association) completed a conversion from the mutual holding company form of organization into the stock holding company form of organization. A newly organized Tennessee
corporation, Jefferson Bancshares, Inc. (the Company), was formed to become the holding company for the Association. The Company sold 6.6 million shares at $10.00 per share and commenced trading on the NASDAQ National Market under the symbol JFBI.



During the process of conversion, the Association changed its name to
Jefferson Federal Bank (the Bank). The Company provides a variety of financial services to individuals and small businesses through its offices in Upper East Tennessee. Its primary deposit products are savings and term certificate accounts and its
lending products are commercial and residential mortgages and to a lesser extent consumer loans.



Principles of Consolidation - The consolidated financial statements include the accounts of Jefferson Bancshares, Inc. and its wholly owned subsidiary, Jefferson Federal Bank. All significant intercompany
balances and transactions have been eliminated in consolidation.



Use of
Estimates - In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the statement of condition dates and revenues and expenses
for the periods shown. Actual results could differ from the estimates and assumptions used in the consolidated financial statements. Material estimates that are particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, the valuation of foreclosed real estate, and deferred tax assets.



Significant Group Concentrations of Credit Risk - The Company originates residential real estate loans and, to a lesser extent, commercial real estate and consumer
loans primarily to customers located in Upper East Tennessee. The ability of the Companys debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.



Significant Accounting Policies - The following comprise the significant accounting
policies, which the Company follows in preparing and presenting its consolidated financial statements:



| | a. | For purposes of reporting cash flows, cash and cash equivalents include cash and balances due from depository institutions and interest-bearing deposits in other depository
institutions with original maturities of three months or less. Interest-bearing deposits in other depository institutions were $2,608 and $88,946 at June 30, 2004 and 2003, respectively.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b. | Investments in debt securities are classified as held-to-maturity or available-for-sale according to the Financial Accounting Standards Boards (FASB)
Statement of Financial Accounting Standard (SFAS) No. 115. Investments classified as held-to-maturity are carried at cost while those identified as available-for-sale are carried at fair value. All securities are adjusted for
amortization of premiums and accretion of discounts over the term of the security using the interest method. Management has the positive intent and ability to carry those securities classified as held-to-maturity to maturity for
long-term investment purposes and, accordingly, such securities are not adjusted for temporary declines in market value. Available-for-sale securities are adjusted for changes in fair value through a direct entry to a separate component
of stockholders equity (i.e. other comprehensive income). Investments in equity securities are carried at the lower of cost or market. The cost of securities sold is determined by specific identification.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 1  NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



| | c. | Loans receivable, net, which management has the intent and ability to hold until maturity or pay-off, are generally carried at unpaid principal balances less loans in process, net
deferred loan fees, unearned discount on loans and allowances for losses. Loan origination and commitment fees and certain direct loan origination costs are deferred and amortized to interest income over the contractual life of the loan using the
interest method.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The accrual of interest on all
loans is discontinued at the time the loan is 90 days delinquent. All interest accrued but not collected for loans considered impaired, placed on non-accrual or charged off is reversed against interest income. The interest on these loans is
accounted for on the cash basis or cost-recovery method until the loan is returned to accrual status. Loans are returned to accrual status when future payments are reasonably assured.



| | d. | The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the
allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The allowance for loan losses is evaluated on a regular basis by management and is based upon managements periodic
review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any underlying collateral and
prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The Company is subject to periodic examination by regulatory
agencies, which may require the Company to record increases in the allowances based on the regulators evaluation of available information. There can be no assurance that the Companys regulators will not require further increases to the
allowances.



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



Specific valuation allowances are established for impaired loans for the difference between the loan amount and the fair value of collateral less
estimated selling costs. The Company considers a loan to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement on
a timely basis. The types of loans for which impairment is measured include non-accrual income property loans (excluding those loans included in the homogeneous portfolio which are collectively reviewed for impairment), large non-accrual
single-family loans and troubled debt restructuring. Such loans are placed on non-accrual status at the point deemed uncollectible. Impairment losses are recognized through an increase in the allowance for loan losses.



| | e. | Credit related financial instruments arising in the ordinary course of business consist primarily of commitments to extend credit. Such financial instruments are recorded when they
are funded.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | f. | Premises and equipment are carried at cost, less accumulated depreciation. Expenditures for assets with a life greater than one year and costing more than $500 are generally
capitalized. Depreciation of premises and equipment is computed using the straight-line and accelerated methods based on the estimated useful lives of the related assets. Estimated lives for buildings, leasehold improvements, equipment and furniture
are thirty nine, thirty nine, five and seven years, respectively. Estimated lives for building improvements are evaluated on a case-by-case basis and depreciated over the estimated remaining life of the improvement.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 1  NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



| | g. | Foreclosed real estate is initially recorded, and subsequently carried, at the lower of cost or fair value less estimated selling costs. Costs related to improvement of foreclosed
real estate are capitalized.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | h. | Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined
based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | i. | Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting
for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to
continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the
excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. The Company has elected to continue with the accounting methodology in Opinion No. 25.
Stock options issued under the Companys stock option plan have no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost is recognized for them.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Had compensation cost for the Companys stock option plan been
determined based on the fair value at the grant dates for awards under the plan consistent with the method prescribed by SFAS No. 123, the Companys net income and earnings per share would have been adjusted to the pro forma amounts indicated
below:



|                                                                                                                                      |  |                      |        |   |      |   |       |  |   |       |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------- | ------ | - | ---- | - | ----- |  | - | ----- | -
|                                                                                                                                      |  | Years Ended June 30, |       
|                                                                                                                                      |  | 2004                 |        |   | 2003 |   | 2002  | 
|Net income:                                                                                                                           |  |                      |        |   |      |   |       |  |   |       |  
|As reported                                                                                                                           |  | $                    | 1,387  |   |      | $ | 3,592 |  | $ | 2,426 |  
|Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax
effects |  |                      | (1,173 | ) |      |   |      |  |   | (34   | )
|                                                                                                                                      |  |                      |        |   |      |   |       |  |   |       |  
|Pro-forma                                                                                                                             |  | $                    | 214    |   |      | $ | 3,592 |  | $ | 2,392 |  
|                                                                                                                                      |  |                      |        |   |      |   |       |  |   |       |  



F-10



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 1  NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



|                                             |  |                     |      |      |   |      |  |   |     
|-------------------------------------------- |  | ------------------- | ---- | ---- | - | ---- |  | - | ----
|                                             |  | Years EndedJune 30,
|                                             |  | 2004                |      | 2003 |   | 2002
|Basic net earnings per share:                |  |                     |      |      |   |      |  |   |     
|As reported                                  |  | $                   | 0.18 |      | $ | 0.45 |  | $ | 0.30
|Pro-forma                                    |  |                     | 0.03 |      |   | 0.45 |  |   | 0.30
|Earnings per common share assuming dilution: |  |                     |      |      |   |      |  |   |     
|As reported                                  |  | $                   | 0.18 |      | $ | 0.45 |  | $ | 0.30
|Pro-forma                                    |  |                     | 0.03 |      |   | 0.45 |  |   | 0.30



| | j. | The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



Cash and due from banks and interest-bearing
deposits with banks - For cash and related instruments, the carrying amount is a reasonable estimate of fair value.



Available-for-sale and held-to-maturity securities - Fair values for securities, excluding restricted equity securities, are based on quoted market
prices. The carrying values of restricted equity securities approximate fair value.



Loans receivable - The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the
same remaining maturities.



Accrued interest receivable
- The carrying amount is a reasonable estimate of fair value for accrued interest receivable.



Deposit liabilities - The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the
reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.



Short-term borrowings - The carrying amounts of short-term borrowings maturing within 90 days approximate their fair
values. Fair values of other short-term borrowings are estimated using discounted cash flow analysis based on the Companys current incremental borrowing rates for similar types of borrowing arrangements.



Off-balance-sheet instruments - Fair values for off-balance-sheet
lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counter-parties credit standings.



