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|UNITED STATES                     
|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 DECEMBER 31, 2008

o TRANSITION REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIESEXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD

COMMISSION FILE NUMBER 0-50237

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|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|VSB
 Bancorp, Inc.                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                            
|(Exact name of registrant as specified in its charter)                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                            
|New York                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                            
|(State or other jurisdiction of incorporation or organization)                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                            
|11 - 3680128                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                            
|(I. R. S. Employer Identification No.)                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                            
|4142 Hylan Boulevard, Staten Island, New York 10308                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                            
|(Address of principal executive offices)                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                            
|(718) 979-1100                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                            
|Issuers telephone number                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                            
|Common Stock                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                            
|(Title of Class)                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                            
|Indicate by
 check mark whether the registrant (1) filed all reports required to be filed
 by Section 13 or 15(d) of the Securities Exchange Act 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.
 Yesx No o

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 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 x.

Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See the
definition of large accelerated filer, accelerated filer and smaller
reporting company in Rule 12b-2 of the Exchange Act.

Large
Accelerated Filer o   Accelerated Filer o   Non-Accelerated
Filer o   Smaller Reporting Company x

Indicate by
check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Exchange Act): Yes o No x

The aggregate market value
of the voting stock held by non-affiliates of the registrant at June 30, 2008
was $12,301,888. Number of shares of the registrants common stock outstanding
as of March 18, 2009: 1,836,432 shares.

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Documents incorporated by
reference:

Portions of the registrants
definitive proxy statement filed on or about March 27, 2009 into
Part III of this Form 10-K.

Forward-Looking Statements

When
used in this Form 10-K, or in any written or oral statement made by us or our
officers, directors or employees, the words and phrases will result,
expect, will continue, anticipate, estimate, project, or similar
terms are intended to identify forward-looking statements. A variety of
factors could cause our actual results and experiences to differ materially
from the anticipated results or other expectations expressed in any
forward-looking statements. Some of the risks and uncertainties that may affect
our operations, performance, development and results, the interest rate
sensitivity of our assets and liabilities, and the adequacy of our loan loss
allowance, include, but are not limited to:

| |   |                                                                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | deterioration
 in local, regional, national or global economic conditions which could result
 in, among other things, an increase in loan delinquencies, a decrease in
 property values, or a change in the real estate turnover rate;
|
| |  | changes in
 market interest rates or changes in the speed at which market interest rates
 change;                                                                                                                                     
|
| |  | changes in
 laws and regulations affecting the financial service industry;                                                                                                                                                            
|
| |  | changes in
 competition; and                                                                                                                                                                                                          
|
| |  | changes in
 consumer preferences by our customers or the customers of our business
 borrowers.                                                                                                                                        

Please
do not place undue reliance on any forward-looking statement, which speaks only
as of the date made. There are many factors, including those described above,
that could affect our future business activities or financial performance and
could cause our actual future results or circumstances to differ materially
from those we anticipate or project. We do not undertake any obligation to
update any forward-looking statement after it is made.

2

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PART I

Item 1. Description
of Business.

Business of VSB Bancorp, Inc.

VSB Bancorp,
Inc. (referred to using terms such as we, us, or the Company) became the
holding company for Victory State Bank (the Bank), a New York chartered
commercial bank, upon the completion of a reorganization of the Bank into the
holding company form of organization. The reorganization was effective in May
2003. All the outstanding stock of Victory State Bank was exchanged for stock
of VSB Bancorp, Inc. on a three for two basis so that the stockholders of
Victory State Bank became the owners of VSB Bancorp, Inc. and VSB Bancorp, Inc.
owns all the stock of Victory State Bank. The common stock we issued in the
transaction qualifies as exempt securities under Section 3(a)(12) of the
Securities Act of 1933. Our primary business is owning all of the issued and
outstanding stock of the Bank. Our common stock is listed on the NASDAQ Global
Market, effective on August 4, 2008. We continue to trade under the symbol
VSBN.

The main
office of the Company and the Bank is at 4142 Hylan Boulevard, Staten Island,
New York 10308, telephone (718) 979-1100. We maintain an Internet web site at
www.victorystatebank.com.

Victory State Bank

Victory State Bank is a New
York State chartered commercial bank, founded in November 1997. The Bank is
supervised by the New York State Banking Department and the Federal Deposit
Insurance Corporation (FDIC). The Banks principal business has been
and continues to be attracting commercial deposits from primarily the general
public and investing those deposits, together with funds generated from
operations and repayments on existing investments, primarily in loans for
business purposes and investment securities. The Banks revenues are derived
principally from interest on our commercial loan and investment securities
portfolios. The Banks primary sources of funds are deposits and principal and
interest payments on loans and investment securities.

Victory State
Bank serves its primary market of Staten Island, New York through its five
banking offices. The Bank opened its original main office in the Oakwood
section of Staten Island in November 1997 which was closed in February 2007 as
the lease expired at that location; its first branch was opened in the West
Brighton section of Staten Island in June 1999; its second branch in the St.
George section of Staten Island in January 2000; its third branch in the Dongan
Hills section of Staten Island in December 2002 and its fourth branch in the
Rosebank section of Staten Island in April 2006. In February 2007, the Bank
opened its new main office in the Great Kills section of Staten Island. The
Banks deposits are insured by the Federal Deposit Insurance Corporation up to
the maximum amounts permitted by law. Victory State Bank also serves its
customers through its website, www.victorystatebank.com.

Market Area and Competition

Victory State
Bank has been, and continues to be, a community-oriented, state-chartered
commercial bank offering a variety of traditional financial services to meet
the needs of the communities in which it operates. Management considers our
reputation for customer service as its major competitive advantage in
attracting and retaining customers in its market area.

Our primary
market area is concentrated in the neighborhoods surrounding our branches in
the New York City Borough of Staten Island. Management believes that our branch
offices are located in communities that can generally be characterized as
stable, residential neighborhoods of predominantly one- to four-family
residences and middle income families.

From 1990 to 2000,
Staten Islands population grew to 443,728 from 378,977, or a 17% increase.
According to U.S. Census Department estimates, this growth rate has slowed,
with the population estimated to have increased by only an additional 8.5%
through July 1, 2007. The decline in the growth rate has itself accelerated,
with the Census Departments estimated year to year rate of increase generally
declining throughout this decade. There was a modest shift from the 20 to 44
year age group to the 45 to 64 year age group during the decade of the 1990s.
As a percentage of population, the 45 to 64 year age group increased from 19.8%
to 23.4% during the decade. The Census Department estimates that this trend
continued through at least 2006, when the 45 to 64 year age group increased to
26.3% of the total population. The largest age group continued to be the 20 to
44 age group, at 35.2% of total population in 2006, down from 37.0% in 2000.

3

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However, the
population news is not all negative when compared to the rest of New York
State. Most notably, Staten Island fairs the highest among all 62 New York
Counties when natural internal population growth is excluded and migration into
the county is estimated. The U.S. Census estimates that net migration into the
county was the highest in the entire state. Only 13 counties had an estimated
net migration into the county during the period from the end of the 2000 census
through July 1, 2007, and Staten Island was the best of those.

Median
household income increased to $55,039 from $50,064 during the decade of the
90s. Per capita income in 1999 was $23,905 in Staten Island, slightly higher
than $23,389, the per capita income of New York State. One third of the
households in Staten Island had household income of more than $75,000 in 1999.
These income levels compare favorably with the national household median of
$41,994 and the national per capita median of $21,587. The Census Department
has not published comparable data for recent years, but management believes
that median household income continues to be strong and that these income
levels in Staten Island provide satisfactory support for personal home
ownership, in turn supporting the home building industry, which is a major
industry focus for Victory State Bank. However, recent economic disruption will
have an adverse effect on local income levels because of increased
unemployment, a reduction in wage increases, and possible wage reductions for
employed persons. Although according to the United States Bureau of Labor
Statistics, the unemployment rate in Staten Island and the New York metro area
is below the national average, the unemployment rate has increased
substantially in the past year and may increase in the future as financial
service firms report continuing layoffs.

Until the recent
decline in the residential housing market, the median sales price of existing
single family homes increased steadily from 2000 through 2006. According to the
New York State Association of Realtors, the median price increased from
$211,000 to $425,000 during that period. According to a report by the Center
for an Urban Future, this means that the cost of a single family home on Staten
Island is now out of reach to many middle-class families. As the population
grew during the 1990s, total housing units increased as well, to 163,993 in
2000, as compared to 139,726 in 1990, an increase of 17.4%. However, perhaps
confirming the reduction in affordability to the middle class, the growth in
housing units has slowed, with an estimate 177,368 housing units at June 30,
2006, an increase of 8.2% since April 1, 2000. This slowing growth presents
challenges to management because of our focus on the home building industry and
related sectors of the local economy.

Declines in
the residential housing market in the past year or two create one potential
problem faced by Staten Island, its residents and its businesses. According to
Zillow.com, a real estate information service, the estimated median home value
has declined 5.6% in the past year. The Center for an Urban Future report
already noted an increase in foreclosures on Staten Island during 2006 which
exceeded the increase in the rest of New York City. The decline in the price of
homes and the economic downturn may accelerate this increase in foreclosed
properties, which could exacerbate the decline in real estate values.

The New York
City metropolitan area has a high density of financial institutions, many of
which are significantly larger and have greater financial resources than we
have, and all of which are our competitors to varying degrees. Our competition
for loans comes principally from commercial banks, savings banks and insurance
companies. Our most direct competition for deposits has come from commercial
banks and savings banks. In addition, we face increasing competition for
deposits from non-bank institutions such as brokerage firms and insurance
companies in such areas as short-term money market funds, corporate and
government securities funds, mutual funds and annuities.

4

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RISK FACTORS

Bank lending is an inherently risky business.
A substantial portion of our assets are invested in loans, and loans
necessarily present many risks. We must first rely on our borrowers to repay
their loans, and if they are unable to do so, we must rely on the value of the
collateral, if any, for the loan. Changing business conditions, increases in
unemployment, personal problems that a borrower may experience, changes in the
regulations that apply to a borrowers business, changes in the political
climate or in public policy, and many other factors outside our control, could
adversely affect the ability of our borrowers to repay their loans or the value
of the collateral we have received. Although we seek to reduce these risks
through underwriting procedures that we believe are prudent, it is impossible
for us to completely eliminate the risks which arise from making loans except
by eliminating our lending operations.

The current turmoil
in the economy in general and among financial institutions in particular could
adversely affect our customers and thus have an indirect adverse effect on us.The
economy in the United States, including the economy in Staten Island, is in a
recession and there is substantial stress on many financial institutions and
financial products. The federal government has intervened by making hundreds of
billions of dollars in capital contributions to the banking industry. We draw a
substantial portion of our customer base from local businesses, especially
those in the building trades and related industries. Our customers are already
being adversely affected by the economic downturn, and if the recession
continues, it will become more difficult for us to conduct prudent and
profitable business in our community.

Making
permanent residential mortgage loans is not a material part of our business,
and our investments in mortgage-backed securities and collateralized mortgage
obligations have been made with a view towards avoiding the types of securities
that are backed by low quality mortgage-related assets. However, one of the
primary focuses of our local business is receiving deposits from, and making
loans to, businesses involved in the construction and building trades industry
on Staten Island. Construction loans represented a significant component of our
loan portfolio, reaching 39.8% of total loans at year end 2005. As we monitored
the economy and the strength of the local construction industry, we elected to
reduce our portfolio of construction loans. However, developers and builders
provide not only a source of loans, but they also provide us with deposits and
other business. If the weakness in the economy continues or worsens, then that
could have a substantial adverse effect on our customers and potential
customers, making it more difficult for us to find satisfactory loan
opportunities and low-cost deposits. This could compel us to invest in lower
yielding securities instead of higher-yielding loans and could also reduce low
cost funding sources such as checking accounts and require that we replace them
with higher cost deposits such as time deposits. Either or both of those shifts
could reduce our net income.

Fluctuations in interest rates could have an
adverse affect on our profitability.Our principal
source of income is the difference between the interest income we earn on
interest-earning assets, such as loans and securities, and our cost of funds,
principally interest paid on deposits. These rates of interest change from time
to time, depending upon a number of factors, including general market interest
rates. However, the frequency of the changes varies among different types of
assets and liabilities. For example, for a five-year loan with an interest rate
based upon the prime rate, the interest rate may change every time the prime
rate changes. In contrast, the rate of interest we pay on a five-year
certificate of deposit adjusts only every five years, based upon changes in
market interest rates.

In general,
the interest rates we pay on deposits adjust more slowly than the interest
rates we earn on loans because the largest part of our loan portfolio consist
of loans with interest rates that fluctuate based upon the prime rate. In
contrast, although many of our deposit categories have interest rates that
could adjust immediately, such as interest checking accounts and savings
accounts, changes in the interest rates on those accounts are at our discretion
and tend to occur more slowly. As a result, recent declines in market interest
rates have had an adverse effect on our net income because the yields we earn
on our loans have declined more rapidly than our cost of funds. Further
declines in market interest rates could have a further adverse effect on our
net income, while increases in market interest rates could increase our net
interest income because our cost of deposits would probably increase more
slowly than the yields on our loans. However, customer preferences and
competitive pressures may negate this positive effect because customers may
choose to move funds into higher-earning deposit types as higher interest rates
make them more attractive, or competitors offer premium rates to attract
deposits. We also have a substantial portfolio of investment securities with
fixed rates of interest, most of which are mortgage-backed securities with an
estimated average life of not more than 5 years.

5

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There is only a very limited trading market
for our common stock. Our common stock is listed on the NASDAQ Global Market, which listing
was effective on August 4, 2008. Our common stock was previously traded on the
NASDAQ Capital Market. We continue to trade under the symbol VSBN. We applied
for the listing on the Global Market in the hope that it would increase the
trading market in our stock and make it easier for individuals to buy and sell
our stock. However, our stock does not trade every day and the average
daily trading volume is limited. During the twelve months ended March 18, 2009,
there were trades reported on only 82 out of 252 trading days, or slightly more
than one out of every three trading days, and our average daily trading volume
during that period was 1,250 shares for all trading days and 3,840 shares per
day for the 82 days on which trades occurred. This data is comparable to the
trading volume data for the previous year when we were not quoted on the NASDAQ
Capital Market. We currently have approximately 151 stockholders of record and
we believe based upon reports we have received from broker/dealers, that there
are approximately an additional 250 stockholders who own their shares in street
name.