Segment Reporting  The Companys operations are solely in the financial
services industry and include providing to its customers traditional banking and other financial services. The Company operates primarily in Upper East Tennessee. Management makes operating decisions and assesses performance based on an ongoing
review of the Companys financial results. Therefore, the Company has a single operating segment for financial reporting purposes.



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 2  RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS



The Bank is required to maintain average balances on hand or with the Federal Home Loan Bank
and Federal Reserve Bank. At June 30, 2004 and 2003, these reserve balances amounted to $1,699 and $9,737, respectively.



NOTE 3  EARNINGS PER SHARE



Earnings per common share and earnings per common share-assuming dilution have been computed on the basis of dividing net earnings by the weighted-average number of
shares of common stock outstanding. Diluted earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company
relate solely to outstanding stock options and are determined using the treasury stock method. Calculations related to earnings per share are provided in the following table.



|                                                                                                                                            |  |                     |  |           |  |          
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------- |  | --------- |  | ---------
|                                                                                                                                            |  | Years EndedJune 30,
|                                                                                                                                            |  | 2004                |  | 2003      |  | 2002     
|Weighted average number of common shares used in computing basic earnings per common share                                                  |  | 7,723,215           |  | 8,001,071 |  | 7,956,325
|Effect of dilutive stock options                                                                                                            |  | 42,266              |  | 41,981    |  | 46,913   
|                                                                                                                                            |  |                     |  |           |  |          
|Weighted average number of common shares and dilutive potential common shares used in computing earnings per common share assuming
dilution |  | 7,765,481           |  | 8,043,052 |  | 8,003,238
|                                                                                                                                            |  |                     |  |           |  |          



The common shares for 2003 and 2002
have been adjusted to reflect the conversion.



NOTE 4  IMPACT OF NEW
ACCOUNTING PRONOUNCEMENTS



Derivative Instruments and Hedging
Activities  In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends Statement 133 for decisions made (1) as part of the Derivatives
Implementation Group process that effectively required amendments to Statement 133, (2) in connection with other Board projects dealing with financial instruments, and (3) in connection with implementation issues raised in relation to the
application of the definition of a derivative, in particular, the meaning of an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market
factors, the meaning of underlying, and the characteristics of a derivative that contains financing components. The changes in this Statement improve financial reporting by requiring that contracts with comparable characteristics be
accounted for similarly. This Statement is effective for contracts entered into or modified after June 30, 2003, with some exceptions. The Company is not involved in any hedging activities.



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 4  IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED)



Financial Instruments with Characteristics of both Liabilities and Equity  In May 2003, the FASB issued
SFAS No. 150, Accounting for Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 30, 2003, with some exceptions. The Company is not a party to such
instruments.



Guarantors Accounting and Disclosure Requirements for
Guarantees - In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires a
liability to be recognized at the time a company issues a guarantee for the fair value of the obligations assumed under certain guarantee agreements. Additional disclosures about guarantee agreements are also required in the interim and annual
consolidated financial statements. The disclosure provisions of FIN 45 are effective for the Company on December 31, 2002. The provisions for initial recognition and measurement of guarantee agreements are effective on a prospective basis for
guarantees that are issued or modified after December 31, 2002. The Company does not have any such guarantees. This statement did not have a material effect on the Companys consolidated financial statements.



Consolidation of Variable Interest Entities - In January 2003, the FASB issued
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46), which establishes guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity. FIN 46
requires a variable interest entity to be consolidated by a company if that company will absorb a majority of the expected losses, will receive a majority of the expected residual returns, or both. Transferors to qualified special-purpose entities
(QSPEs) and certain other interests in a QSPE are not subject to the requirements of FIN 46. On December 17, 2003, the FASB revised FIN 46 (FIN 46R) and deferred the effective date of FIN 46 to no later than the end of the first reporting
period that ends after March 15, 2004, however, for special-purpose entities the Company would be required to apply FIN 46 as of December 31, 2003. The Interpretation had no effect on the Companys consolidated financial statements.



NOTE 5  INVESTMENT SECURITIES



Investment securities are summarized as follows:



|                                           |  |               |        |   |                 |   |                  |  |   |           |   |  |   |       
|------------------------------------------ |  | ------------- | ------ | - | --------------- | - | ---------------- |  | - | --------- | - |  | - | ------
|                                           |  | June 30, 2004
|                                           |  | AmortizedCost |        |   | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue
|Securities Available-for-Sale              |  |               |        |   |                 |   |                  |  |   |           |   |  |   |       
|Debt securities:                           |  |               |        |   |                 |   |                  |  |   |           |   |  |   |       
|Federal agency                             |  | $             | 80,443 |   |                 | $ | 205              |  | $ | (1,375    | ) |  | $ | 79,273
|Municipals                                 |  |               | 3,425  |   |                 |   | 1                |  |   | (112      | ) |  |   | 3,314 
|Mortgage-backed:                           |  |               |        |   |                 |   |                  |  |   |           |   |  |   |       
|GNMA                                       |  |               | 10,875 |   |                 |   | 24               |  |   | (82       | ) |  |   | 10,817
|FNMA                                       |  |               | 1,492  |   |                 |   | 50               |  |   |          |   |  |   | 1,542 
|FHLMC                                      |  |               | 55     |   |                 |   | 4                |  |   |          |   |  |   | 59    
|                                           |  |               |        |   |                 |   |                  |  |   |           |   |  |   |       
|Total securities available-for-sale        |  | $             | 96,290 |   |                 | $ | 284              |  | $ | (1,569    | ) |  | $ | 95,005
|                                           |  |               |        |   |                 |   |                  |  |   |           |   |  |   |       
|Weighted-average rate                      |  |               | 3.22   | % |                 |   |                  |  |   |           |   |  |   |       
|                                           |  |               |        |   |                 |   |                  |  |   |           |   |  |   |       
|Federal Home Loan Bank of Cincinnati stock |  | $             | 1,580  |   |                 | $ |                 |  | $ |          |   |  | $ | 1,580 
|                                           |  |               |        |   |                 |   |                  |  |   |           |   |  |   |       
|Weighted-average rate                      |  |               | 4.00   | % |                 |   |                  |  |   |           |   |  |   |       
|                                           |  |               |        |   |                 |   |                  |  |   |           |   |  |   |       



F-13



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 5  INVESTMENT SECURITIES (CONTINUED)



|                                           |  |               |        |   |                 |   |                  |  |           |   |  |   |       
|------------------------------------------ |  | ------------- | ------ | - | --------------- | - | ---------------- |  | --------- | - |  | - | ------
|                                           |  | June 30, 2003
|                                           |  | AmortizedCost |        |   | UnrealizedGains |   | UnrealizedLosses |  | FairValue
|Securities Available-for-Sale              |  |               |        |   |                 |   |                  |  |           |   |  |   |       
|Debt securities:                           |  |               |        |   |                 |   |                  |  |           |   |  |   |       
|Federal agency                             |  | $             | 55,646 |   |                 | $ | 928              |  | $         |  |  | $ | 56,574
|Mortgage-backed:                           |  |               |        |   |                 |   |                  |  |           |   |  |   |       
|GNMA                                       |  |               | 16,726 |   |                 |   | 399              |  |           |  |  |   | 17,125
|FNMA                                       |  |               | 2,456  |   |                 |   | 114              |  |           |  |  |   | 2,570 
|FHLMC                                      |  |               | 124    |   |                 |   | 7                |  |           |  |  |   | 131   
|                                           |  |               |        |   |                 |   |                  |  |           |   |  |   |       
|Total securities available-for-sale        |  | $             | 74,952 |   |                 | $ | 1,448            |  | $         |  |  | $ | 76,400
|                                           |  |               |        |   |                 |   |                  |  |           |   |  |   |       
|Weighted-average rate                      |  |               | 3.40   | % |                 |   |                  |  |           |   |  |   |       
|                                           |  |               |        |   |                 |   |                  |  |           |   |  |   |       
|Federal Home Loan Bank of Cincinnati stock |  | $             | 1,518  |   |                 | $ |                 |  | $         |  |  | $ | 1,518 
|                                           |  |               |        |   |                 |   |                  |  |           |   |  |   |       
|Weighted-average rate                      |  |               | 4.00   | % |                 |   |                  |  |           |   |  |   |       
|                                           |  |               |        |   |                 |   |                  |  |           |   |  |   |       



Investment securities with a carrying
value of $3,833 and $4,542 were pledged to secure public funds and/or advances from the Federal Home Loan Bank at June 30, 2004 and 2003, respectively.



Maturities of debt securities at June 30, 2004, are summarized as follows:



|                               |  |                                  |        |                      |   |        |  |      |  
|------------------------------ |  | -------------------------------- | ------ | -------------------- | - | ------ |  | ---- | -
|                               |  | Available-for-SaleClassification |        | WeightedAverageYield |  
|                               |  | AmortizedCost                    |        | FairValue            |  
|Within 1 year                  |  | $                                | 200    |                      | $ | 201    |  | 4.45 | %
|Over 1 year through 5 years    |  |                                  | 58,606 |                      |   | 57,966 |  | 3.18 | %
|After 5 years through 10 years |  |                                  | 24,731 |                      |   | 24,104 |  | 3.21 | %
|Over 10 years                  |  |                                  | 331    |                      |   | 316    |  | 3.57 | %
|                               |  |                                  |        |                      |   |        |  |      |  
|                               |  |                                  | 83,868 |                      |   | 82,587 |  |      |  
|Mortgage backed securities     |  |                                  | 12,422 |                      |   | 12,418 |  | 3.42 | %
|                               |  |                                  |        |                      |   |        |  |      |  
|                               |  | $                                | 96,290 |                      | $ | 95,005 |  | 3.22 | %
|                               |  |                                  |        |                      |   |        |  |      |  



Proceeds from sale of debt securities
and gross realized gains and losses on these sales are summarized as follows:



|                      |  |                     |        |   |      |   |       |  |   |        |  
|--------------------- |  | ------------------- | ------ | - | ---- | - | ----- |  | - | ------ | -
|                      |  | Year Ended June 30, |       
|                      |  | 2004                |        |   | 2003 |   | 2002  | 
|Proceeds from sales   |  | $                   | 25,000 |   |      | $ | 3,725 |  | $ | 22,013 |  
|                      |  |                     |        |   |      |   |       |  |   |        |  
|Gross realized gains  |  | $                   | 147    |   |      | $ | 81    |  | $ | 151    |  
|Gross realized losses |  |                     | (125   | ) |      |   |      |  |   | (10    | )
|                      |  |                     |        |   |      |   |       |  |   |        |  
|Net gains (losses)    |  | $                   | 22     |   |      | $ | 81    |  | $ | 141    |  
|                      |  |                     |        |   |      |   |       |  |   |        |  



F-14



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 6  LOANS RECEIVABLE, NET



Loans receivable, net are summarized as follows:



|                            |  |          |         |   |      |   |         |  
|--------------------------- |  | -------- | ------- | - | ---- | - | ------- | -
|                            |  | June 30, |        
|                            |  | 2004     |         |   | 2003 |  
|Real estate loans:          |  |          |         |   |      |   |         |  
|Residential 1-4 family      |  | $        | 84,784  |   |      | $ | 84,628  |  
|Home equity lines of credit |  |          | 3,143   |   |      |   | 1,736   |  
|Multi-family                |  |          | 9,213   |   |      |   | 13,229  |  
|Construction                |  |          | 3,001   |   |      |   | 3,584   |  
|Commercial                  |  |          | 59,993  |   |      |   | 49,020  |  
|Land                        |  |          | 10,760  |   |      |   | 10,197  |  
|                            |  |          |         |   |      |   |         |  
|                            |  |          | 170,894 |   |      |   | 162,394 |  
|                            |  |          |         |   |      |   |         |  
|Commercial business loans   |  |          | 12,640  |   |      |   | 13,472  |  
|                            |  |          |         |   |      |   |         |  
|Non-real estate loans:      |  |          |         |   |      |   |         |  
|Automobile loans            |  |          | 2,200   |   |      |   | 3,081   |  
|Mobile home loans           |  |          | 531     |   |      |   | 719     |  
|Loans secured by deposits   |  |          | 1,084   |   |      |   | 1,841   |  
|Other consumer loans        |  |          | 2,038   |   |      |   | 1,715   |  
|                            |  |          |         |   |      |   |         |  
|Total consumer loans        |  |          | 5,853   |   |      |   | 7,356   |  
|                            |  |          |         |   |      |   |         |  
|Sub-total                   |  |          | 189,387 |   |      |   | 183,222 |  
|Less:                       |  |          |         |   |      |   |         |  
|Deferred loan fees, net     |  |          | (306    | ) |      |   | (366    | )
|Unearned discount on loans  |  |          | (1      | ) |      |   | (5      | )
|Allowance for losses        |  |          | (2,479  | ) |      |   | (2,841  | )
|                            |  |          |         |   |      |   |         |  
|Loans, net                  |  | $        | 186,601 |   |      | $ | 180,010 |  
|                            |  |          |         |   |      |   |         |  
|Weighted-average rate       |  |          | 6.41    | % |      |   | 7.71    | %
|                            |  |          |         |   |      |   |         |  



The following is a summary of
information pertaining to impaired and non-accrual loans:



|                                       |  |          |       |      |   |      
|-------------------------------------- |  | -------- | ----- | ---- | - | -----
|                                       |  | June 30,
|                                       |  | 2004     |       | 2003
|Total impaired loans                   |  | $        | 265   |      | $ | 161  
|Valuation allowance for impaired loans |  | $        | 64    |      | $ | 24   
|Total non-accrual loans                |  | $        | 1,083 |      | $ | 1,756



F-15



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JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 6  LOANS RECEIVABLE, NET (CONTINUED)





|                                             |  |                      |     |      |   |      |  |   |   
|-------------------------------------------- |  | -------------------- | --- | ---- | - | ---- |  | - | --
|                                             |  | Years Ended June 30,
|                                             |  | 2004                 |     | 2003 |   | 2002
|Average investment in impaired loans         |  | $                    | 240 |      | $ | 153  |  | $ | 80
|Interest income recognized on impaired loans |  | $                    | 16  |      | $ | 4    |  | $ | 1 



No additional funds are committed to
be advanced in connection with impaired loans.



Commercial real estate loans
are secured principally by office buildings, shopping centers, churches and other rental real estate. Real estate construction loans are secured principally by single-family dwellings.



Following is a summary of activity in allowance for losses:



|                             |  |                      |       |   |      |   |        |      |  |   |        |  
|---------------------------- |  | -------------------- | ----- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                             |  | Years Ended June 30, |      
|                             |  | 2004                 |       |   | 2003 |   |        | 2002 | 
|Balance, beginning of period |  | $                    | 2,841 |   |      | $ | 2,696  |      |  | $ | 2,209  |  
|Loans charged-off            |  |                      | (625  | ) |      |   | (1,077 | )    |  |   | (1,416 | )
|Recoveries                   |  |                      | 263   |   |      |   | 435    |      |  |   | 682    |  
|Provision charged to expense |  |                      |      |   |      |   | 787    |      |  |   | 1,221  |  
|                             |  |                      |       |   |      |   |        |      |  |   |        |  
|Balance, end of period       |  | $                    | 2,479 |   |      | $ | 2,841  |      |  | $ | 2,696  |  
|                             |  |                      |       |   |      |   |        |      |  |   |        |  



Following is a summary of loans to
directors, executive officers and associates of such persons:



|                       |  |   |       |  
|---------------------- |  | - | ----- | -
|Balance, June 30, 2002 |  | $ | 784   |  
|Additions              |  |   | 376   |  
|Repayment              |  |   | (75   | )
|                       |  |   |       |  
|Balance, June 30, 2003 |  |   | 1,085 |  
|Additions              |  |   | 215   |  
|Repayment              |  |   | (135  | )
|                       |  |   |       |  
|Balance, June 30, 2004 |  | $ | 1,165 |  
|                       |  |   |       |  



These loans were made on substantially
the same terms as those prevailing at the time for comparable transactions with unaffiliated persons.