The
geographic concentration of our loans increases the risk that adverse economic
conditions could affect our net income.Substantially all of our loans are mortgage loans
on property located in Staten Island, New York, or loans to residents of or
businesses on Staten Island. Staten Island has experienced an economic down
turn in recent years. In addition, due to the importance of the home building
trade on Staten Island, the recent adverse conditions in the residential real
estate market has had an additional negative impact on many local businesses
that make up our core customer base. A continued economic slow-down or decline
in the local economy could have an adverse effect on us for a number of
reasons. Adverse economic conditions could hurt the ability of our borrowers to
repay their loans. If real estate values decline, reductions in the value of
real estate collateral could make it more difficult for us to recover the full
amount due on loans which go into default. Furthermore, economic difficulties
can also increase deposit outflows as customers must use savings to pay bills.
This could increase our cost of funds because of the need to replace the
deposit outflow. All of these factors might combine to reduce significantly our
net income.

Adverse
Financial Results of Other Financial Institutions Could Adversely Affect Our
Net Income.In the
past year, there have been many failures and near-failures among financial
institutions. The number of FDIC-insured banks that have failed has increased,
and the FDIC insurance fund reserve ratio, representing the ratio of the fund
to the level of insured deposits, has declined due to losses caused by bank
failures. As a result, the FDIC has increased its deposit insurance premiums on
remaining institutions, including well-capitalized institutions like Victory
State Bank, in order to replenish the insurance fund. If bank failures continue
to occur, and more so if the level of failures increases, the FDIC insurance
fund will further decline, and the FDIC is likely to continue to impose higher
premiums on healthy banks. Thus, despite the prudent steps we may take to avoid
the mistakes made by other banks, our costs of operations may increase as a
result of those mistakes by others.

Our FDIC insurance premium was $122,869 in 2008. In 2009, the FDIC has
already announced an increase in deposit insurance premiums so institutions
like our Bank, even though we are in the lowest regulatory risk category, will
be subject to an assessment rate between seven (7) and twelve (12) basis points
per annum, which is higher than the assessment rate in 2008 of from five (5) to
seven (7) basis points. Additionally, the FDIC has proposed a special 20 basis
point assessment, payable on September 30, 2009, in order to continue the
process of replenishing the insurance fund, and the FDIC has also stated that
they are considering an additional 10 basis point special assessment at each
quarter end thereafter, depending on the viability of the insurance fund. These
assessments will significantly increase our deposit insurance expense 2009. We
estimate that if our deposits remain constant, our FDIC insurance assessment in
2009 will be at least $260,000 and, if the 20 basis point special assessment is
imposed, that will increase to $600,000.

Changes
in the federal or state regulation of financial institutions could have an
adverse effect on future operations.Federal and New York State banking laws and
regulations exert substantial control over our operations. Federal and state
regulatory authorities have extensive discretion in connection with their
supervision of Victory State Bank, such as the right to impose restrictions on
operations and the insistence that we increase our allowance for loan losses.
Furthermore, federal and state laws affecting banks are constantly being
revised, often imposing new restrictions or increasing competitive pressures
through de-regulation. Any change in the regulatory structure or statutes or
regulations applicable to banks, bank holding companies, or their competitors,
whether by the Congress, the FDIC, the Federal Reserve System, the New York
State legislature, the New York State Banking Department or any other
regulator, could have a material impact on our operations and profitability.

6

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Similarly, there have recently been a number of proposals at both the
state and the federal level, to impose additional requirements on residential
mortgage lenders and other entities in the residential real estate business. We
are not a residential mortgage lender and we do not expect that these
proposals, if adopted, will have a direct negative effect on us. However, the
proposals could reduce residential development, increase the cost of housing,
and restrict the ability of small local businesses in that sector to compete with
larger companies with greater resources. That could have an adverse effect on
our customer base. Furthermore, proposals to permit what are commonly known as
cram downs in bankruptcies involving residential mortgage loans could have a
direct adverse effect on the value of the collateral for existing residential
mortgage loans, and thus an indirect effect on mortgage-backed securities in
which we invest.

We operate in an
extremely competitive environment.We operate in one
of the most competitive environments for financial products in the world. Many
of the worlds largest financial institutions have offices in our local
communities, and they have far greater financial resources than we have. We
seek to distinguish ourselves from those institutions by providing personalized
service and providing the same level of care to small community based
businesses that only Fortune 500 companies can obtain from the largest banks.

The loss of key personnel could
impair our future success.Our future success depends in part on the service of our executive
officer, other key management officers, as well as our staff, and our ability
to continue to attract, motivate, and retain additional highly qualified
employees. The loss of one or more of our key personnel or our inability to
timely recruit replacements for such personnel, or otherwise attract, motivate,
or retain qualified personnel could have an adverse effect on our business,
operating results and financial condition.

Lending
Activities

Loan
Portfolio Composition.Our loan portfolio consists primarily of commercial mortgage loans and
unsecured commercial loans. At December 31, 2008, we had total unsecured
commercial loans outstanding of $9,558,296, or 14.4% of total loans, and
commercial real estate loans of $39,918,879, or 60.1% of total loans. There
were $11,896,432 of construction loans secured by real estate, $10,996,432 of
which were construction loans to businesses for the construction of either
commercial property or residential property for sale, representing 16.5% of
total loans. Other loans in our portfolio principally included commercial loans
secured by assets other than real estate totaling $1,177,796 or 1.8% of total
loans at December 31, 2008; residential mortgage loans of $2,548,159, or 3.8%
of total loans and consumer non-mortgage loans of $599,293 or 0.9% of total loans. Although
we generally do not make traditional permanent residential mortgage loans, we
occasionally make residential mortgage loans to the principals of commercial
customers. For the year ended December 31, 2008, approximately $51,560,377, or
77.6%, of loans for business purposes had adjustable interest rates based on
the prime rate of interest.

The following
table sets forth the composition of our loan portfolio in dollar amounts and in
percentages at the dates indicated.

7

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|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|--------------------------------------------------- |  | --------------- | ---------- | ---------- | ----- | ------ | - | ---------- |  | ------ | - | ---------- | ---------- | ------ | ----- | ---------- | - | ---------- |  | ---------- | - | - | ---------- |  | ----- | -
|                                                    |  | At December 31, |           
|                                                    |  |                 |           
|                                                    |  | 2008            |            | 2007       |       | 2006   |   | 2005       |  | 2004   |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |  
|                                                    |  | Amount          |            | %
of Total |       | Amount |   | %
of Total |  | Amount |   | %
of Total |            | Amount |       | % of
Total |   | Amount     |  | % of
Total |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Commercial loans:                                   |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Commercial secured                                  |  | $               | 1,177,796  |            | 1.8   | %      | $ | 1,171,152  |  | 1.9    | % | $          | 1,231,880  |        | 1.8   | %          | $ | 1,584,484  |  | 2.1        | % | $ | 1,572,824  |  | 2.3   | %
|Commercial unsecured                                |  |                 | 9,558,296  |            | 14.4  |        |   | 10,981,044 |  | 17.5   |   |            | 10,882,002 |        | 16.3  |            |   | 11,078,101 |  | 14.9       |   |   | 9,620,243  |  | 14.1  |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Total commercial loans                              |  |                 | 10,736,092 |            | 16.2  |        |   | 12,152,196 |  | 19.4   |   |            | 12,113,882 |        | 18.1  |            |   | 12,662,585 |  | 17.0       |   |   | 11,193,067 |  | 16.4  |  
|Real Estate loans:                                  |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Commercial                                          |  |                 | 39,918,879 |            | 60.1  |        |   | 31,607,039 |  | 50.6   |   |            | 33,215,627 |        | 49.9  |            |   | 29,794,108 |  | 40.1       |   |   | 31,741,069 |  | 46.5  |  
|One-to-four family                                  |  |                 | 2,548,159  |            | 3.8   |        |   | 2,314,716  |  | 3.7    |   |            | 165,801    |        | 0.2   |            |   | 298,779    |  | 0.4        |   |   | 1,112,032  |  | 1.6   |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Total real estate loans                             |  |                 | 42,467,038 |            | 63.9  |        |   | 33,921,755 |  | 54.3   |   |            | 33,381,428 |        | 50.1  |            |   | 30,092,887 |  | 40.5       |   |   | 32,853,101 |  | 48.1  |  
|Construction loans:                                 |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Commercial                                          |  |                 | 10,996,432 |            | 16.5  |        |   | 13,585,698 |  | 21.7   |   |            | 17,552,797 |        | 26.4  |            |   | 26,623,846 |  | 35.8       |   |   | 19,893,858 |  | 29.1  |  
|Owner occupied one-to-four family                   |  |                 | 900,000    |            | 1.4   |        |   | 1,523,895  |  | 2.4    |   |            | 1,825,000  |        | 2.7   |            |   | 2,987,500  |  | 4.0        |   |   | 2,960,000  |  | 4.3   |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Total construction loans                            |  |                 | 11,896,432 |            | 17.9  |        |   | 15,109,593 |  | 24.1   |   |            | 19,377,797 |        | 29.1  |            |   | 29,611,346 |  | 39.8       |   |   | 22,853,858 |  | 33.4  |  
|Other loans:                                        |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Consumer loans                                      |  |                 | 599,293    |            | 0.9   |        |   | 566,356    |  | 0.9    |   |            | 826,528    |        | 1.2   |            |   | 1,477,366  |  | 2.0        |   |   | 1,048,448  |  | 1.5   |  
|Other loans                                         |  |                 | 757,481    |            | 1.1   |        |   | 827,122    |  | 1.3    |   |            | 974,278    |        | 1.5   |            |   | 486,009    |  | 0.7        |   |   | 435,837    |  | 0.6   |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Total other loans                                   |  |                 | 1,356,774  |            | 2.0   |        |   | 1,393,478  |  | 2.2    |   |            | 1,800,806  |        | 2.7   |            |   | 1,963,375  |  | 2.7        |   |   | 1,484,285  |  | 2.1   |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Total loans                                         |  |                 | 66,456,336 |            | 100.0 | %      |   | 62,577,022 |  | 100.0  | % |            | 66,673,913 |        | 100.0 | %          |   | 74,330,193 |  | 100.0      | % |   | 68,384,311 |  | 100.0 | %
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Less:                                               |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Unearned discounts, net and deferred loan fees,
net |  |                 | 209,684    |            |       |        |   | 203,944    |  |        |   |            | 263,236    |        |       |            |   | 386,088    |  |            |   |   | 337,426    |  |       |  
|Allowance for loan losses                           |  |                 | 987,876    |            |       |        |   | 927,161    |  |        |   |            | 1,128,824  |        |       |            |   | 1,153,298  |  |            |   |   | 1,299,520  |  |       |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  
|Loans, net                                          |  | $               | 65,258,776 |            |       |        | $ | 61,445,917 |  |        |   | $          | 65,281,853 |        |       |            | $ | 72,790,807 |  |            |   | $ | 66,747,365 |  |       |  
|                                                    |  |                 |            |            |       |        |   |            |  |        |   |            |            |        |       |            |   |            |  |            |   |   |            |  |       |  

The following table sets
forth our loan originations and principal repayments for the periods indicated.
We did not purchase or sell any loans in 2008, 2007 or 2006.

|                               |  |                              |             |                              |   |                              |   |   |             |  
|------------------------------ |  | ---------------------------- | ----------- | ---------------------------- | - | ---------------------------- | - | - | ----------- | -
|                               |  | Year Ended
December 31, 2008 |             | Year Ended
December 31, 2007 |   | Year Ended
December 31, 2006 |  
|                               |  |                              |             |                              |   |                              |  
|                              
|Commercial Loans (gross):      |  |                              |             |                              |   |                              |   |   |             |  
|At beginning of period         |  | $                            | 12,152,196  |                              | $ | 12,113,882                   |   | $ | 12,662,585  |  
|Commercial loans originated:   |  |                              |             |                              |   |                              |   |   |             |  
|Secured                        |  |                              | 1,841,943   |                              |   | 857,106                      |   |   | 997,696     |  
|Unsecured                      |  |                              | 30,451,244  |                              |   | 66,749,010                   |   |   | 65,961,375  |  
|                               |  |                              |             |                              |   |                              |   |   |             |  
|Total commercial loans         |  |                              | 32,293,187  |                              |   | 67,606,116                   |   |   | 66,959,071  |  
|Principal repayments           |  |                              | (33,709,291 | )                            |   | (67,567,802                  | ) |   | (67,507,774 | )
|                               |  |                              |             |                              |   |                              |   |   |             |  
|At end of period               |  | $                            | 10,736,092  |                              | $ | 12,152,196                   |   | $ | 12,113,882  |  
|                               |  |                              |             |                              |   |                              |   |   |             |  
|Real
 Estate loans:            |  |                              |             |                              |   |                              |   |   |             |  
|At beginning of period         |  | $                            | 33,921,755  |                              | $ | 33,381,428                   |   | $ | 30,092,887  |  
|Real estate loans
 originated: |  |                              |             |                              |   |                              |   |   |             |  
|Commercial                     |  |                              | 12,217,500  |                              |   | 7,735,374                    |   |   | 17,983,000  |  
|One-to-four family             |  |                              | 4,180,000   |                              |   | 2,200,000                    |   |   | 365,000     |  
|                               |  |                              |             |                              |   |                              |   |   |             |  
|Total real estate loans        |  |                              | 16,397,500  |                              |   | 9,935,374                    |   |   | 18,348,000  |  
|Principal repayments           |  |                              | (7,852,217  | )                            |   | (9,395,047                   | ) |   | (15,059,459 | )
|                               |  |                              |             |                              |   |                              |   |   |             |  
|At end of period               |  | $                            | 42,467,038  |                              | $ | 33,921,755                   |   | $ | 33,381,428  |  
|                               |  |                              |             |                              |   |                              |   |   |             |  
|Construction
 loans            |  |                              |             |                              |   |                              |   |   |             |  
|At beginning of period         |  | $                            | 15,109,593  |                              | $ | 19,377,797                   |   | $ | 29,611,346  |  
|Construction loans originated  |  |                              | 8,422,000   |                              |   | 17,280,000                   |   |   | 9,940,000   |  
|Principal repayments           |  |                              | (11,635,161 | )                            |   | (21,548,204                  | ) |   | (20,173,549 | )
|                               |  |                              |             |                              |   |                              |   |   |             |  
|At end of period               |  | $                            | 11,896,432  |                              | $ | 15,109,593                   |   | $ | 19,377,797  |  
|                               |  |                              |             |                              |   |                              |   |   |             |  
|Other
 loans (gross):          |  |                              |             |                              |   |                              |   |   |             |  
|At beginning of period         |  | $                            | 1,393,478   |                              | $ | 1,800,806                    |   | $ | 1,963,375   |  
|Other loans originated         |  |                              | 769,067     |                              |   | 717,098                      |   |   | 1,251,666   |  
|Principal repayments           |  |                              | (805,771    | )                            |   | (1,124,426                   | ) |   | (1,414,235  | )
|                               |  |                              |             |                              |   |                              |   |   |             |  
|At end of period               |  | $                            | 1,356,774   |                              | $ | 1,393,478                    |   | $ | 1,800,806   |  
|                               |  |                              |             |                              |   |                              |   |   |             |  