F-16



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JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 7  MORTGAGE SERVICING



Mortgage loans serviced for others are not included in the accompanying statements of financial condition. The unpaid principal balances of
mortgage loans serviced for others were $0, $7, and $18, at June 30, 2004, 2003 and 2002, respectively.



Custodial escrow balances maintained in connection with the foregoing loan servicing were approximately $0, $0, and $0, at June 30, 2004, 2003, and 2002, respectively.



NOTE 8  PREMISES AND EQUIPMENT, NET



Premises and equipment, net are summarized as follows:



|                                               |  |          |       |      |   |      
|---------------------------------------------- |  | -------- | ----- | ---- | - | -----
|                                               |  | June 30,
|                                               |  | 2004     |       | 2003
|Land                                           |  | $        | 1,695 |      | $ | 645  
|Office building                                |  |          | 3,748 |      |   | 3,739
|Leasehold improvements                         |  |          | 74    |      |   | 74   
|Furniture and equipment                        |  |          | 1,846 |      |   | 1,853
|                                               |  |          |       |      |   |      
|                                               |  |          | 7,363 |      |   | 6,311
|Less accumulated depreciation and amortization |  |          | 2,243 |      |   | 2,143
|                                               |  |          |       |      |   |      
|                                               |  | $        | 5,120 |      | $ | 4,168
|                                               |  |          |       |      |   |      



Depreciation and amortization expense
for the years ended June 30, 2004, 2003, and 2002, was $288, $306 and $289, respectively.



Pursuant to the terms of non-cancelable lease agreements in effect at June 30, 2004, pertaining to real property, future minimum payments are as follows:



|                            |  |   |   
|--------------------------- |  | - | --
|For the year ended June 30, |  |  
|2005                        |  | $ | 16
|2006                        |  |   | 16
|                            |  |   |   
|Total                       |  | $ | 32
|                            |  |   |   



Lease expense for June 30, 2004, 2003,
and 2002 was $15, $15, and $15, respectively.



The Company has also entered
into a service contract for data processing services. Future minimum payments under this agreement are as follows:



|                            |  |   |      
|--------------------------- |  | - | -----
|For the year ended June 30, |  |  
|2005                        |  | $ | 142  
|2006                        |  |   | 249  
|2007                        |  |   | 249  
|2008                        |  |   | 252  
|2009                        |  |   | 252  
|                            |  |   |      
|Total                       |  | $ | 1,144
|                            |  |   |      



Data processing service expense for
June 30, 2004, 2003, and 2002 was $358, $357, and $344, respectively.



F-17



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 9 - DEPOSITS



Deposits are summarized as follows:



|                                                             |  |          |         |   |      |   |         |  
|------------------------------------------------------------ |  | -------- | ------- | - | ---- | - | ------- | -
|                                                             |  | June 30, |        
|Description and Interest Rate                                |  | 2004     |         |   | 2003 |  
|Noninterest-bearing NOW accounts                             |  | $        | 7,958   |   |      | $ | 99,109  |  
|NOW accounts, 0.50% and 0.75%, respectively                  |  |          | 15,220  |   |      |   | 17,767  |  
|Passbook accounts, 0.50% and 0.75%, respectively             |  |          | 13,849  |   |      |   | 19,346  |  
|Money market deposit accounts, 1.21% and 1.30%, respectively |  |          | 28,930  |   |      |   | 28,588  |  
|                                                             |  |          |         |   |      |   |         |  
|Total transactions accounts                                  |  |          | 65,957  |   |      |   | 164,810 |  
|                                                             |  |          |         |   |      |   |         |  
|Certificates:                                                |  |          |         |   |      |   |         |  
|0.00 - 1.00%                                                 |  |          | 7,442   |   |      |   | 302     |  
|1.01 - 2.00%                                                 |  |          | 35,578  |   |      |   | 39,547  |  
|2.01 - 3.00%                                                 |  |          | 54,532  |   |      |   | 59,642  |  
|3.01 - 4.00%                                                 |  |          | 26,984  |   |      |   | 27,896  |  
|4.01 - 5.00%                                                 |  |          | 13,785  |   |      |   | 22,737  |  
|5.01 - 6.00%                                                 |  |          | 655     |   |      |   | 5,133   |  
|6.01 - 7.00%                                                 |  |          |        |   |      |   | 4,180   |  
|                                                             |  |          |         |   |      |   |         |  
|Total certificates, 2.50% and 3.41%, respectively            |  |          | 138,976 |   |      |   | 159,437 |  
|                                                             |  |          |         |   |      |   |         |  
|Total deposits                                               |  | $        | 204,933 |   |      | $ | 324,247 |  
|                                                             |  |          |         |   |      |   |         |  
|Weighted-average rate - deposits                             |  |          | 1.94    | % |      |   | 2.49    | %
|                                                             |  |          |         |   |      |   |         |  



The aggregate amount of time deposits
in denominations of $100,000 or more was $33,918 and $37,932, respectively, at June 30, 2004 and 2003.



The Savings Association Insurance Fund, as administrated by the Federal Deposit Insurance Corporation, insures deposits up to applicable limits. Deposit amounts in excess of $100,000 are generally not federally
insured.



At June 30, 2004, the scheduled maturities of time deposits are as
follows:



|      |  |   |        
|----- |  | - | -------
|2005  |  | $ | 106,656
|2006  |  |   | 20,550 
|2007  |  |   | 11,603 
|2008  |  |   | 167    
|      |  |   |        
|Total |  | $ | 138,976
|      |  |   |        



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 9 - DEPOSITS (CONTINUED)



Following is a summary of interest on deposits:



|                                  |  |                      |       |      |   |       |  |   |       
|--------------------------------- |  | -------------------- | ----- | ---- | - | ----- |  | - | ------
|                                  |  | Years Ended June 30,
|                                  |  | 2004                 |       | 2003 |   | 2002 
|NOW                               |  | $                    | 85    |      | $ | 125   |  | $ | 137   
|Passbook accounts                 |  |                      | 75    |      |   | 141   |  |   | 262   
|Money market deposit accounts     |  |                      | 358   |      |   | 466   |  |   | 237   
|Certificates                      |  |                      | 4,154 |      |   | 5,691 |  |   | 9,536 
|                                  |  |                      |       |      |   |       |  |   |       
|                                  |  |                      | 4,672 |      |   | 6,423 |  |   | 10,172
|Less - early withdrawal penalties |  |                      | 2     |      |   | 5     |  |   | 7     
|                                  |  |                      |       |      |   |       |  |   |       
|                                  |  | $                    | 4,670 |      | $ | 6,418 |  | $ | 10,165
|                                  |  |                      |       |      |   |       |  |   |       



NOTE 10 - FHLB ADVANCE



Pursuant to collateral agreements with the Federal Home Loan Bank
(FHLB), advances are secured by a Blanket Mortgage Collateral Agreement. The Agreement pledges the entire one-to-four family residential mortgage portfolio and allows a maximum advance of $61,930 at June 30, 2004. Outstanding advances
were $6,000 and $2,000 at June 30, 2004 and 2003, respectively.



NOTE 11
 INCOME TAXES



In computing federal income tax, savings institutions
treated as small banks for tax years beginning before 1996 were allowed a statutory bad debt deduction based on specified experience formulas or 8% of otherwise taxable income, subject to limitations based on aggregate loans and savings balances.
For tax years after 1996, financial institutions meeting the definition of a small bank can use either the experience method or the specific charge-off method in computing their bad debt deduction. The Company qualifies as a
small bank and is using the experience method. As of June 30, 2004, the end of the most recent tax year, the Companys tax bad debt reserves were approximately $1,312. If these tax bad debt reserves are used for other than loan losses, the
amount used will be subject to federal income taxes at the then prevailing corporate rates. Beginning in the year ended June 30, 1999, the Company must recapture $622 of tax loss reserves over six years (i.e. $104 per year).



Income taxes are summarized as follows:



|               |  |                      |        |   |      |   |       |      |  |   |       |  
|-------------- |  | -------------------- | ------ | - | ---- | - | ----- | ---- |  | - | ----- | -
|               |  | Years Ended June 30, |       
|               |  | 2004                 |        |   | 2003 |   |       | 2002 | 
|Current taxes: |  |                      |        |   |      |   |       |      |  |   |       |  
|Federal income |  | $                    | 1,690  |   |      | $ | 1,890 |      |  | $ | 1,509 |  
|State excise   |  |                      | 4      |   |      |   | 255   |      |  |   | 193   |  
|               |  |                      |        |   |      |   |       |      |  |   |       |  
|               |  |                      | 1,694  |   |      |   | 2,145 |      |  |   | 1,702 |  
|               |  |                      |        |   |      |   |       |      |  |   |       |  
|Deferred taxes |  |                      |        |   |      |   |       |      |  |   |       |  
|Federal income |  |                      | (1,004 | ) |      |   | (74   | )    |  |   | (270  | )
|State excise   |  |                      | 16     |   |      |   | (3    | )    |  |   | (14   | )
|               |  |                      |        |   |      |   |       |      |  |   |       |  
|               |  |                      | (988   | ) |      |   | (77   | )    |  |   | (284  | )
|               |  |                      |        |   |      |   |       |      |  |   |       |  
|               |  | $                    | 706    |   |      | $ | 2,068 |      |  | $ | 1,418 |  
|               |  |                      |        |   |      |   |       |      |  |   |       |  



F-19



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 11  INCOME TAXES (CONTINUED)



The provisions of SFAS No. 109 require the Company to establish a deferred tax liability for the tax effect of the
tax bad debt reserves over the base year amounts. The recorded deferred tax liability for the excess reserves was $0 and $35 at June 30, 2004 and 2003, respectively. The Companys base year tax bad debt reserve is $1,312. The estimated deferred
tax liability on the base year amount is approximately $502, which has not been recorded in the accompanying consolidated financial statements.



The provision for income taxes differs from the federal statutory corporate rate as follows:



|                                               |  |                                           |   |  |      |   |  |      |  
|---------------------------------------------- |  | ----------------------------------------- | - |  | ---- | - |  | ---- | -
|                                               |  | Percentage of EarningsBefore Income Taxes |  
|                                               |  | Years Ended June 30,                      |  
|                                               |  | 2004                                      |   |  | 2003 |   |  | 2002 |  
|Tax at statutory rate                          |  | 34.0                                      | % |  | 34.0 | % |  | 34.0 | %
|Increase (decrease) in taxes:                  |  |                                           |   |  |      |   |  |      |  
|State income taxes, net of federal tax benefit |  | 0.1                                       |   |  | 3.0  |   |  | 3.3  |  
|Other, net                                     |  | (0.4                                      | ) |  | (0.5 | ) |  | (0.4 | )
|                                               |  |                                           |   |  |      |   |  |      |  
|Effective tax rate                             |  | 33.7                                      | % |  | 36.5 | % |  | 36.9 | %
|                                               |  |                                           |   |  |      |   |  |      |  



The components of the net deferred tax
asset are summarized as follows:



|                                              |  |          |       |   |      |   |       |  
|--------------------------------------------- |  | -------- | ----- | - | ---- | - | ----- | -
|                                              |  | June 30, |      
|                                              |  | 2004     |       |   | 2003 |  
|Deferred tax liabilities:                     |  |          |       |   |      |   |       |  
|FHLB stock dividends                          |  | $        | (403  | ) |      | $ | (376  | )
|Allowance for "available-for-sale" securities |  |          |      |   |      |   | (550  | )
|Depreciation                                  |  |          | (22   | ) |      |   |      |  
|                                              |  |          |       |   |      |   |       |  
|                                              |  |          | (425  | ) |      |   | (926  | )
|                                              |  |          |       |   |      |   |       |  
|Deferred tax assets:                          |  |          |       |   |      |   |       |  
|Charitable contributions                      |  |          | 1,194 |   |      |   |      |  
|Deferred loan fees, net                       |  |          | 117   |   |      |   | 139   |  
|Allowance for available-for-sale securities |  |          | 492   |   |      |   |      |  
|Accrued sick pay                              |  |          |      |   |      |   | 45    |  
|MRP compensation                              |  |          | 84    |   |      |   |      |  
|Deferred compensation                         |  |          | 12    |   |      |   | 7     |  
|Allowance for losses on loans                 |  |          | 957   |   |      |   | 1,086 |  
|REO writedowns                                |  |          | 23    |   |      |   | 54    |  
|Unearned profit on sale of REO                |  |          | 48    |   |      |   | 67    |  
|                                              |  |          |       |   |      |   |       |  
|Gross deferred tax assets                     |  |          | 2,927 |   |      |   | 1,398 |  
|Valuation allowance                           |  |          |      |   |      |   |      |  
|                                              |  |          |       |   |      |   |       |  
|Deferred tax asset                            |  |          | 2,927 |   |      |   | 1,398 |  
|                                              |  |          |       |   |      |   |       |  
|Net deferred tax asset                        |  | $        | 2,502 |   |      | $ | 472   |  
|                                              |  |          |       |   |      |   |       |  



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 12  EMPLOYEE BENEFIT PLANS



401 (K) RETIREMENT PLAN. The Company has a defined contribution pension plan covering all employees having attained the age of 20 and
1⁄2 and completing six months of service. Normal retirement date is the participants sixty-fifth birthday.



Before the Company established the Employee Stock Ownership Plan (effective July 1, 2003), the 401(k) plan was funded by annual employer contributions of 10% of the total
plan compensation of all participants in the plan. The amount contributed by the employer was divided among the participants in the same proportion that each participants compensation bore to the aggregate compensation of all participants.
Employer contributions vest to employees over a seven-year period. Employees are permitted to make contributions of up to 50% of their compensation subject to certain limits based on federal tax laws. Total pension plan expense for the years ended
June 30, 2003 and 2002, was $184 and $192, respectively.



EMPLOYEE STOCK
OWNERSHIP PLAN.As part of the conversion, the Bank established an Employee Stock Ownership Plan (ESOP). On July 1, 2003, the ESOP purchased 670,089 shares of Jefferson Bancshares, Inc. from proceeds provided by the Company in the form of a
loan. Thus, the ESOP is considered a leveraged plan. Employees are eligible for participation in the plan upon attaining 20 and 1⁄2 years of age and completing six consecutive calendar months during which he has performed at least 500 hours of
service. Each plan year, the Bank may, in its discretion, make a contribution to the plan; however, at a minimum, the Bank has agreed to make as a contribution the amount necessary to service the debt incurred to acquire the stock.



Shares are scheduled for release as the loan is repaid. The present amortization schedule
calls for 43,206.63 shares to be released each December 31. Dividends on unallocated shares are used to repay the loan while dividends paid on allocated shares become part of the plans assets. Accounting for the ESOP consists of recognizing
compensation expense for the fair market value of the shares as of the date of release. Allocated shares are included in earnings per share calculations while unallocated shares are not included.



ESOP compensation expense was $590 for the year ended June 30, 2004. The original number of
shares committed was 670,089 and 21,990 were released during the year ended June 30, 2004. The 648,099 remaining unearned shares had an approximate fair market value of $8,419 at June 30, 2004.



STOCK COMPENSATION PLANS.The Company maintains stock-based benefit plans under which
certain employees and directors are eligible to receive restricted stock grants or options. Under the 2004 Stock-Based Benefit Plan, the maximum number of shares that may be granted as restricted stock is 279,500, and a maximum of 698,750 shares may
be issued through the exercise of nonstatutory or incentive stock options. The exercise price of each option equals the market price of the Companys stock on the date of grant and an options maximum term is ten years.



Restricted stock grants aggregating 160,711 shares were awarded on January 29, 2004, having a
fair value of $2,200. Restrictions on the grants lapse in annual increments over five years. The market value as of the grant date of the restricted stock grants is charged to expense as the restrictions lapse. Compensation expense for grants
vesting in 2004, 2003 and 2002, was $220, $0 and $24, respectively.