8

---



Loan Maturity. The following table shows the contractual
maturity of our loans at December 31, 2008. As we have decreased construction
loans as a percentage of our loan portfolio and increased other real estate
mortgage loans, we have increased the average contractual maturity of our loan
portfolio. However, to limit interest rate risk, we have continued to
concentrate our efforts principally on the origination of loans with adjustable
interest rates.

|                          |  |                      |           |                    |   |              |  |             |            |             |   |            |  |   |           |  |   |            | 
|------------------------- |  | -------------------- | --------- | ------------------ | - | ------------ |  | ----------- | ---------- | ----------- | - | ---------- |  | - | --------- |  | - | ---------- | 
|                          |  | At December 31, 2008 |          
|                          |  |                      |          
|                          |  | Commercial
Unsecured |           | Commercial
Secured |   | Construction |  | Real Estate |            | Other
Loans |   | Total      | 
|                          |  |                      |           |                    |   |              |  |             |            |             |   |            | 
|                          |  |                      |           |                    |   |              |  |             |            |             |   |            |  |   |           |  |   |            | 
|Amounts due:              |  |                      |           |                    |   |              |  |             |            |             |   |            |  |   |           |  |   |            | 
|Within one year           |  | $                    | 5,714,776 |                    | $ | 798,596      |  | $           | 7,328,932  |             | $ | 9,293,526  |  | $ | 1,017,616 |  | $ | 24,153,446 | 
|After one year:           |  |                      |           |                    |   |              |  |             |            |             |   |            |  |   |           |  |   |            | 
|One to five years         |  |                      | 3,843,520 |                    |   | 379,200      |  |             | 4,567,500  |             |   | 8,739,115  |  |   | 339,158   |  |   | 17,868,493 | 
|After five years          |  |                      |          |                    |   |             |  |             |           |             |   | 24,434,397 |  |   |          |  |   | 24,434,397 | 
|                          |  |                      |           |                    |   |              |  |             |            |             |   |            |  |   |           |  |   |            | 
|Total amount due          |  |                      | 9,558,296 |                    |   | 1,177,796    |  |             | 11,896,432 |             |   | 42,467,038 |  |   | 1,356,774 |  |   | 66,456,336 | 
|                          |  |                      |           |                    |   |              |  |             |            |             |   |            |  |   |           |  |   |            | 
|Less:                     |  |                      |           |                    |   |              |  |             |            |             |   |            |  |   |           |  |   |            | 
|Unearned fees             |  |                      |          |                    |   |             |  |             | 54,816     |             |   | 154,868    |  |   |          |  |   | 209,684    | 
|Allowance for loan losses |  |                      | 372,803   |                    |   | 7,451        |  |             | 100,737    |             |   | 475,211    |  |   | 31,674    |  |   | 987,876    | 
|                          |  |                      |           |                    |   |              |  |             |            |             |   |            |  |   |           |  |   |            | 
|Loans, net                |  | $                    | 9,185,493 |                    | $ | 1,170,345    |  | $           | 11,740,879 |             | $ | 41,836,959 |  | $ | 1,325,100 |  | $ | 65,258,776 | 
|                          |  |                      |           |                    |   |              |  |             |            |             |   |            |  |   |           |  |   |            | 

The following table sets
forth at December 31, 2008, the dollar amount of all loans, due after December
31, 2009, and whether such loans have fixed or variable interest rates.

|                           |  |                             |           |          |   |            |  |   |            | 
|-------------------------- |  | --------------------------- | --------- | -------- | - | ---------- |  | - | ---------- | 
|                           |  | Due After December 31, 2009 |          
|                           |  |                             |          
|                           |  | Fixed                       |           | Variable |   | Total      | 
|                           |  |                             |           |          |   |            | 
|                           |  |                             |           |          |   |            | 
|Commercial Business Loans: |  |                             |           |          |   |            |  |   |            | 
|Unsecured                  |  | $                           | 182,575   |          | $ | 3,660,945  |  | $ | 3,843,520  | 
|Secured                    |  |                             | 137,701   |          |   | 241,499    |  |   | 379,200    | 
|Real Estate                |  |                             |           |          |   |            |  |   |            | 
|Commercial                 |  |                             | 2,010,010 |          |   | 30,815,343 |  |   | 32,825,353 | 
|One-to-four                |  |                             | 348,159   |          |   |           |  |   | 348,159    | 
|Construction               |  |                             | 900,000   |          |   | 3,667,500  |  |   | 4,567,500  | 
|Other loans                |  |                             | 339,158   |          |   |           |  |   | 339,158    | 
|                           |  |                             |           |          |   |            |  |   |            | 
|Total loans                |  | $                           | 3,917,603 |          | $ | 38,385,287 |  | $ | 42,302,890 | 
|                           |  |                             |           |          |   |            |  |   |            | 

Commercial Business Lending. We originate commercial business loans
directly to the professional and business community in our market area. We
target small to medium sized business, and professionals such as lawyers,
doctors and accountants. Applications for commercial business loans are
obtained primarily from the efforts of our directors and senior management, who
have extensive contacts in the local business community, or from branch
referrals. As of December 31, 2008, commercial business loans totaled
$10,736,092 or 16.2% of total loans.

Commercial business loans we
originate generally have terms of five years or less and have adjustable
interest rates tied to the Wall Street Journal Prime Rate plus a margin. Most
of our commercial business loans have terms of less than one year and one of
the challenges facing management is the constant effort to originate commercial
business loans as existing loans are repaid. Such loans may be secured or
unsecured. Secured commercial business loans can be collateralized by
receivables, inventory and other assets. All these loans are either loans to
individuals for which they have personal liability or loans to entities backed
by the personal guarantee of principals of the borrower. The loans generally
have shorter maturities and higher yields than real estate mortgage loans.
Management has extensive experience in originating commercial business loans
within our marketplace.

9

---



Commercial
business loans generally carry the greatest credit risks of the loans in our
portfolio because repayment is more dependent on the success of the business
operations of the borrower. Some of these loans are unsecured and those that
are secured frequently have collateral that rapidly depreciates or is difficult
to control in the event of a default.

Commercial Real Estate Lending.
We originate commercial real estate loans that are generally secured by
properties used for business purposes such as retail stores, other mixed-use
(business and residential) properties, restaurants, light industrial and small
office buildings located in our primary market area. Our commercial real estate
loans are generally made in amounts up to 70% of the appraised value of the
property. These loans are most commonly made with terms up to five years with
interest rates that adjust to 100 or 150 basis points above the floating prime
rate. A significant portion of these loans are subject to an interest rate
floor ranging between 7.00% and 8.00%. Our underwriting standards consider the
collateral of the borrower, the net operating income of the property and the
borrowers expertise, credit history and profitability. We require personal
guarantees from the borrower or the principals of the borrowing entity. At
December 31, 2008, our commercial real estate loans totaled $42,467,038, or
63.9% of total loans.

Loans secured
by commercial real estate are generally larger and have traditionally been
considered to involve greater risks than one-to-four family residential
mortgage loans, but generally lesser risks than commercial business loans.
Because payments on loans secured by commercial real estate properties are
often dependent on the successful operation and management of the properties,
repayment of such loans may be subject to adverse conditions in the real estate
market or the economy, to a greater extent than other types of loans. We seek
to minimize these risks through our lending policies and underwriting
standards, which restrict new originations of such loans to our primary lending
area and qualify such loans on the basis of the propertys income stream,
collateral value and debt service ratio.

Construction Lending.
Our construction loans primarily have been made to builders and developers to
finance the construction of one- to four-family residential properties and, to
a lesser extent, multi-family residential real estate properties. Our policies
provide that construction loans may be made in amounts up to the lesser of 80%
of the total hard and soft costs of the project or Victory State Banks loans
to-one borrower limitation. We generally require personal guarantees.
Construction loans generally are made with prime-based interest rates with
terms up to 18 months. Loan proceeds are disbursed in increments as
construction progresses and as inspections warrant. At December 31, 2008, our
construction loans totaled $11,896,432 or 17.9% of total loans. This represents
a reduction of our construction loan portfolio over the past three years as
economic conditions in the construction industry combined to cause us to be
more cautious in originating these loans while also reducing the number of
satisfactory loan opportunities available to us.

Construction
loans on non-owner occupied real estate generally carry greater credit risks
than permanent mortgage loans on comparable completed properties because their
repayment is more dependent on the borrowers ability to sell or rent units
under construction and the general as well as local economic conditions.
Because payments on construction loans are often dependent on the successful
completion of construction project and the management of the project, repayment
of such loans may be subject to adverse conditions in the real estate market or
the economy, to a greater extent than other types of loans.

Loan Approval Procedures and Authority.
All unsecured loans in excess of $250,000 and all secured loans over $400,000,
are reviewed and approved by the Loan Committee, which consists of seven
directors of Victory State Bank, prior to commitment. Smaller loans may be
approved by underwriters designated by the Banks Chief Executive Officer.
Consumer loans not secured by real estate and unsecured consumer loans,
depending on the amount of the loan and the loan to value ratio, where
applicable, require the approval of the Banks Chief Lending Officer and/or
Chief Executive Officer.

Upon receipt
of a completed loan application from a prospective borrower, we order a credit
report and we verify other information. If necessary, we request additional
financial information. An independent appraiser we designate performs an
appraisal of the real estate intended to secure the proposed loan. The Board of
Victory State Bank annually approves the independent appraisers and approves
the Banks appraisal policy. It is our policy to obtain title insurance on all
real estate first mortgage loans and on substantially all subordinate mortgage
loans. Borrowers must also obtain hazard insurance prior to closing. Some
borrowers are required to make monthly escrow deposits which we then use to pay
items such as real estate taxes.

10

---



Delinquencies and Classified Assets

Delinquent Loans.
Our collection procedures for mortgage loans include sending a past due notice
at 15 days and a late notice after payment is 30 days past due. In the event
that payment is not received after the late notice, letters are sent or phone
calls are made to the borrower. We attempt to obtain full payment or work out a
repayment schedule with the borrower to avoid foreclosure. Generally, we
authorize foreclosure proceedings when a loan is over 90 days delinquent. We
record property acquired in foreclosure as real estate owned at the lower of
its appraised value less costs to dispose, or cost. We cease to accrue interest
on all loans 90 days past due and reverse all accrued but unpaid interest when
the loan becomes non-accrual. We continue to accrue interest on construction
loans that are 90 days past the maturity date of the loan if we expect the loan
to be paid in full in the next 60 days and all interest is paid up to date.

The collection
procedures for non-mortgage other loans generally include telephone calls to
the borrower after ten days of the delinquency and late notices at 15 and 25
days past due. Letters and telephone calls generally continue until the matter
is referred to a collection attorney or resolved. After the loan is 90 days
past due, the loan is referred to counsel and is written-off.

Classified Assets.
Federal regulations and our Loan Review and Risk Rating Policy provide for the
classification of loans and other assets we consider to be of lesser quality as
Substandard, Doubtful or Loss assets. An asset is considered
Substandard if it is inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any.
Substandard assets include those characterized by the distinct possibility
that the insured institution will sustain some loss if the deficiencies are not
corrected. Assets classified as Doubtful have all of the weaknesses inherent
in those classified Substandard with the added characteristic that the
weaknesses present make collection or liquidation in full, on the basis of
currently existing facts, conditions, and values, highly questionable and
improbable. Assets classified as Loss are those considered uncollectible
and of such little value that their continuance as assets without the
establishment of a specific loss reserve is not warranted. Assets which do not
currently expose us to sufficient risk to warrant classification but which
possess weaknesses are designated Special Mention by management. At December
31, 2008, we had twenty three (23) loans, in the aggregate amount of
$4,402,731, classified as special mention. We had eighteen (18) loans, in the
aggregate amount of $3,993,240, classified as substandard, nine of which, in
the aggregate amount of $3,133,193, are secured by real estate. The Bank is
actively collecting the substandard loans and expects to collect substantially
all the amounts due. We had one (1) loan, in the amount of $7,187, classified
as doubtful, and no loans classified as loss as of December 31, 2008.

When we
classify an asset as Substandard or Doubtful, we provide, as part of our
general allowance for loan losses, an amount management deems prudent to
recognize the risks pertaining to the asset. A general allowance represents a
loss allowance which has been established to recognize the inherent risk
associated with lending activities, but which, unlike a specific allowance, has
not been allocated to particular problem assets. When we classify an asset as
Loss, we either establish a specific allowance for losses equal to 100% of
the amount of the asset or charge off that amount.

Victory State
Banks Loan Review Officer and Board of Directors regularly review problem
loans and review all classified assets on a quarterly basis. We believe our
policies are consistent with the regulatory requirements regarding classified
assets. Our determination as to the classification of our assets and the amount
of our valuation allowances is subject to review by the New York State Banking
Department and the FDIC, which can order the establishment of additional
general or specific loss allowances.

11

---



The following
table sets forth delinquencies in our loan portfolio as of the dates indicated:

|                                |  |                      |   |                 |   |         |   |           |    |  |   |           |  
|------------------------------- |  | -------------------- | - | --------------- | - | ------- | - | --------- | -- |  | - | --------- | -
|                                |  | At December 31, 2008 |  
|                                |  |                      |  
|                                |  | 60-89 Days           |   | 90 Days or more |  
|                                |  |                      |   |                 |  
|                                |  | Number               |   | Principal       |   | Number  |   | Principal |   
|                                |  |                      |   |                 |   |         |   |           |   
|Commercial real estate          |  |                      | 2 |                 | $ | 207,047 |   |           | 5  |  | $ | 1,453,846 |  
|Commercial construction         |  |                      |  |                 |   |        |   |           | 2  |  |   | 480,000   |  
|Commercial unsecured            |  |                      |  |                 |   |        |   |           | 7  |  |   | 345,221   |  
|                                |  |                      |   |                 |   |         |   |           |    |  |   |           |  
|Total                           |  |                      | 2 |                 | $ | 207,047 |   |           | 14 |  | $ | 2,279,067 |  
|                                |  |                      |   |                 |   |         |   |           |    |  |   |           |  
|Delinquent loans to total loans |  |                      |   |                 |   | 0.31    | % |           |    |  |   | 3.43      | %

|                                |  |                      |   |                 |   |           |   |           |    |  |   |           |  
|------------------------------- |  | -------------------- | - | --------------- | - | --------- | - | --------- | -- |  | - | --------- | -
|                                |  | At December 31, 2007 |  
|                                |  |                      |  
|                                |  | 60-89 Days           |   | 90 Days or more |  
|                                |  |                      |   |                 |  
|                                |  | Number               |   | Principal       |   | Number    |   | Principal |   
|                                |  |                      |   |                 |   |           |   |           |   
|Commercial real estate          |  |                      | 2 |                 | $ | 1,406,936 |   |           | 3  |  | $ | 459,371   |  
|Commercial construction         |  |                      | 2 |                 |   | 2,944,000 |   |           | 6  |  |   | 2,505,134 |  
|Commercial unsecured            |  |                      | 1 |                 |   | 300,000   |   |           | 2  |  |   | 14,970    |  
|Other                           |  |                      |  |                 |   |          |   |           | 1  |  |   | 5,877     |  
|                                |  |                      |   |                 |   |           |   |           |    |  |   |           |  
|Total                           |  |                      | 5 |                 | $ | 4,650,936 |   |           | 12 |  | $ | 2,985,352 |  
|                                |  |                      |   |                 |   |           |   |           |    |  |   |           |  
|Delinquent loans to total loans |  |                      |   |                 |   | 7.43      | % |           |    |  |   | 4.77      | %

|                                |  |                      |   |                 |   |        |   |           |   |  |   |         |  
|------------------------------- |  | -------------------- | - | --------------- | - | ------ | - | --------- | - |  | - | ------- | -
|                                |  | At December 31, 2006 |  
|                                |  |                      |  
|                                |  | 60-89 Days           |   | 90 Days or more |  
|                                |  |                      |   |                 |  
|                                |  | Number               |   | Principal       |   | Number |   | Principal |  
|                                |  |                      |   |                 |   |        |   |           |  
|Commercial real estate          |  |                      |  |                 | $ |       |   |           | 3 |  | $ | 773,924 |  
|Commercial unsecured            |  |                      | 2 |                 |   | 29,648 |   |           | 1 |  |   | 20,709  |  
|Other                           |  |                      | 1 |                 |   | 9,676  |   |           |  |  |   |        |  
|                                |  |                      |   |                 |   |        |   |           |   |  |   |         |  
|Total                           |  |                      | 3 |                 | $ | 39,324 |   |           | 4 |  | $ | 794,633 |  
|                                |  |                      |   |                 |   |        |   |           |   |  |   |         |  
|Delinquent loans to total loans |  |                      |   |                 |   | 0.06   | % |           |   |  |   | 1.19    | %

|                                |  |                      |   |                 |   |        |   |           |   |  |   |           |  
|------------------------------- |  | -------------------- | - | --------------- | - | ------ | - | --------- | - |  | - | --------- | -
|                                |  | At December 31, 2005 |  
|                                |  |                      |  
|                                |  | 60-89 Days           |   | 90 Days or more |  
|                                |  |                      |   |                 |  
|                                |  | Number               |   | Principal       |   | Number |   | Principal |  
|                                |  |                      |   |                 |   |        |   |           |  
|Commercial real estate          |  |                      |  |                 | $ |       |   |           | 6 |  | $ | 1,123,081 |  
|Commercial construction         |  |                      |  |                 |   |       |   |           | 2 |  |   | 579,000   |  
|Commercial unsecured            |  |                      | 1 |                 |   | 8,420  |   |           |  |  |   |          |  
|                                |  |                      |   |                 |   |        |   |           |   |  |   |           |  
|Total                           |  |                      | 1 |                 | $ | 8,420  |   |           | 8 |  | $ | 1,702,081 |  
|                                |  |                      |   |                 |   |        |   |           |   |  |   |           |  
|Delinquent loans to total loans |  |                      |   |                 |   | 0.01   | % |           |   |  |   | 2.29      | %

|                                |  |                      |   |                 |   |         |   |           |   |  |   |         |  
|------------------------------- |  | -------------------- | - | --------------- | - | ------- | - | --------- | - |  | - | ------- | -
|                                |  | At December 31, 2004 |  
|                                |  |                      |  
|                                |  | 60-89 Days           |   | 90 Days or more |  
|                                |  |                      |   |                 |  
|                                |  | Number               |   | Principal       |   | Number  |   | Principal |  
|                                |  |                      |   |                 |   |         |   |           |  
|Commercial real estate          |  |                      | 2 |                 | $ | 256,137 |   |           | 4 |  | $ | 160,310 |  
|Commercial unsecured            |  |                      |  |                 |   |        |   |           | 1 |  |   | 20,112  |  
|Other                           |  |                      |  |                 |   |        |   |           | 1 |  |   | 2,476   |  
|                                |  |                      |   |                 |   |         |   |           |   |  |   |         |  
|Total                           |  |                      | 2 |                 | $ | 256,137 |   |           | 6 |  | $ | 182,898 |  
|                                |  |                      |   |                 |   |         |   |           |   |  |   |         |  
|Delinquent loans to total loans |  |                      |   |                 |   | 0.37    | % |           |   |  |   | 0.27    | %

Loans 90 days or more past
due represent non-accrual loans and loans that are contractually past due
maturity but are still accruing interest.

12

---



Non-performing Assets.
The following table sets forth information about our non-performing assets at
December 31, 2008, 2007 and 2006.

|                                      |  |                      |           |                      |   |                      |   |   |         |  
|------------------------------------- |  | -------------------- | --------- | -------------------- | - | -------------------- | - | - | ------- | -
|                                      |  | At December 31, 2008 |           | At December 31, 2007 |   | At December 31, 2006 |  
|                                      |  |                      |           |                      |   |                      |  
|Non-performing assets:                |  |                      |           |                      |   |                      |   |   |         |  
|Commercial loans:                     |  |                      |           |                      |   |                      |   |   |         |  
|Unsecured                             |  | $                    | 345,221   |                      | $ | 14,970               |   | $ | 20,709  |  
|Commercial real estate                |  |                      | 1,453,846 |                      |   | 459,371              |   |   | 188,872 |  
|Construction                          |  |                      | 480,000   |                      |   | 480,000              |   |   |        |  
|Consumer loan                         |  |                      |          |                      |   | 5,877                |   |   |        |  
|                                      |  |                      |           |                      |   |                      |   |   |         |  
|                                      |  |                      |           |                      |   |                      |   |   |         |  
|Total non-performing assets           |  | $                    | 2,279,067 |                      | $ | 960,218              |   | $ | 209,581 |  
|                                      |  |                      |           |                      |   |                      |   |   |         |  
|Non-performing loans to total loans   |  |                      | 3.43      | %                    |   | 1.53                 | % |   | 0.31    | %
|Non-performing loans to total assets  |  |                      | 1.07      | %                    |   | 0.47                 | % |   | 0.10    | %
|Non-performing assets to total assets |  |                      | 1.07      | %                    |   | 0.47                 | % |   | 0.10    | %

The gross
interest income that would have been recorded in 2008 if the non-accrual loans
had been current in accordance with their original terms was $114,464. The
amount of interest income on those loans that was included in net income for
2008 was $27,115.

The following
table sets forth the aggregate carrying value of our assets classified as
Substandard, Doubtful and Loss according to asset type:

|                          |  |                      |    |          |   |           |  |        |   |  |   |       | 
|------------------------- |  | -------------------- | -- | -------- | - | --------- |  | ------ | - |  | - | ----- | 
|                          |  | At December 31, 2008 |   
|                          |  |                      |   
|                          |  | Substandard          |    | Doubtful |  
|                          |  |                      |    |          |  
|                          |  | Number               |    | Amount   |   | Number    |  | Amount |  
|                          |  |                      |    |          |   |           |  |        |  
|Classification of assets: |  |                      |    |          |   |           |  |        |   |  |   |       | 
|Commercial Loans:         |  |                      |    |          |   |           |  |        |   |  |   |       | 
|Unsecured                 |  |                      | 7  |          | $ | 380,047   |  |        |  |  | $ |      | 
|Commercial Real Estate    |  |                      | 9  |          |   | 3,133,193 |  |        | 1 |  |   | 7,187 | 
|Construction              |  |                      | 2  |          |   | 480,000   |  |        |  |  |   |      | 
|Consumer Loan             |  |                      |   |          |   |          |  |        |  |  |   |      | 
|                          |  |                      |    |          |   |           |  |        |   |  |   |       | 
|Total loans               |  |                      | 18 |          | $ | 3,993,240 |  |        | 1 |  | $ | 7,187 | 
|                          |  |                      |    |          |   |           |  |        |   |  |   |       | 

No assets were
classified as Loss at year end 2008 or 2007.

Non-Performing Loans

Management
closely monitors non-performing loans and other assets with potential problems
on a regular basis. We had thirteen non-performing loans, totaling $2,279,067,
at December 31, 2008, compared to six non-performing loans, totaling $960,218,
at December 31, 2007. The following is information about the six largest
non-performing loans, totaling $1,928,726 in outstanding principal balance.
Management believes it has taken appropriate steps with a view towards
maximizing recovery and minimizing loss on these loans.

|  |                                                                                                                                                                                                                                                                                                                                              
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | $859,968 in
 three loans to a builder secured and cross-collateralized by first mortgage
 liens on three lots in Staten Island on which single family houses are being
 built. The loans are past maturity and we have commenced foreclosure actions.
 A motion to appoint a referee was submitted and we are awaiting the courts
 decision.

13

---



|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | $396,321 in
 a loan to a business that has ceased operations but which loan is secured by
 a first mortgage on real property in Suffolk County and personally guaranteed
 by the principals. The property is listed for sale at a price substantially
 in excess of the loan amount. The loan was past due during 2008 and we
 negotiated and extended an interim work out, pending the completion of a sale
 of the property. The borrowers and the guarantors signed the work out
 documents in October and paid interest through December 31, 2008.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | $525,128 in
 a loan to a local business. The loan is in arrears but the borrower continues
 to make partial payments. The loan is secured by a first mortgage on a
 commercial building, a third mortgage on the borrowers personal residence, a
 security interest in the business, and the personal guaranties of the
 principals. The commercial property is listed for sale at a price in excess
 of all amounts owed.                                                                                                                           

Allowance for Loan Losses

It is our
policy to provide a valuation allowance for probable incurred losses on loans
based on our past loan loss experience, known and inherent risks in the loan
portfolio, adverse situations which may affect the borrowers ability to repay,
estimated value of underlying collateral and current economic conditions in our
lending area. The allowance is increased by provisions for loan losses charged
to earnings and is reduced by charge-offs, net of recoveries. While management
uses available information to estimate losses on loans, future additions to the
allowance may be necessary based upon any changes in economic conditions or if
our loan portfolio increases. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Banks
allowance for loan losses. Such agencies may require the Bank to recognize
additions to the allowance based on judgments different from those of
management. Management believes, based upon all relevant and available
information, that the allowance for loan losses is appropriate.

When analyzing
whether the level of the allowance for loan losses is appropriate, management
considers performing loans in our loan portfolio that have no material
identified weaknesses. Management establishes an amount equal to a fixed
percentage of the performing loans in each of our five principal loan
categories to be included in the allowance to cover inherent weaknesses in the
broad category of loans. Management also analyzes each loan that has been
identified as having specific weaknesses to determine the appropriate level of
the allowance for that loan. This analysis considers both the general factors
which are considered in assessing performing loans as well as specific facts
pertinent to each loan, such as collateral value, borrowers income and ability
to repay, payment history, the reasons for and length of the delinquency, and
the value of any credit support. Although loans may be analyzed individually or
in groups to determine the allowance, the entire allowance is available for any
losses that occur.

In order to
assist in determining the allowance, an independent loan review firm, senior
management and the Banks Board of Directors review the allowance for loan
losses quarterly. If they determine that the allowance is inappropriate, then
management increases or decreases the provision for loan losses to bring the
allowance to the appropriate level.

As of December
31, 2008, our allowance for loan losses was $987,876 or 1.49% of total loans.
Based upon all relevant and presently available information, management
believes that the allowance for loan losses is appropriate. We continue to
monitor and modify the level of the allowance for loan losses in order to
maintain the allowance at a level which management considers appropriate. While
management uses available information to recognize losses on loans, future
additions to the allowance may be necessary, based on changes in economic and
local market conditions beyond managements control. In addition, federal and
state bank regulatory agencies periodically review Victory State Banks loan
loss allowance as part of their periodic safety and soundness examinations of
the Bank. They may recommend or seek to compel increases in the allowance if
they believe that weaknesses in the loan portfolio are more significant than
managements assessment.