The fair
value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:



|                        |  |       |   |  |      |  |       |  
|----------------------- |  | ----- | - |  | ---- |  | ----- | -
|                        |  | 2004  |   |  | 2003 |  | 2002  |  
|Dividend yield          |  | 1.17  | % |  | N/A  |  | 3.16  | %
|Expected life (years)   |  | 10    |   |  | N/A  |  | 5     |  
|Expected volatility     |  | 10.02 | % |  | N/A  |  | 20.74 | %
|Risk-free interest rate |  | 4.22  | % |  | N/A  |  | 3.93  | %



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 12  EMPLOYEE BENEFIT PLANS (CONTINUED)



A summary of the status of the Companys stock option plan is presented below:



|                                                               |  |        |         |      |                              |      |        |  |                              |  |        |      |  |                              |         |   |  |   |     
|-------------------------------------------------------------- |  | ------ | ------- | ---- | ---------------------------- | ---- | ------ |  | ---------------------------- |  | ------ | ---- |  | ---------------------------- | ------- | - |  | - | ----
|                                                               |  | 2004   |         | 2003 |                              | 2002
|                                                               |  | Shares |         |      | WeightedAverageExercisePrice |      | Shares |  | WeightedAverageExercisePrice |  | Shares |      |  | WeightedAverageExercisePrice
|Outstanding at beginning of year                               |  |        | 70,389  |      |                              | $    | 4.07   |  | 70,389                       |  | $      | 4.07 |  |                              | 93,000  |   |  | $ | 3.52
|Granted                                                        |  |        | 401,778 |      |                              |      | 13.69  |  |                             |  |        |      |  |                              | 25,597  |   |  |   | 5.19
|Exercised                                                      |  |        | (9,532  | )    |                              |      | 3.52   |  |                             |  |        |      |  |                              | (48,208 | ) |  |   | 3.59
|Forfeited                                                      |  |        |        |      |                              |      |        |  |                             |  |        |      |  |                              |        |   |  |   |     
|                                                               |  |        |         |      |                              |      |        |  |                              |  |        |      |  |                              |         |   |  |   |     
|Outstanding at end of year                                     |  |        | 462,635 |      |                              |      | 12.44  |  | 70,389                       |  |        | 4.07 |  |                              | 70,389  |   |  |   | 4.07
|Options exercisable at year-end                                |  |        | 60,857  |      |                              |      | 4.16   |  | 70,389                       |  |        | 4.07 |  |                              | 70,389  |   |  |   | 4.07
|Weighted-average fair value of options granted during the year |  | $      | 13.69   |      |                              |      |        |  |                              |  |        |      |  | $                            | 5.19    |   |  |   |     



Information pertaining to options
outstanding at June 30, 2004 is as follows:



|                           |  |                     |  |                                         |  |                              |       |                   |        |                              |   |     
|-------------------------- |  | ------------------- |  | --------------------------------------- |  | ---------------------------- | ----- | ----------------- | ------ | ---------------------------- | - | ----
|                           |  | Options Outstanding |  | Options Exercisable                    
|Range of Exercise Prices   |  | NumberOutstanding   |  | WeightedAverageRemainingContractualLife |  | WeightedAverageExercisePrice |       | NumberExercisable |        | WeightedAverageExercisePrice
|$3.52 - $ 5.19             |  | 60,857              |  | 2.7 years                               |  | $                            | 4.16  |                   | 60,857 |                              | $ | 4.16
|$13.69                     |  | 401,778             |  | 9.5 years                               |  |                              | 13.69 |                   |       |                              |   |    
|                           |  |                     |  |                                         |  |                              |       |                   |        |                              |   |     
|Outstanding at end of year |  | 462,635             |  | 8.7 years                               |  | $                            | 12.44 |                   | 60,857 |                              | $ | 4.16
|                           |  |                     |  |                                         |  |                              |       |                   |        |                              |   |     



NOTE 13  MINIMUM REGULATORY
CAPITAL REQUIREMENTS



The Bank is subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material
effect on the Company and Banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets,
liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other
factors.



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 13  MINIMUM REGULATORY CAPITAL REQUIREMENTS (CONTINUED)



Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum
amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and core and tangible capital (as defined) to tangible assets (as defined). Management believes as
of June 30, 2004 and 2003, that the Bank met all capital adequacy requirements to which it was subject.



As of June 30, 2004, the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well
capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the
Banks category. The Banks actual capital amounts and ratios as of June 30, 2004 and 2003, are also presented in the table.



|                                         |  |        |        |       |                             |   |        |                                                                      |        |  |       |        |        |       |        |     |   |      |  
|---------------------------------------- |  | ------ | ------ | ----- | --------------------------- | - | ------ | -------------------------------------------------------------------- | ------ |  | ----- | ------ | ------ | ----- | ------ | --- | - | ---- | -
|                                         |  | Actual |        |       | Minimum CapitalRequirements |   |        | Minimum To BeWell CapitalizedUnder PromptCorrective ActionProvisions |       
|                                         |  | Amount |        | Ratio |                             |   | Amount |                                                                      | Ratio  |  |       | Amount |        | Ratio |       
|As of June 30, 2004:                     |  |        |        |       |                             |   |        |                                                                      |        |  |       |        |        |       |        |     |   |      |  
|Total Capital (to Risk Weighted Assets)  |  | $      | 64,731 |       | 38.8                        | % |        | $                                                                    | 13,352 |  | > 8.0 | %      |        | $     | 16,690 |     | 3 | 10.0 | %
|Core Capital (to Tangible Assets)        |  |        | 62,640 |       | 22.2                        | % |        |                                                                      | 11,280 |  | > 4.0 | %      |        |       | 14,101 |     | 3 | 5.0  | %
|Tangible Capital (to Tangible Assets)    |  |        | 62,640 |       | 22.2                        | % |        |                                                                      | 4,230  |  | > 1.5 | %      |        |       | N/A    |    
|Tier 1 Capital (to Risk Weighted Assets) |  |        | 62,640 |       | 37.5                        | % |        |                                                                      | N/A    |  |       |        | 10,014 |       | 3      | 6.0 | %
|As of June 30, 2003:                     |  |        |        |       |                             |   |        |                                                                      |        |  |       |        |        |       |        |     |   |      |  
|Total Capital (to Risk Weighted Assets)  |  | $      | 37,472 |       | 21.1                        | % |        | $                                                                    | 14,235 |  | > 8.0 | %      |        | $     | 17,794 |     | 3 | 10   | %
|Core Capital (to Tangible Assets)        |  |        | 35,255 |       | 9.8                         | % |        |                                                                      | 14,468 |  | > 4.0 | %      |        |       | 18,085 |     | 3 | 5    | %
|Tangible Capital (to Tangible Assets)    |  |        | 35,255 |       | 9.8                         | % |        |                                                                      | 5,426  |  | > 1.5 | %      |        |       | N/A    |    
|Tier 1 Capital (to Risk Weighted Assets) |  |        | 35,255 |       | 19.8                        | % |        |                                                                      | N/A    |  |       |        | 10,676 |       | 3      | 6   | %



F-23



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 13 - MINIMUM REGULATORY CAPITAL REQUIREMENTS (CONTINUED)



The following table provides reconciliation between GAAP capital and the various categories of regulatory capital:



|                                  |  |          |        |   |      |   |        |  
|--------------------------------- |  | -------- | ------ | - | ---- | - | ------ | -
|                                  |  | Bank     |       
|                                  |  | June 30, |       
|                                  |  | 2004     |        |   | 2003 |  
|GAAP Capital                      |  | $        | 63,237 |   |      | $ | 36,625 |  
|Adjustments:                      |  |          |        |   |      |   |        |  
|Deferred taxes                    |  |          | (1,178 | ) |      |   | (472   | )
|Unrealized (gains)/losses         |  |          | 581    |   |      |   | (898   | )
|                                  |  |          |        |   |      |   |        |  
|Core, Tangible and Tier 1 Capital |  |          | 62,640 |   |      |   | 35,255 |  
|Adjustments:                      |  |          |        |   |      |   |        |  
|Allowances for losses             |  |          | 2,091  |   |      |   | 2,217  |  
|                                  |  |          |        |   |      |   |        |  
|Total Capital                     |  | $        | 64,731 |   |      | $ | 37,472 |  
|                                  |  |          |        |   |      |   |        |  



NOTE 14  RESTRICTIONS ON
DIVIDENDS, LOANS AND ADVANCES



Federal and state banking regulations place
certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the Bank, and loans or advances are limited to
10 percent of the Banks capital stock and surplus on a secured basis.