14

---



The following
table sets forth the activity in our allowance for loan losses:

|                                                                                                          |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|--------------------------------------------------------------------------------------------------------- |  | ------------------------------- | -------- | ---- | - | --------- | - | ---- | --------- | ---- | - | --------- | - | - | --------- | -
|                                                                                                          |  | For the Year
Ended
December 31, |         
|                                                                                                          |  |                                 |          |      |   |           |   |     
|                                                                                                          |  | 2008                            |          | 2007 |   | 2006      |   | 2005 |           | 2004 |  
|                                                                                                          |  |                                 |          |      |   |           |   |      |           |      |  
|                                                                                                          |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|Allowance for Loan Losses:                                                                                |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|Balance at beginning of period                                                                            |  | $                               | 927,161  |      | $ | 1,128,824 |   | $    | 1,153,298 |      | $ | 1,299,520 |   | $ | 1,162,776 |  
|Charge-offs:                                                                                              |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|Commercial loans:                                                                                         |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|Unsecured                                                                                                 |  |                                 | (483,326 | )    |   | (254,986  | ) |      | (62,181   | )    |   | (318,399  | ) |   | (180,125  | )
|Consumer loan                                                                                             |  |                                 | (7,959   | )    |   |          |   |      | (17,511   | )    |   |          |   |   |          |  
|Other loans                                                                                               |  |                                 | (3,503   | )    |   | (8,639    | ) |      | (28,111   | )    |   | (25,302   | ) |   | (4,940    | )
|                                                                                                          |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|Total charge-offs                                                                                         |  |                                 | (494,788 | )    |   | (263,625  | ) |      | (107,803  | )    |   | (343,701  | ) |   | (185,065  | )
|Recoveries                                                                                                |  |                                 | 270,503  |      |   | 66,962    |   |      | 148,329   |      |   | 257,479   |   |   | 171,809   |  
|                                                                                                          |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|Net (charge-offs) / recoveries                                                                            |  |                                 | (224,285 | )    |   | (196,663  | ) |      | 40,526    |      |   | (86,222   | ) |   | (13,256   | )
|Provision charged to income                                                                               |  |                                 | 285,000  |      |   | (5,000    | ) |      | (65,000   | )    |   | (60,000   | ) |   | 150,000   |  
|                                                                                                          |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|Balance at end of period                                                                                  |  | $                               | 987,876  |      | $ | 927,161   |   | $    | 1,128,824 |      | $ | 1,153,298 |   | $ | 1,299,520 |  
|                                                                                                          |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|                                                                                                          |  |                                 |          |      |   |           |   |      |           |      |   |           |   |   |           |  
|Ratio of net charge-offs / (recoveries) during the period to average
 loans outstanding during the period |  |                                 | 0.35     | %    |   | 0.32      | % |      | -0.06     | %    |   | 0.12      | % |   | 0.02      | %
|Ratio of allowance for loan losses to total loans at the end of
period                                    |  |                                 | 1.49     | %    |   | 1.48      | % |      | 1.69      | %    |   | 1.55      | % |   | 1.90      | %
|Ratio of allowance for loan losses to non-performing loans at the end
 of the period                      |  |                                 | 43.35    | %    |   | 96.56     | % |      | 538.61    | %    |   | 72.03     | % |   | 899.96    | %
|Ratio of allowance for loan losses to non-performing assets at the end
 of the period                     |  |                                 | 43.35    | %    |   | 96.56     | % |      | 538.61    | %    |   | 72.03     | % |   | 899.96    | %

The following
table sets forth the allocation of our allowance for loan losses among each of
the categories listed.

|                        |  |                      |         |                                       |  |                      |   |                                       |         |                      |  |                                       |   |        |           |                                       |  |        |   |                                       |           |  |  |       |   |   |           |  |  |       |  
|----------------------- |  | -------------------- | ------- | ------------------------------------- |  | -------------------- | - | ------------------------------------- | ------- | -------------------- |  | ------------------------------------- | - | ------ | --------- | ------------------------------------- |  | ------ | - | ------------------------------------- | --------- |  |  | ----- | - | - | --------- |  |  | ----- | -
|                        |  | At December 31, 2008 |         | At December 31, 2007                  |  | At December 31, 2006 |   | At December 31, 2005                  |         | At December 31, 2004 | 
|                        |  |                      |         |                                       |  |                      |   |                                       |         |                      | 
|                        |  | Amount               |         | % of Loans
in Category
to
Total Loans |  | Amount               |   | % of Loans
in Category
to
Total Loans |         | Amount               |  | % of Loans
in Category
to
Total Loans |   | Amount |           | % of Loans
in Category
to
Total Loans |  | Amount |   | % of Loans
in Category
to
Total Loans |          
|                        |  |                      |         |                                       |  |                      |   |                                       |         |                      |  |                                       |   |        |           |                                       |  |        |   |                                       |          
|                       
|Allowance:              |  |                      |         |                                       |  |                      |   |                                       |         |                      |  |                                       |   |        |           |                                       |  |        |   |                                       |           |  |  |       |   |   |           |  |  |       |  
|Commercial loans:       |  |                      |         |                                       |  |                      |   |                                       |         |                      |  |                                       |   |        |           |                                       |  |        |   |                                       |           |  |  |       |   |   |           |  |  |       |  
|Unsecured               |  | $                    | 372,803 |                                       |  | 14.4                 | % | $                                     | 330,355 |                      |  | 17.5                                  | % | $      | 337,054   |                                       |  | 16.3   | % | $                                     | 360,532   |  |  | 14.9  | % | $ | 351,215   |  |  | 14.1  | %
|Secured                 |  |                      | 7,451   |                                       |  | 1.8                  |   |                                       | 19,877  |                      |  | 1.9                                   |   |        | 10,859    |                                       |  | 1.8    |   |                                       | 2,349     |  |  | 2.1   |   |   | 17,660    |  |  | 2.3   |  
|Commercial real estate  |  |                      | 449,525 |                                       |  | 60.1                 |   |                                       | 345,407 |                      |  | 50.6                                  |   |        | 518,620   |                                       |  | 49.9   |   |                                       | 363,072   |  |  | 40.1  |   |   | 490,488   |  |  | 46.5  |  
|Residential real estate |  |                      | 25,686  |                                       |  | 3.8                  |   |                                       | 15,887  |                      |  | 3.7                                   |   |        | 12,501    |                                       |  | 0.2    |   |                                       | 7,835     |  |  | 0.4   |   |   | 11,296    |  |  | 1.6   |  
|Construction loans      |  |                      | 100,737 |                                       |  | 17.9                 |   |                                       | 166,437 |                      |  | 24.1                                  |   |        | 198,901   |                                       |  | 29.1   |   |                                       | 362,590   |  |  | 39.8  |   |   | 358,632   |  |  | 33.4  |  
|Other loans             |  |                      | 31,674  |                                       |  | 2.0                  |   |                                       | 49,198  |                      |  | 2.2                                   |   |        | 50,889    |                                       |  | 2.7    |   |                                       | 56,920    |  |  | 2.7   |   |   | 70,229    |  |  | 2.1   |  
|                        |  |                      |         |                                       |  |                      |   |                                       |         |                      |  |                                       |   |        |           |                                       |  |        |   |                                       |           |  |  |       |   |   |           |  |  |       |  
|Total allowances        |  | $                    | 987,876 |                                       |  | 100.0                | % | $                                     | 927,161 |                      |  | 100.0                                 | % | $      | 1,128,824 |                                       |  | 100.0  | % | $                                     | 1,153,298 |  |  | 100.0 | % | $ | 1,299,520 |  |  | 100.0 | %
|                        |  |                      |         |                                       |  |                      |   |                                       |         |                      |  |                                       |   |        |           |                                       |  |        |   |                                       |           |  |  |       |   |   |           |  |  |       |  

Investment Activities

State-chartered
banking institutions have the authority to invest in various types of liquid
assets, including United States Treasury Obligations, securities of various
federal agencies, certain certificates of deposits of insured banks and savings
institutions, certain bankers acceptances, repurchase agreements and federal
funds. Additionally, it is appropriate for us to maintain investments for
ongoing liquidity needs and we have maintained liquid assets at a level
believed to be adequate to meet our normal daily activities.

Our investment
policy, established by the Board of Directors of Victory State Bank and
implemented by its Asset/Liability Committee, attempts to provide and maintain
liquidity, generate a favorable return on investments without incurring undue
interest rate and credit risk, and complement our lending activities. Although
we classify most of our securities portfolio as available for sale, it is our
practice to retain most of our securities until they mature.

15

---



Our policies
generally limit investments to government and federal agency securities or AAA
rated securities, including corporate debt obligations, which are investment
grade with weighted average lives of seven years or less. Our policies provide
that all investment purchases be ratified by the Banks Board and may only be
initiated by the President or Chief Financial Officer of the Bank. Investment
securities consist of collateralized mortgage obligations (CMO) with
estimated average lives, based upon prepayment assumptions that management
believes are reasonable, of 4.5 years or less, mortgage-backed securities
(MBS) with maturities of seven years or less and U.S. Agency notes with a
maturity of less than 15 years. These CMOs and MBS are backed by federal
agencies such as Federal National Mortgage Association (FNMA) and the Federal
Home Loan Mortgage Corporation (FHLMC) or are AAA rated whole loan
securities. No investment securities in our portfolio have experienced ratings
down grades. At December 31, 2008, we had investment securities with a cost
basis of $119,212,790 and a fair value of $120,288,588. All investment
securities at December 31, 2008, were either CMOs or MBSs. The entire
investment portfolio at December 31, 2008 was classified as available for sale
and is accounted on a fair market value basis.

The following
table sets forth certain information regarding the amortized cost and fair
values of the investment securities, available for sale portfolio at the dates
indicated:

|                                           |  |                 |             |             |   |                 |  |             |             |                 |   |             |  |   |             |  |   |             | 
|------------------------------------------ |  | --------------- | ----------- | ----------- | - | --------------- |  | ----------- | ----------- | --------------- | - | ----------- |  | - | ----------- |  | - | ----------- | 
|                                           |  | At December 31, |            
|                                           |  |                 |            
|                                           |  | 2008            |             | 2007        |   | 2006            | 
|                                           |  |                 |             |             |   |                 | 
|                                           |  | Amortized 
Cost |             | Fair 
Value |   | Amortized 
Cost |  | Fair 
Value |             | Amortized 
Cost |   | Fair 
Value | 
|                                           |  |                 |             |             |   |                 |  |             |             |                 |   |             | 
|                                           |  |                 |             |             |   |                 |  |             |             |                 |   |             | 
|Investments securities, available for sale |  |                 |             |             |   |                 |  |             |             |                 |   |             |  |   |             |  |   |             | 
|US Government Agency                       |  | $               |            |             | $ |                |  | $           |            |                 | $ |            |  | $ | 8,500,000   |  | $ | 8,443,906   | 
|FNMA                                       |  |                 | 6,646,320   |             |   | 6,690,593       |  |             | 5,762,683   |                 |   | 5,746,955   |  |   | 7,607,408   |  |   | 7,397,799   | 
|FHLMC                                      |  |                 | 37,411      |             |   | 37,643          |  |             | 161,513     |                 |   | 162,752     |  |   | 228,986     |  |   | 229,625     | 
|GNMA                                       |  |                 | 1,576,764   |             |   | 1,632,790       |  |             | 1,892,949   |                 |   | 1,849,267   |  |   | 2,264,561   |  |   | 2,171,125   | 
|Whole Loan MBS                             |  |                 | 2,620,965   |             |   | 2,559,037       |  |             | 3,135,102   |                 |   | 3,103,907   |  |   | 3,554,783   |  |   | 3,453,363   | 
|Collateralized mortgage obligations        |  |                 | 108,331,330 |             |   | 109,368,525     |  |             | 107,571,610 |                 |   | 106,951,236 |  |   | 94,198,430  |  |   | 92,074,793  | 
|                                           |  |                 |             |             |   |                 |  |             |             |                 |   |             |  |   |             |  |   |             | 
|                                           |  |                 |             |             |   |                 |  |             |             |                 |   |             |  |   |             |  |   |             | 
|                                           |  | $               | 119,212,790 |             | $ | 120,288,588     |  | $           | 118,523,857 |                 | $ | 117,814,117 |  | $ | 116,354,168 |  | $ | 113,770,611 | 
|                                           |  |                 |             |             |   |                 |  |             |             |                 |   |             |  |   |             |  |   |             | 

The table
below sets forth certain information regarding the amortized cost, weighted
average yields and stated maturities of our investment securities at December
31, 2008 and 2007.

|                                     |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|------------------------------------ |  | -------------------- | ------ | ---------------------- |  | ------------ | - | ---------------------- | --------- | ------------- |  | ---------------------- | - | ------------- | ---------- | ---------------------- |  | ----- | - | - | ---------- |  |  | ---- | - | - | ----------- | 
|                                     |  | At
December 31, 2008 |       
|                                     |  |                      |       
|                                     |  | Less
Than
1 Year     |        | Weighted
Average
Yield |  | 1 To 5
Years |   | Weighted
Average
Yield |           | 5 To 10
Years |  | Weighted
Average
Yield |   | Over 10
Years |            | Weighted
Average
Yield |  | Total |  
|                                     |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |  
|                                     |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|Investment
 Securities:              |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|US Government
 Agency                |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|Agency                               |  | $                    |       |                        |  |             | % | $                      |          |               |  |                       | % | $             |           |                        |  |      | % | $ |           |  |  |     | % | $ |            | 
|FNMA 7 Year
 Balloon                 |  |                      |       |                        |  |             |   |                        | 1,897,587 |               |  | 4.47                   |   |               | 2,190,239  |                        |  | 4.41  |   |   | 2,558,494  |  |  | 3.74 |   |   | 6,646,320   | 
|FHLMC                                |  |                      | 37,411 |                        |  | 2.79         |   |                        |          |               |  |                       |   |               |           |                        |  |      |   |   |           |  |  |     |   |   | 37,411      | 
|GNMA                                 |  |                      |       |                        |  |             |   |                        |          |               |  |                       |   |               | 1,576,764  |                        |  | 4.39  |   |   |           |  |  |     |   |   | 1,576,764   | 
|Whole Loan MBS                       |  |                      |       |                        |  |             |   |                        |          |               |  |                       |   |               | 2,620,965  |                        |  | 4.44  |   |   |           |  |  |     |   |   | 2,620,965   | 
|Collateralized
 Mortgage Obligations |  |                      |       |                        |  |             |   |                        | 2,187,168 |               |  | 5.13                   |   |               | 47,617,983 |                        |  | 4.41  |   |   | 58,526,179 |  |  | 4.76 |   |   | 108,331,330 | 
|                                     |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|                                     |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|Total                                |  | $                    | 37,411 |                        |  | 2.79         | % | $                      | 4,084,755 |               |  | 4.82                   | % | $             | 54,005,951 |                        |  | 4.41  | % | $ | 61,084,673 |  |  | 4.72 | % | $ | 119,212,790 | 
|                                     |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 

16

---



|                                    |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|----------------------------------- |  | -------------------- | ------ | ---------------------- |  | ------------ | - | ---------------------- | --------- | ------------- |  | ---------------------- | - | ------------- | ---------- | ---------------------- |  | ----- | - | - | ---------- |  |  | ---- | - | - | ----------- | 
|                                    |  | At December 31, 2007 |       
|                                    |  |                      |       
|                                    |  | Less Than
1 Year     |        | Weighted
Average
Yield |  | 1 To 5
Years |   | Weighted
Average
Yield |           | 5 To 10
Years |  | Weighted
Average
Yield |   | Over 10
Years |            | Weighted
Average
Yield |  | Total |  
|                                    |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |  
|                                    |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|Investment Securities:              |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|US Government Agency                |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|Agency                              |  | $                    |       |                        |  |             | % | $                      |          |               |  |                       | % | $             |           |                        |  |      | % | $ |           |  |  |     | % | $ |            | 
|FNMA 7 Year Balloon                 |  |                      |       |                        |  |             |   |                        | 2,235,724 |               |  | 4.51                   |   |               |           |                        |  |      |   |   | 3,526,959  |  |  | 3.90 |   |   | 5,762,683   | 
|FHLMC                               |  |                      | 81,608 |                        |  | 4.93         |   |                        | 79,905    |               |  | 4.98                   |   |               |           |                        |  |      |   |   |           |  |  |     |   |   | 161,513     | 
|GNMA                                |  |                      |       |                        |  |             |   |                        |          |               |  |                       |   |               |           |                        |  |      |   |   | 1,892,949  |  |  | 4.39 |   |   | 1,892,949   | 
|Whole Loan MBS                      |  |                      |       |                        |  |             |   |                        |          |               |  |                       |   |               |           |                        |  |      |   |   | 3,135,102  |  |  | 4.66 |   |   | 3,135,102   | 
|Collateralized Mortgage Obligations |  |                      |       |                        |  |             |   |                        |          |               |  |                       |   |               | 26,652,356 |                        |  | 4.70  |   |   | 80,919,254 |  |  | 4.61 |   |   | 107,571,610 | 
|                                    |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|                                    |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 
|Total                               |  | $                    | 81,608 |                        |  | 4.93         | % | $                      | 2,315,629 |               |  | 4.53                   | % | $             | 26,652,356 |                        |  | 4.70  | % | $ | 89,474,264 |  |  | 4.58 | % | $ | 118,523,857 | 
|                                    |  |                      |        |                        |  |              |   |                        |           |               |  |                        |   |               |            |                        |  |       |   |   |            |  |  |      |   |   |             | 

Source of Funds

General. Deposits
are the primary source of our funds for use in lending, investing and for other
general purposes. In addition to deposits, we obtain funds from principal
repayments and prepayments on loans and securities. Loan and securities
repayments are a relatively stable source of funds, while deposit inflows and
outflows as well as unscheduled prepayments are influenced by general interest
rates and money market conditions.

Deposits. We offer a
variety of deposit accounts having a range of interest rates and terms. Our
deposits consist of non-interest bearing checking accounts, money market
accounts, time deposit (certificate) accounts, statement savings and NOW
accounts. The flow of deposits is influenced significantly by general economic
conditions, changes in money market rates, prevailing interest rates and
competition. Our deposits are obtained primarily from the areas in which our
offices are located. We do not actively solicit certificate accounts in excess
of $100,000, nor do we use brokers to obtain deposits. However, in connection
with our efforts in establishing banking development districts in Staten
Island, we accept large balance municipal deposits as part of the New York
State and New York City banking development district programs. These municipal
deposits total $35 million, are at a subsidized rate, and mature on an annual
basis. There can be no assurance that the Bank will be able to retain these
municipal deposits or be able to renew them at subsidized rates as compared to
current market rates at that time. Management constantly monitors our deposit
accounts and, based on historical experience, management believes it will
retain a large portion of such accounts upon maturity. Deposit account terms we
offer vary according to the minimum balance required, the time periods that the
funds must remain on deposit and the interest rates, among other factors. In
determining the characteristics of the deposit account programs we offer, we
consider potential profitability, matching terms of the deposits with loan
products, the attractiveness to the customers and the rates offered by our
competitors.

Our focus on
customer service, primarily for the business and professional community in our
marketplace, has facilitated our retention of non-interest bearing checking
accounts and low costing NOW and savings accounts, which generally have
interest rates substantially less than certificate of deposits. At December 31,
2008, these types of low cost deposit accounts amounted to $88,647,294, or
47.1% of total deposits.

The following
table presents deposit activity for the periods indicated.

17

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|                                                 |  |                             |             |                             |   |                             |   |   |             |  
|------------------------------------------------ |  | --------------------------- | ----------- | --------------------------- | - | --------------------------- | - | - | ----------- | -
|                                                 |  | Year EndedDecember 31, 2008 |             | Year EndedDecember 31, 2007 |   | Year EndedDecember 31, 2006 |  
|                                                 |  |                             |             |                             |   |                             |  
|                                                 |  |                             |             |                             |   |                             |   |   |             |  
|Beginning balance                                |  | $                           | 176,334,443 |                             | $ | 186,683,150                 |   | $ | 193,251,159 |  
|Net increase/(decrease) before interest
credited |  |                             | 9,646,073   |                             |   | (13,454,165                 | ) |   | (9,416,115  | )
|Interest credited on deposits                    |  |                             | 2,128,933   |                             |   | 3,105,458                   |   |   | 2,848,106   |  
|                                                 |  |                             |             |                             |   |                             |   |   |             |  
|                                                 |  |                             |             |                             |   |                             |   |   |             |  
|Ending balance                                   |  | $                           | 188,109,449 |                             | $ | 176,334,443                 |   | $ | 186,683,150 |  
|                                                 |  |                             |             |                             |   |                             |   |   |             |  

The following
table provides information regarding the remaining term to maturity of our time
deposits over $100,000 at December 31, 2008:

|                              |  |   |            |  | 
|----------------------------- |  | - | ---------- |  | 
|Maturity
Period               |  |   | Amount     | 
|                              |  |   |            | 
|                              |  |   |            | 
|Three months or less          |  | $ | 47,372,390 | 
|Over three through six months |  |   | 13,876,894 | 
|Over six through 12 months    |  |   | 4,276,902  | 
|Over 12 months                |  |   |           | 
|                              |  |   |            | 
|Total                         |  | $ | 65,526,186 | 
|                              |  |   |            | 

The following
table presents by various rate categories, the amount and the periods to
maturity of the certificate accounts outstanding at December 31, 2008.

|                      |  |                    |            |                              |   |                               |  |                                  |         |                  |   |         |  |   |           |  |   |            | 
|--------------------- |  | ------------------ | ---------- | ---------------------------- | - | ----------------------------- |  | -------------------------------- | ------- | ---------------- | - | ------- |  | - | --------- |  | - | ---------- | 
|                      |  | Six MonthsAnd Less |            | Over Six Mos.Through OneYear |   | Over One YearThrough TwoYears |  | Over Two YearsThrough ThreeYears |         | Over Three
Years |   | Total   | 
|                      |  |                    |            |                              |   |                               |  |                                  |         |                  |   |         | 
|Certificate accounts: |  |                    |            |                              |   |                               |  |                                  |         |                  |   |         |  |   |           |  |   |            | 
|0.50% to 1.99%        |  | $                  | 30,528,457 |                              | $ |                              |  | $                                |        |                  | $ |        |  | $ |          |  | $ | 30,528,457 | 
|2.00% to 2.99%        |  |                    | 21,578,360 |                              |   | 18,189,364                    |  |                                  | 582,851 |                  |   |        |  |   |          |  |   | 40,350,575 | 
|3.00% to 3.99%        |  |                    | 551,151    |                              |   | 2,001,826                     |  |                                  |        |                  |   | 559,100 |  |   | 1,651,855 |  |   | 4,763,932  | 
|4.00% to 4.99%        |  |                    | 519,695    |                              |   | 160,835                       |  |                                  |        |                  |   |        |  |   |          |  |   | 680,530    | 
|                      |  |                    |            |                              |   |                               |  |                                  |         |                  |   |         |  |   |           |  |   |            | 
|                      |  |                    |            |                              |   |                               |  |                                  |         |                  |   |         |  |   |           |  |   |            | 
|                      |  | $                  | 53,177,663 |                              | $ | 20,352,025                    |  | $                                | 582,851 |                  | $ | 559,100 |  | $ | 1,651,855 |  | $ | 76,323,494 | 
|                      |  |                    |            |                              |   |                               |  |                                  |         |                  |   |         |  |   |           |  |   |            | 

Borrowings

We do not
routinely utilize borrowings, but in connection with the issuance of $5 million
in trust preferred securities in August 2003, we issued a $5.2 million
subordinated note to VSB Capital Trust I. Therefore, at December 31, 2007, we
had $5.2 million in subordinated debt. On August 8, 2008, we repaid the
subordinated debenture in full at par, received payment of $155,000 on account
of our common securities of the Trust, and all the outstanding Trust Preferred
Capital Securities were likewise redeemed, thereby ending the entire
arrangement.

Personnel

As of December
31, 2008, we had 46 full-time employees and 15 part-time employees. These
employees are not represented by a collective bargaining unit and we consider
our relationship with our employees to be good.

18

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REGULATION AND SUPERVISION

Regulation of VSB Bancorp, Inc.

VSB Bancorp,
Inc., is a New York corporation and is subject to and governed by the New York
Business Corporation Law. It is a bank holding company and thus is subject to
regulation, supervision, and examination by the Federal Reserve.

Bank Holding Company Regulation.As
a bank holding company, we are required to file periodic reports and other
information with the Federal Reserve and the Federal Reserve may conduct
examinations of us.

We are subject
to capital adequacy guidelines of the Federal Reserve. The guidelines apply on
a consolidated basis and require bank holding companies to maintain a minimum
ratio of Tier 1 capital to total assets of 4.0%. The minimum ratio is 3.0% for
the most highly rated bank holding companies. The Federal Reserves capital
adequacy guidelines also require bank holding companies to maintain a minimum
ratio of qualifying total capital to risk-weighted assets of 8.0%, and a
minimum ratio of Tier 1 capital to risk-weighted assets of 4.0%. As of December
31, 2008, the ratio of Tier 1 capital to total assets was 10.70%, the ratio of
Tier 1 capital to risk-weighted assets was 24.51%, and the ratio of qualifying
total capital to risk-weighted assets was 25.58%.

Our ability to
pay dividends can be restricted if overall capital falls below levels
established by the Federal Reserves guidelines.

Federal
Reserve approval is required if we seek to acquire direct or indirect ownership
or control of 5% or more of the voting shares of a bank or bank holding
company. We must obtain Federal Reserve approval before we acquire all or substantially
all the assets of a bank or merge or consolidate with another bank holding
company. These provisions also would apply to a bank holding company that
sought to acquire 5% or more of the common stock of or to merge or consolidate
with us.

Bank holding
companies like us may not engage in activities other than banking and
activities so closely related to banking or managing or controlling banks as to
be a proper incident thereto. Federal Reserve regulations contain a list of
permissible non-banking activities that are closely related to banking or
managing or controlling banks and the Federal Reserve has identified a limited
number of additional activities by order. These activities include lending
activities, certain data processing activities, and securities brokerage and
investment advisory services, trust activities and leasing activities. A bank
holding company must file an application or a notice with the Federal Reserve
prior to acquiring more than 5% of the voting shares of a company engaged in
such activities. A bank holding company that is well capitalized and well
managed and meets other conditions may provide notice after making the
acquisition.

We have the
right to elect to be treated as a financial holding company if the Bank is well
capitalized and well managed and has at least a satisfactory record of
performance under the Community Reinvestment Act. Financial holding companies
that meet certain conditions may engage in activities that are financial in
nature or incidental to financial activities, or activities that are
complementary to a financial activity and do not pose a substantial risk to the
safety and soundness of depository institutions or the financial system
generally. Federal law identifies certain activities that are deemed to be
financial in nature, including non-banking activities currently permissible for
bank holding companies to engage in both within and outside the United States,
as well as insurance and securities underwriting and merchant banking
activities. The Federal Reserve may identify additional activities that are
permissible financial activities. No prior notice to the Federal Reserve is
required for a financial holding company to acquire a company engaged in these
activities or to commence these activities directly or indirectly through a
subsidiary.

We have not
elected to be treated as a financial holding company since we have no current
plans to use the authority to engage in expanded activities. However, we may
elect to do so in the future.

19

---



The Sarbanes-Oxley Act. The
Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) imposes a broad range of
corporate governance and accounting requirements for public companies
(including VSB Bancorp, Inc.) designed to promote honesty and transparency in
corporate America. Among many other provisions, Section 404 of Sarbanes-Oxley
requires that public company annual reports describe the responsibility of
management to establish and maintain an internal control structure and contain
an assessment of the effectiveness of the internal control structure and
procedures of the issuer for financial reporting. The Securities and Exchange
Commission had extended the deadline for non-accelerated filers (such as VSB
Bancorp, Inc.) to comply with the requirements under Section 404. This is our
second Annual Report for which we are required to include a report under
Section 404 and we have included such a report as Item 8A of this Annual
Report. We are not yet required to include an attestation by our independent
registered public accountants as to managements assessment under Section 404.
Managements assessment did not result in substantial additional cost because
the financial nature of our business makes internal control and monetary
reporting a fundamental component of the operation of much of our business.
However, we anticipate that if the Securities and Exchange Commission requires
that we include an accountants attestation of managements assessment, as is
currently planned for next year that would result in a substantial increase in
our accounting and auditing expense.

Statutory Restrictions on Acquisition of VSB
Bancorp, Inc., and Victory State Bank

Applicable
provisions of the New York Banking Law, the federal Bank Holding Company Act,
and other federal statutes, restrict the ability of persons or entities to
acquire control of a bank holding company. Under the Change in Bank Control
Act, persons who intend to acquire control of a bank holding company, either
directly or indirectly or through or in concert with one or more persons must
give 60 days prior written notice to the Federal Reserve. Control would
exist when an acquiring party directly or indirectly has voting control of at
least 25% of our voting securities or the power to direct our management or
policies. Under Federal Reserve regulations, a rebuttable presumption of
control would arise with respect to an acquisition where, after the
transaction, the acquiring party has ownership control, or the power to vote at
least 10% (but less than 25%) of our common stock.