At
June 30, 2004, the Banks retained earnings available for the payment of dividends was $32,914. Accordingly, $5,392 of the Companys equity in the net assets of the Bank was restricted at June 30, 2004. Funds available for loans or
advances by the Bank to the Company amounted to $6,324.



In addition, dividends
paid by the Bank to the Company would be prohibited if the effect thereof would cause the Banks capital to be reduced below applicable minimum capital requirements.



NOTE 15  FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK



The Company is a party to financial instruments with off-balance risk in the normal course of business. These financial instruments
generally include commitments to originate mortgage loans. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the balance sheet. The Companys maximum exposure to
credit loss in the event of nonperformance by the borrower is represented by the contractual amount and related accrued interest receivable of those instruments. The Company minimizes this risk by evaluating each borrowers creditworthiness on
a case-by-case basis. Collateral held by the Company consists of a first or second mortgage on the borrowers property. The amount of collateral obtained is based upon an appraisal of the property.



The fair value of a financial instrument is the current amount that would be exchanged
between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Companys various financial instruments. In cases
where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of
future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS 107 excludes certain financial instruments from its disclosure requirements. Accordingly, the aggregate fair value
amounts presented may not necessarily represent the underlying fair value of the Company.



F-24



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 15  FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED)



The estimated fair values of the Companys financial instruments are as follows:



|                                                                          |  |                |          |   |               |   |          |                |  |   |            |   |  |   |          |  
|------------------------------------------------------------------------- |  | -------------- | -------- | - | ------------- | - | -------- | -------------- |  | - | ---------- | - |  | - | -------- | -
|                                                                          |  | June 30, 2004  |          |   | June 30, 2003 |  
|                                                                          |  | CarryingAmount |          |   | Fair Value    |   |          | CarryingAmount |  |   | Fair Value |  
|Financial assets:                                                         |  |                |          |   |               |   |          |                |  |   |            |   |  |   |          |  
|Cash and balances due from banks and interest-bearing deposits with banks |  | $              | 6,411    |   |               | $ | 6,411    |                |  | $ | 96,543     |   |  | $ | 96,543   |  
|Available-for-sale and held-to maturity securities                        |  |                | 95,005   |   |               |   | 95,005   |                |  |   | 76,400     |   |  |   | 76,400   |  
|Federal Home Loan Bank stock                                              |  |                | 1,580    |   |               |   | 1,580    |                |  |   | 1,518      |   |  |   | 1,518    |  
|Loans receivable                                                          |  |                | 186,601  |   |               |   | 189,153  |                |  |   | 180,010    |   |  |   | 182,715  |  
|Accrued interest receivable                                               |  |                | 1,826    |   |               |   | 1,826    |                |  |   | 1,934      |   |  |   | 1,934    |  
|Financial liabilities:                                                    |  |                |          |   |               |   |          |                |  |   |            |   |  |   |          |  
|Deposits                                                                  |  |                | (204,933 | ) |               |   | (205,248 | )              |  |   | (324,247   | ) |  |   | (325,855 | )
|FHLB Advance                                                              |  |                | (6,000   | ) |               |   | (6,115   | )              |  |   | (2,000     | ) |  |   | (2,273   | )
|Off-balance-sheet assets (liabilities):                                   |  |                |          |   |               |   |          |                |  |   |            |   |  |   |          |  
|Commitments to extend credit                                              |  |                |         |   |               |   | (5,123   | )              |  |   |           |   |  |   | (3,238   | )
|Letters of credit                                                         |  |                |         |   |               |   | (141     | )              |  |   |           |   |  |   | (92      | )
|Unused lines of credit                                                    |  |                |         |   |               |   | (6,735   | )              |  |   |           |   |  |   | (1,848   | )



NOTE 16  COMMITMENTS AND
CONTINGENCIES



Commitments to originate mortgage loans are legally binding
agreements to lend to the Companys customers and generally expire in ninety days or less. Commitments at June 30, 2004 to originate adjustable-rate loans were approximately $4.9 million. Commitments at June 30, 2004 to originate fixed-rate
loans were approximately $332 with a term of fifteen years or less and interest rates of 4.45% to 7.60%. Commitments at June 30, 2003 and 2002 to originate adjustable-rate loans were approximately $1.1 and $1.1 million, respectively. Commitments at
June 30, 2003 and 2002 to originate fixed-rate loans with terms of fifteen years or less were approximately $494 and $110, respectively. Fixed rates ranged from 5.50% to 6.00% for June 30, 2003 and 7.00% to 7.75% for June 30, 2002.



The Company has entered into an employment agreement with its President and Chief
Executive Officer Anderson L. Smith. The agreement stipulates the terms, duties and compensation and provides remedies for both parties upon certain events occurring. Furthermore, the agreement provides for a performance bonus and deferred
compensation upon CEO Smith attaining age 65.



Upon completion of the Plan of
Conversion (the Plan), a liquidation account was established in an amount equal to the total equity of the Association as of the latest practicable date prior to the Conversion. The liquidation account was established to provide limited
priority claim to the assets of the Association to eligible account holders, as defined in the Plan, who continue to maintain deposits in the Association/Bank after the Conversion. In the unlikely event of a complete liquidation of the
Bank, and only in such event, each eligible account holder and supplemental eligible account holder would receive a liquidation distribution, prior to any payment to the holder of the Banks common stock. This distribution would be based upon
each eligible account holders and supplemental eligible account holders proportionate share of the then total remaining qualifying deposits. At the time of the conversion, the liquidation account, which is an off-balance sheet memorandum
account, amounted to $29.5 million.



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 17  RELATED PARTY TRANSACTIONS



In the ordinary course of business, the Company obtains products and services from directors or affiliates thereof. In the opinion of
management, such transactions are made on substantially the same terms as those prevailing at the time for comparable transactions with unaffiliated persons.



NOTE 18  CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY



Financial information pertaining only to Jefferson Bancshares, Inc. is as follows:



Balance Sheet





|                                                            |  |               |       
|----------------------------------------------------------- |  | ------------- | ------
|                                                            |  | June 30, 2004
|Assets                                                      |  |               |       
|Cash and due from banks                                     |  | $             | 209   
|Investment securities classified as available for sale, net |  |               | 21,647
|Investment in common stock of Jefferson Federal Bank        |  |               | 38,306
|Loan receivable from ESOP                                   |  |               | 6,536 
|Deferred tax asset                                          |  |               | 1,323 
|Other assets                                                |  |               | 432   
|                                                            |  |               |       
|Total assets                                                |  | $             | 68,453
|                                                            |  |               |       
|Liabilities and Stockholders Equity                        |  |               |       
|Accrued expenses                                            |  | $             | 755   
|Stockholders' equity                                        |  |               | 67,698
|                                                            |  |               |       
|Total liabilities and stockholders equity                  |  | $             | 68,453
|                                                            |  |               |       