The New York
Banking Law requires prior approval of the New York Banking Board before any
action is taken that causes any company to acquire direct or indirect control
of a banking institution that is organized in the State of New York. The term control
is defined generally to mean the power to direct or cause the direction of the
management and policies of the banking institution and is presumed to exist if
the company owns, controls or holds with power to vote 10% or more of the
voting stock of the banking institution.

Section 912 of
the New York Business Corporation Law, known as the New York Anti-Takeover Law,
restricts the ability of interested stockholders to engage in business
combinations with a New York corporation. In general terms, Section 912
prohibits any New York corporation covered by the statute from merging with an
interested shareholder (i.e., one who owns 20% or more of the outstanding
voting stock) for five years following the date on which the interested
shareholder first acquired 20% of the stock, unless before that date the Board
of Directors of the corporation had approved either the merger or the
interested shareholders stock purchase.

Section 912
defines an interested stockholder as the beneficial owner, directly or indirectly,
of 20% or more of the outstanding voting stock of a corporation; and certain
other entities that have owned 20% or more of a corporations stock during the
past five years. A business combination is defined as a merger, consolidation,
sale of 10% or more of the assets, or similar transaction.

Unless an
interested stockholder waits five years after becoming an interested
stockholder to engage in a business combination, the business combination is
prohibited unless our Board of Directors has approved either (a) the business
combination or (b) the acquisition of stock by the interested stockholder,
before the interested stockholder acquired its 20% interest. Even though the
interested stockholder waits five years, the business combination is prohibited
unless either:

20

---



(i)
          the business
combination or the acquisition of stock by the interested stockholder was
approved by the Board of Directors before the interested stockholder acquired
its 20% interest;

(ii)
          the business
combination is approved by a majority vote of all outstanding shares of stock
not beneficially owned by the interested stockholder or its affiliates or
associates at a meeting held at least five years after the interested
stockholder becomes an interested stockholder; or

(iii)
          the price paid for
common stock acquired in the business combination is, in general terms, at
least as much as the greater of (a) highest price paid by the interested
stockholder for any stock since the interested stockholder first owned 5% of
the stock of the corporation, or (b) the market value of the stock as of the
date of announcement of the business combination; and the price paid for stock
other than common stock is subject to comparable minimum standards.

Regulation of Victory State Bank

The Bank is
subject to extensive regulation and examination by the New York State Banking
Department (Department), as its chartering authority, and by the FDIC, as the
insurer of its deposits. The federal and state laws and regulations which are
applicable to banks regulate, among other things, the scope of their business,
their investments, their reserves against deposits, the timing of the
availability of deposited funds and the nature and amount of and collateral for
certain loans. The Bank must file reports with the Department and the FDIC
concerning its activities and financial condition, in addition to obtaining
regulatory approvals prior to entering into certain transactions such as
establishing branches and mergers with, or acquisitions of, other depository
institutions. There are periodic examinations by the Department and the FDIC to
test the Banks 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 regulation, whether
by the Department, the FDIC or as a result of the enactment of legislation,
could have a material adverse impact on the Bank and its operations.

Capital Requirements

The FDIC
imposes capital adequacy standards on state-chartered banks, which, like the
Bank, are not members of the Federal Reserve System.

The FDICs
capital regulations establish a minimum 3.0% Tier I leverage capital
requirement for the most highly-rated state-chartered, non-member banks, with
an additional cushion of at least 100 basis points for all other
state-chartered, non-member banks, which effectively will increase the minimum
Tier I leverage ratio for such other banks to 4.0%. Under the FDICs
regulation, the highest-rated banks are those that the FDIC determines are not
anticipating or experiencing significant growth and have well diversified risk,
including no undue interest rate risk exposure, excellent asset quality, high
liquidity, good earnings and, in general, which are considered a strong banking
organization and are rated composite 1 under the Uniform Financial Institutions
Rating System. Tier I or core capital is defined as the sum of common
stockholders equity (including retained earnings), non-cumulative perpetual
preferred stock and related surplus, and minority interests in consolidated
subsidiaries, minus all intangible assets other than certain qualifying
supervisory goodwill and certain mortgage servicing rights.

The FDIC also
requires that banks meet a risk-based capital standard. The risk-based capital
standard for banks requires the maintenance of a ratio of total capital (which
is defined as Tier I capital and supplementary capital) to risk-weighted assets
of 8.0% and Tier I capital to risk-weighted assets of 4%. In determining the
amount of risk-weighted assets, all assets, plus certain off-balance sheet
assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the
FDIC believes are inherent in the type of asset or item. The components of Tier
I capital are the same as for the leverage capital standard. The components of
supplementary capital include certain perpetual preferred stock, certain
mandatory convertible securities, certain subordinated debt and intermediate
preferred stock and general allowances for loan and lease losses. Allowance for
loan and lease losses includable in supplementary capital is limited to a
maximum of 1.25%of risk-weighted
assets. Overall, the amount of capital counted toward supplementary capital
cannot exceed 100% of core capital.

21

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The FDIC has
an additional, higher capital level, known as well-capitalized. In order to be
classified as well-capitalized, a bank must have a Tier 1 leverage ratio of at
least 5%, a Tier 1 risk-based capital ratio of at least 6% and a total
risk-based capital ratio of at least 10%.

At December 31,
2008, the Bank exceeded all of the capital ratio standards for a
well-capitalized bank.

The following
table shows the Banks actual capital amounts and ratios.

|                                           |  |        |            |                               |       |                                                                  |  |       |           |        |      |       |  |   |            |  |       |   | 
|------------------------------------------ |  | ------ | ---------- | ----------------------------- | ----- | ---------------------------------------------------------------- |  | ----- | --------- | ------ | ---- | ----- |  | - | ---------- |  | ----- | - | 
|                                           |  | Actual |            | For capital
adequacy purposes |       | To be well-capitalized
under prompt corrective
action provisions | 
|                                           |  |        |            |                               |       |                                                                  | 
|                                           |  | Amount |            | Ratio                         |       | Amount                                                           |  | Ratio |           | Amount |      | Ratio | 
|                                           |  |        |            |                               |       |                                                                  |  |       |           |        |      |       | 
|                                          
|As of December 31, 2008                    |  |        |            |                               |       |                                                                  |  |       |           |        |      |       |  |   |            |  |       |   | 
|Tier 1 Capital 
 (to Average Assets)       |  | $      | 22,087,000 |                               | 10.45 | %                                                                |  | $     | 8,516,543 |        | 4.00 | %     |  | $ | 10,645,678 |  | 5.00  | % | 
|Tier 1 Capital 
 (to Risk Weighted Assets) |  |        | 22,087,000 |                               | 24.34 | %                                                                |  |       | 3,681,128 |        | 4.00 | %     |  |   | 5,521,692  |  | 6.00  | % | 
|Total Capital 
 (to Risk Weighted Assets)  |  |        | 23,075,000 |                               | 25.43 | %                                                                |  |       | 7,362,255 |        | 8.00 | %     |  |   | 9,202,819  |  | 10.00 | % | 
|                                           |  |        |            |                               |       |                                                                  |  |       |           |        |      |       |  |   |            |  |       |   | 

Activities and Investments of New York-Chartered Banks.

The Bank
derives its lending, investment
and other authority primarily from the applicable provisions of New York State
Banking Law and the regulations of the Department, as limited by FDIC
regulations and other federal laws and regulations. See Activities and
Investments of FDIC Insured State-Chartered Banks below. These New York laws
and regulations authorize the Bank to invest in real estate mortgages, consumer
and commercial loans, certain types of debt securities, including certain
corporate debt securities and obligations of federal, State and local
governments and agencies, and certain other assets. A banks aggregate lending
powers are not subject to percentage of asset limitations, although there are limits
applicable to single borrowers. A New York-chartered bank may also exercise
trust powers upon approval of the Department. The Bank does not have trust
powers.

The New York
Banking Board has the power to adopt regulations that enable state chartered banks
to exercise the rights, powers and privileges permitted for a national bank.
The Bank has not engaged in material activities authorized by such regulations.

With certain
limited exceptions, the Bank may not make loans or extend credit for
commercial, corporate or business purposes (including lease financing) to a
single borrower, the aggregate amount of which would be in excess of 15% of the
Banks net worth, on an unsecured basis, and 25% of the net worth if the excess
is collateralized by readily marketable collateral or collateral otherwise
having a value equal to the amount by which the loan exceeds 15% of the Banks
net worth. Theses limits do not apply to loans made by VSB Bancorp, Inc.
directly at the holding company level. The Bank currently complies with all
applicable loans-to-one-borrower limitations and VSB Bancorp, Inc. has not made
any loans in its own name except for its loan to its Employee Stock Ownership
Plan.

22

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Activities and Investments of FDIC-Insured
State-Chartered Banks.

The activities
and equity investments of FDIC-insured, state-chartered banks are generally
limited to those that are permissible for national banks. Under regulations
dealing with equity investments, an insured state bank generally may not
directly or indirectly acquire or retain any equity investment of a type, or in
an amount, that is not permissible for a national bank. An insured state bank
is not prohibited from, among other things, (i) acquiring or retaining a
majority interest in a subsidiary, (ii) investing as a limited partner in a
partnership the sole purpose of which is direct or indirect investment in the
acquisition, rehabilitation or new construction of a qualified housing project,
provided that such limited partnership investments may not exceed 2% of the
banks total assets, (iii) acquiring up to 10% of the voting stock of a company
that solely provides or reinsures directors, trustees and officers liability
insurance coverage or bankers blanket bond group insurance coverage for
insured depository institutions, and (iv) acquiring or retaining the voting
shares of a depository institution if certain requirements are met. In
addition, an FDIC-insured state-chartered bank may not directly, or indirectly
through a subsidiary, engage as principal in any activity that is not
permissible for a national bank unless the FDIC has determined that such
activities would pose no risk to the insurance fund of which it is a member and
the bank is in compliance with applicable regulatory capital requirements.

Regulatory Enforcement Authority

Applicable
banking laws include substantial enforcement powers available to federal
banking regulators. This enforcement authority includes, among other things,
the ability to assess civil money penalties, to issue cease-and-desist or
removal orders and to initiate injunctive actions against banking organizations
and institution-affiliated parties, as defined. In general, these enforcement
actions may be initiated for violations of laws and regulations and unsafe or
unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with
regulatory authorities.

Under the New
York State Banking Law, the Department may issue an order to a New York-chartered
banking institution to appear and explain an apparent violation of law, to
discontinue unauthorized or unsafe practices and to keep prescribed books and
accounts. Upon a finding by the Department that any director, trustee or
officer of any banking organization has violated any law, or has continued
unauthorized or unsafe practices in conducting the business of the banking
organization after having been notified by the Department to discontinue such
practices, such director, trustee or officer may be removed from office by the
Department after notice and an opportunity to be heard. The Bank does not know
of any past or current practice, condition or violation that might lead to any
proceeding by the Department against the Bank or any of its directors or officers.
The Department also may take possession of a banking organization under
specified statutory criteria.

Prompt Corrective Action.

Section 38 of
the Federal Deposit Insurance Act (FDIA) provides the federal banking
regulators with broad power to take prompt corrective action to resolve the
problems of undercapitalized institutions. The extent of the regulators powers
depends on whether the institution in question is well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized
or critically undercapitalized. A bank is deemed to be (i) well capitalized
if it has total risk-based capital ratio of 10.0% or more, has a Tier I
risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio
of 5.0% or more and is not subject to specified requirements to meet and
maintain a specific capital level for any capital measure, (ii) adequately
capitalized if it has a total risk-based capital ratio of 8.0% or more, a Tier
I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratio
of 4.0% or more (3.0% under certain circumstances) and does not meet the
definition of well capitalized, (iii) undercapitalized if it has a total
risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital
ratio that is less than 4.0% or a Tier I leverage capital ratio that is less
than 4.0% (3.0% under certain circumstances), (iv) significantly
undercapitalized if it has a total risk-based capital ratio that is less than
6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I
leverage capital ratio that is less than 3.0%, and (v) critically
undercapitalized if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. The regulations also provide that a federal banking regulator may, after notice and an opportunity
for a hearing, reclassify a well capitalized
institution as adequately capitalized and may require an adequately capitalized institution or
an undercapitalized institution
to comply with supervisory actions as if it were in the next lower category if the institution is in an unsafe or unsound condition
or engaging in an unsafe or unsound practice. The federal banking regulator may not, however, reclassify a significantly
undercapitalized institution as critically undercapitalized.

23

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An institution
generally must file a written capital restoration plan which meets specified
requirements, as well as a performance guaranty by each company that controls
the institution, with an appropriate federal banking regulator within 45 days
of the date that the institution receives notice or is deemed to have notice
that it is undercapitalized, significantly undercapitalized or critically
undercapitalized. Immediately upon becoming undercapitalized, an institution
becomes subject to statutory provisions, which, among other things, set forth
various mandatory and discretionary restrictions on the operations of such an
institution.

At December
31, 2008, the Company and the Bank had capital levels which qualified them as
well-capitalized institutions.

FDIC Insurance

The Bank is a
member of the FDIC. As insurer, the FDIC is authorized to conduct examinations
of, and to require reporting by, FDIC-insured institutions. It also may
prohibit any FDIC-insured institution from engaging in any activity the FDIC
determines by regulation or order to pose a serious threat to the FDIC.

In late 2006,
the FDIC imposed deposit insurance premium assessments for the first time in a
number of years, effective beginning in 2007. Our FDIC insurance premium was
$122,869 in 2008. In 2009, the FDIC has announced that institutions like our
Bank will be subject to an assessment rate between seven (7) and twelve (12)
basis points per annum. Additionally, the FDIC has proposed a special 20 basis
point assessment, payable on September 30, 2009, with a potential additional 10
basis point special assessment at each quarter end, depending on the viability
of the Bank Insurance Fund (BIF). The raising of the base assessment rates
and the addition of these special assessments will significantly increase the
expense to the Bank in 2009. We estimate that if our deposit levels and deposit
composition remains the same, our assessment for FDIC insurance premiums in
2009 will be at least $260,000 and, if the 20 basis point special assessment is
imposed, the assessment may increase to $600,000. Additional assessments, if
any, would further increase our deposit insurance costs. On October 3, 2008,
FDIC deposit insurance temporarily increased from $100,000 to $250,000 per
depositor through December 31, 2009.