Statement of Income



|                                                                                            |  |                          |        |  
|------------------------------------------------------------------------------------------- |  | ------------------------ | ------ | -
|                                                                                            |  | June 30, 2004            |       
|                                                                                            | 
|                                                                                            |  | Year Ended June 30, 2004 |       
|Dividends from Jefferson Federal Bank                                                       |  | $                        | 1,006  |  
|Interest on investment securities                                                           |  |                          | 907    |  
|Other income                                                                                |  |                          | 1      |  
|                                                                                            |  |                          |        |  
|Total income                                                                                |  |                          | 1,914  |  
|                                                                                            |  |                          |        |  
|Charitable contribution                                                                     |  |                          | 4,000  |  
|Other operating expenses                                                                    |  |                          | 182    |  
|                                                                                            |  |                          |        |  
|Total operating expenses                                                                    |  |                          | 4,182  |  
|                                                                                            |  |                          |        |  
|(Loss) before income taxes and equity in undistributed net income of Jefferson Federal Bank |  |                          | (2,268 | )
|Income tax (benefit)                                                                        |  |                          | (1,294 | )
|                                                                                            |  |                          |        |  
|                                                                                            |  |                          | (974   | )
|Equity in undistributed net income of Jefferson Federal Bank                                |  |                          | 2,361  |  
|                                                                                            |  |                          |        |  
|Net income                                                                                  |  | $                        | 1,387  |  
|                                                                                            |  |                          |        |  



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 18  CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (CONTINUED)



Statement of Cash Flows



|                                                                                  |  |                         |         |  
|--------------------------------------------------------------------------------- |  | ----------------------- | ------- | -
|                                                                                  |  | Year EndedJune 30, 2004 |        
|Cash flows from operating activities:                                             |  |                         |         |  
|Net income                                                                        |  | $                       | 1,387   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                         |         |  
|Equity in undistributed net income of Jefferson Federal Bank                      |  |                         | (2,361  | )
|Deferred tax benefit                                                              |  |                         | (1,191  | )
|Stock contributed to Charitable Foundation                                        |  |                         | 3,750   |  
|Increase in other assets                                                          |  |                         | (516    | )
|Increase in other liabilities                                                     |  |                         | 82      |  
|                                                                                  |  |                         |         |  
|Net cash provided by operations                                                   |  |                         | 1,151   |  
|                                                                                  |  |                         |         |  
|Cash flows from investing activities:                                             |  |                         |         |  
|Sales and maturities of debt securities                                           |  |                         | 7,095   |  
|Purchase of debt securities                                                       |  |                         | (29,084 | )
|Investment in Jefferson Federal Bank                                              |  |                         | (32,236 | )
|Loan to ESOP                                                                      |  |                         | (6,536  | )
|                                                                                  |  |                         |         |  
|Net cash used for investing activities                                            |  |                         | (60,761 | )
|                                                                                  |  |                         |         |  
|Cash flows from financing activities:                                             |  |                         |         |  
|Proceeds from stock conversion, net                                               |  |                         | 64,472  |  
|Purchase of company stock for incentive plan                                      |  |                         | (3,708  | )
|Dividends paid on common stock                                                    |  |                         | (1,005  | )
|Other                                                                             |  |                         | 60      |  
|                                                                                  |  |                         |         |  
|Net cash provided by financing activities                                         |  |                         | 59,819  |  
|                                                                                  |  |                         |         |  
|Net increase in cash and cash equivalents                                         |  |                         | 209     |  
|Cash and cash equivalents at beginning of year                                    |  |                         |        |  
|                                                                                  |  |                         |         |  
|Cash and cash equivalents at end of year                                          |  | $                       | 209     |  
|                                                                                  |  |                         |         |  



F-27



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##### Table of Contents

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY



Notes to Consolidated Financial Statements

(Dollars in Thousands)



NOTE 19  QUARTERLY FINANCIAL INFORMATION



The following table summarizes selected information regarding the Companys results of operations for the periods indicated (in
thousands except per share data):



|                                                    |  |                    |        |   |                  |   |               |  |              |       |  |   |      
|--------------------------------------------------- |  | ------------------ | ------ | - | ---------------- | - | ------------- |  | ------------ | ----- |  | - | -----
|                                                    |  | Three Months Ended
|                                                    |  | September30, 2003  |        |   | December31, 2003 |   | March 31,2004 |  | June 30,2004
|                                                    |  | (Unaudited)       
|Interest income                                     |  | $                  | 4,142  |   |                  | $ | 4,063         |  | $            | 3,996 |  | $ | 3,866
|Interest expense                                    |  |                    | 1,329  |   |                  |   | 1,264         |  |              | 1,130 |  |   | 1,053
|                                                    |  |                    |        |   |                  |   |               |  |              |       |  |   |      
|Net interest income                                 |  |                    | 2,813  |   |                  |   | 2,799         |  |              | 2,866 |  |   | 2,813
|Provision for loan losses                           |  |                    |       |   |                  |   |              |  |              |      |  |   |     
|                                                    |  |                    |        |   |                  |   |               |  |              |       |  |   |      
|Net interest income after provision for loan losses |  |                    | 2,813  |   |                  |   | 2,799         |  |              | 2,866 |  |   | 2,813
|Noninterest income                                  |  |                    | 234    |   |                  |   | 252           |  |              | 265   |  |   | 316  
|Noninterest expense                                 |  |                    | 5,548  |   |                  |   | 1,514         |  |              | 1,670 |  |   | 1,533
|                                                    |  |                    |        |   |                  |   |               |  |              |       |  |   |      
|Earnings before income taxes                        |  |                    | (2,501 | ) |                  |   | 1,537         |  |              | 1,461 |  |   | 1,596
|Income taxes                                        |  |                    | (910   | ) |                  |   | 571           |  |              | 428   |  |   | 617  
|                                                    |  |                    |        |   |                  |   |               |  |              |       |  |   |      
|Net earnings                                        |  | $                  | (1,591 | ) |                  | $ | 966           |  | $            | 1,033 |  | $ | 979  
|                                                    |  |                    |        |   |                  |   |               |  |              |       |  |   |      
|Earnings per share, basic                           |  | $                  | (0.19  | ) |                  | $ | 0.12          |  | $            | 0.13  |  | $ | 0.13 
|Earnings per share, diluted                         |  | $                  | (0.19  | ) |                  | $ | 0.11          |  | $            | 0.13  |  | $ | 0.13 



|                                                    |  |                    |       |                  |   |               |  |              |       |  |   |      
|--------------------------------------------------- |  | ------------------ | ----- | ---------------- | - | ------------- |  | ------------ | ----- |  | - | -----
|                                                    |  | Three Months Ended
|                                                    |  | September30, 2002  |       | December31, 2002 |   | March 31,2003 |  | June 30,2003
|                                                    |  | (Unaudited)       
|Interest income                                     |  | $                  | 4,577 |                  | $ | 4,367         |  | $            | 4,222 |  | $ | 4,093
|Interest expense                                    |  |                    | 1,847 |                  |   | 1,729         |  |              | 1,495 |  |   | 1,447
|                                                    |  |                    |       |                  |   |               |  |              |       |  |   |      
|Net interest income                                 |  |                    | 2,730 |                  |   | 2,638         |  |              | 2,727 |  |   | 2,646
|Provision for loan losses                           |  |                    | 307   |                  |   | 240           |  |              | 240   |  |   |     
|                                                    |  |                    |       |                  |   |               |  |              |       |  |   |      
|Net interest income after provision for loan losses |  |                    | 2,423 |                  |   | 2,398         |  |              | 2,487 |  |   | 2,646
|Noninterest income                                  |  |                    | 284   |                  |   | 235           |  |              | 242   |  |   | 218  
|Noninterest expense                                 |  |                    | 1,230 |                  |   | 1,304         |  |              | 1,341 |  |   | 1,397
|                                                    |  |                    |       |                  |   |               |  |              |       |  |   |      
|Earnings before income taxes                        |  |                    | 1,477 |                  |   | 1,329         |  |              | 1,388 |  |   | 1,467
|Income taxes                                        |  |                    | 551   |                  |   | 503           |  |              | 377   |  |   | 637  
|                                                    |  |                    |       |                  |   |               |  |              |       |  |   |      
|Net earnings                                        |  | $                  | 926   |                  | $ | 826           |  | $            | 1,011 |  | $ | 830  
|                                                    |  |                    |       |                  |   |               |  |              |       |  |   |      
|Earnings per share, basic                           |  | $                  | 0.49  |                  | $ | 0.44          |  | $            | 0.54  |  | $ | 0.45 
|Earnings per share, diluted                         |  | $                  | 0.49  |                  | $ | 0.44          |  | $            | 0.54  |  | $ | 0.44 



F-28