The FDIC has
also recently increased insurance coverage on non-interest bearing demand
accounts, Interest Only Lawyers Accounts (IOLA) and Negotiable Order of
Withdrawal (NOW) accounts paying less than 50 basis points to an unlimited
amount, but with the payment of an additional assessment fee. On December 5,
2008, the Bank opted in to the Temporary Account Guarantee Program, providing
for the unlimited insurance coverage on non-interest bearing transaction, IOLA
and NOW accounts but we opted out of the Debt Guarantee Program.

Although the
increase in the amount of FDIC insurance available has no direct effect on our
insurance premiums, the increase is likely to increase losses to the deposit
insurance fund when banks fail. This could cause the FDIC to increase deposit
insurance premiums on existing banks, or continue higher premium levels for a
longer period of time, which would reduce our net income.

The FDIC may
terminate the deposit insurance of any insured depository institution,
including the Bank, if it determines, after a hearing, that the institution has
engaged or is engaging in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed by an agreement with the FDIC. It
also may suspend deposit insurance temporarily during the hearing process for
the permanent termination of insurance, if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined
by the FDIC. Management is aware of no existing circumstances that would result
in termination of the Banks deposit insurance.

24

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Troubled Asset Relief Program and Capital
Purchase Program

The United
States Department of the Treasury recently announced a Capital Purchase Program
(CPP) in which the Treasury will purchase preferred stock from approved
institutions, with certain limitations and restrictions. These programs
are all entirely voluntary. VSB Bancorp, Inc. and Victory State Bank, have
strong capital (Tier 1 Capital ratio in excess of 10% and Total Risk Based Capital
ratio in excess of 25%). We have reported positive and increased quarterly
earnings in 2008 and we did not originate or invest in subprime mortgages nor
in FNMA and FHLMC preferred stock. Upon reviewing all of the details of the
Treasury programs, we did not participate in these programs.

Brokered Deposits

Under federal
law and applicable regulations, (i) a well capitalized bank may solicit and
accept, renew or roll over any brokered deposit without restriction, (ii) an
adequately capitalized bank may not accept, renew or roll over any brokered
deposit unless it has applied for and been granted a waiver of this prohibition
by the FDIC and (iii) an undercapitalized bank may not (x) accept, renew or
roll over any brokered deposit or (y) solicit deposits by offering an effective
yield that exceeds by more than 75 basis points the prevailing effective yields
on insured deposits of comparable maturity in such institutions normal market
area or in the market area in which such deposits are being solicited. The term
undercapitalized insured depository institution is defined to mean any
insured depository institution that fails to meet the minimum regulatory
capital requirement prescribed by its appropriate federal banking agency. The
FDIC may, on a case-by-case basis and upon application by an adequately
capitalized insured depository institution, waive the restriction on brokered
deposits upon a finding that the acceptance of brokered deposits does not
constitute an unsafe or unsound practice with respect to such institution. The
Bank had no brokered deposits outstanding at December 31, 2008.

Community Reinvestment and Consumer
Protection Laws

In connection
with its lending activities, the Bank is subject to a variety of federal laws
designed to protect borrowers and promote lending to various sectors of the
economy and population. Included among these are the Home Mortgage Disclosure
Act, Real Estate Settlement Procedures Act, Truth-in-Lending Act, Equal Credit
Opportunity Act, Fair Credit Reporting Act and Community Reinvestment Act
(CRA).

The CRA
requires FDIC insured banks to define the assessment areas that they serve,
identify the credit needs of those assessment areas and take actions that
respond to the credit needs of the community. The FDIC must conduct regular CRA
examinations of the Bank and assign it a CRA rating of outstanding,
satisfactory, needs improvement or unsatisfactory. The Bank is also
subject to provisions of the New York State Banking Law which impose similar
obligations to serve the credit needs of its assessment areas. The New York
Banking Department makes a biennial written assessment of a banks compliance,
and makes the assessment available to the public. Federal and New York State
laws both require consideration of these ratings when reviewing a banks
application to engage in certain transactions, including mergers, asset
purchases and the establishment of branch offices. A negative assessment may
serve as a basis for the denial of any such application. The Bank has received
Satisfactory ratings from both the New York Banking Department and the FDIC.

The Board of
Governors of the Federal Reserve System has recently proposed changes to its
Truth in Lending regulations and the U.S. Department of Housing and Urban Development
has recently proposed changes to its Real Estate Settlement Procedures Act
regulations that may have a significant effect on consumer lending, especially
residential mortgage lending to consumers. Although consumer lending is not a
material part of our lending program, any changes which affect the housing
industry have a potential to adversely affect our customers because, as we have
explained throughout this annual report, the building trades, especially
related to residential construction, are an important focus of our customer
base. Therefore, any regulations that make it more expensive for our customers
to operate, or that restrict the ability of our customers to conduct business,
could have an adverse effect on our operations.

25

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Limitations on Dividends

The payment of
dividends by the Bank is subject to various regulatory requirements. Under New
York State Banking Law, a New York-chartered stock bank may declare and pay
dividends out of its net profits, unless there is an impairment of capital, but
approval of the Superintendent of Banks is required if the total of all
dividends declared in a calendar year would exceed the total of its net profits
for that year combined with its retained net profits of the preceding two
years, subject to certain adjustments.

Miscellaneous

The Bank is
subject to restrictions on loans to its non-bank subsidiaries, on investments
in the stock or securities thereof, on the taking of such stock or securities
as collateral for loans to any borrower, and on the issuance of a guarantee or
letter of credit on behalf of the Bank or its non-bank subsidiaries. The Bank
also is subject to restrictions on most types of transactions with the Bank or
its non-bank subsidiaries, requiring that the terms of such transactions be
substantially equivalent to terms of similar transactions with non-affiliated
firms.

Assessments

Banking
institutions are required to pay assessments to both the FDIC and the NYSBD to
fund their operations. The assessments are based upon the amount of the Banks
total assets. The Bank must also pay an examination fee to the NYSBD when they
conduct an examination. The Bank paid federal and state assessments and
examination fees of $161,783 in 2008.

Transactions with Related Parties

The Banks
authority to engage in transactions with related parties or affiliates (i.e.,
any entity that controls or is under common control with an institution,
including the Bank) or to make loans to certain insiders is limited by Sections
23A and 23B of the Federal Reserve Act. Section 23A limits the aggregate amount
of transactions with any individual affiliate to 10% of the capital and surplus
of the institution and also limits the aggregate amount of transactions with
all affiliates to 20% of the institutions capital and surplus.

Loans to
affiliates must be secured by collateral with a value that depends on the
nature of the collateral. The purchase of low quality assets from affiliates is
generally prohibited. Loans and asset purchases with affiliates, must be on terms
and under circumstances, including credit standards, that are substantially the
same or at least as favorable to the institution as those prevailing at the
time for comparable transactions with nonaffiliated companies. In the absence
of comparable transactions, such transactions may only occur under terms and
circumstances, including credit standards that in good faith would be offered
to or would apply to nonaffiliated companies.

The Banks
authority to extend credit to executive officers, directors and 10%
shareholders, as well as entities controlled by such persons, is currently
governed by Regulation O of the Federal Reserve Board. Regulation O generally
requires such loans to be made on terms substantially similar to those offered
to unaffiliated individuals (except for preferential loans made in accordance
with broad based employee benefit plans), places limits on the amount of loans
the Bank may make to such persons based, in part, on the Banks capital
position, and requires certain approval procedures to be followed.

Standards for Safety and Soundness

FDIC
regulations require that Victory State Bank adopt procedures and systems
designed to foster safe and sound operations in the areas of internal controls,
information systems, internal and audit systems, loan documentation, credit
underwriting, interest rate risk exposure, asset growth, asset quality,
earnings and compensation, fees and benefits. Among other things, these
regulations prohibit compensation and benefits and arrangements that are excessive
or that could lead to a material financial loss. If Victory State Bank fails to
meet any of these standards, it will be required to submit to the FDIC a plan
specifying the steps that will be taken to cure the deficiency. If it fails to
submit an acceptable plan or fails to implement the plan, FDIC the will require
it or VSB Bancorp, Inc. to correct the deficiency and until corrected, may
impose restrictions on them.

26

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The FDIC has
also adopted regulations that require Victory State Bank to adopt written loan
policies and procedures that are consistent with safe and sound operation, are
appropriate for the size of the Bank, and must be reviewed by the Banks Board
of Directors annually. Victory State Bank has adopted such policies and
procedures, the material provisions of which are discussed above as part of the
discussion of our lending operations.

Federal Reserve System

The Federal
Reserve Board regulations require banks to maintain non-interest earning
reserves against their transaction accounts (primarily regular checking
accounts and interest-bearing checking accounts). The Federal Reserve Board
regulations generally require that reserves be maintained against aggregate
transaction accounts as follows: for accounts aggregating $34.6 million or less
(subject to adjustment by the Federal Reserve Board) the reserve requirement is
3%; for accounts greater than $34.6 million, the reserve requirement is $1.0
million plus 10% (subject to adjustment by the Federal Reserve Board between 8%
and 14%) against that portion of total transaction accounts in excess of $43.9
million. The first $9.3 million of otherwise reservable balances (subject to
adjustments by the Federal Reserve Board) are exempted from the reserve
requirements. The Bank is in compliance with these requirements. Because
required reserves must be maintained in the form of either vault cash or a
non-interest-bearing account at a Federal Reserve Bank or a pass-through
account as defined by the Federal Reserve Board, the effect of this reserve
requirement is to reduce our interest-earning assets.

TAXATION

Federal Taxation

General

We are subject
to federal income taxation in the same general manner as other corporations
with some exceptions discussed below. The following discussion of federal
taxation is intended only to summarize certain pertinent federal income tax
matters and is not a comprehensive description of the tax rules applicable to
us. Our federal income tax returns have not been audited or closed without
audit by the Internal Revenue Service.

Method of Accounting

We report our
income and expenses on the accrual method of accounting and use a tax year
ending December 31 for filing our consolidated federal income tax returns. The
Company files consolidated tax returns with the Bank and VSB Capital Trust I.

Bad Debt Reserves

We use the
experience method in computing bad debt deductions for federal tax purposes.

Minimum Tax

The Internal
Revenue Code imposes an alternative minimum tax (AMT) at a rate of 20% on a
base of regular taxable income plus certain tax preferences (alternative
minimum taxable income or AMTI). The AMT is payable to the extent such AMT
is in excess of the Companys regular tax liability. Net operating losses can
offset no more than 90% of AMT. Certain payments of alternative minimum tax may
be used as credits against regular tax liabilities in future years. We have not
been subject to the alternative minimum tax and have no such amounts available
as credits.

27

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State and Local Taxation

New York State and New York City Taxation.

New York State
Franchise Tax on corporations is
imposed in an amount equal to the greater of (a) 7.5% of entire net income
allocable to New York State (b) 3% of alternative entire net income allocable
to New York State (c) 0.01% of the average value of assets allocable to New
York State or (d) a nominal minimum tax. Entire net income is based on federal
taxable income, subject to certain modifications. Alternative entire net income
is equal to entire net income without certain modifications. The New York City
Corporation Tax is imposed using similar alternative taxable income methods and
rates.

A temporary
Metropolitan Transportation Business Tax Surcharge on banking corporations
doing business in the Metropolitan District has been applied since 1982. We
transact a significant portion of our business within this District and thus we
are subject to this surcharge. The current surcharge rate is 17% of the State
franchise tax liability. New York City does not impose comparable surcharges.

For New York
State and City tax purposes, the bad debt deduction may be computed using a
specific formula based on our actual loss history (Experience Method).

Item 2. Properties.

At December
31, 2008, we conducted our business through five banking offices. Our main
office and banking facility is at 4142 Hylan Boulevard.

|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |           |  | 
|---------------------------------------------------- |  | -------------- |  | --------------- |  | ------------------------------- |  | ------------------------ |  | ------------------------------------------------------------ | - | --------- |  |  | - | --------- |  | 
|Location                                             |  | Description    |  | Leased or
Owned |  | OriginalDate
Leased or
Acquired |  | Date of
Lease
Expiration |  | Net Book Valueof Leasehold
Improvements at
December 31, 2008 |  
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |  
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |          
|4142 Hylan Boulevard 
 Staten Island, N.Y. 10308 (1) |  | Main
 Office   |  | Leased          |  | 2005                            |  | 3/25/2020                |  |                                                              | $ | 1,972,655 |  | 
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |           |  | 
|755 Forest Avenue 
 Staten Island, N.Y. 10310        |  | Branch         |  | Leased          |  | 1999                            |  | 11/30/2013               |  |                                                              | $ | 58,633    |  | 
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |           |  | 
|One Hyatt Street 
 Staten Island, N.Y. 10301         |  | Branch         |  | Leased          |  | 1999                            |  | 10/30/2014               |  |                                                              | $ | 29,815    |  | 
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |           |  | 
|1762 Hylan Boulevard 
 Staten Island, N.Y. 10305     |  | Branch         |  | Leased          |  | 2001                            |  | 6/30/2016                |  |                                                              | $ | 368,228   |  | 
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |           |  | 
|1766 Hylan Boulevard (2)
 Staten Island, N.Y. 10305  |  | Retail
 Stores |  | Leased          |  | 2001                            |  | 6/30/2016                |  |                                                              | $ | 95,442    |  | 
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |           |  | 
|1065 Bay Street 
 Staten Island, N.Y. 10305          |  | Branch         |  | Leased          |  | 2006                            |  | 04/26/2021               |  |                                                              | $ | 155,838   |  | 
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |           |  | 
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |           |  | 
|Total net book value                                 |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  | $ | 2,680,611 |  | 
|                                                     |  |                |  |                 |  |                                 |  |                          |  |                                                              |   |           |  |  |   |           |  | 

|    |                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In February 2007, we opened
 our new main office at 4142 Hylan Boulevard.                                                                                            
|    |                                                                                                                                                                      
|(2) | We leased the retail stores
 at 1766 Hylan Boulevard as a component of the lease for the 1762 Hylan
 Boulevard branch and we sublease the property to retail tenants.

28

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Item 3. Legal Proceedings.

The Bank is a
defendant in an action pending in Supreme Court, Richmond County, commenced by
IndyMac Bank, F.S.B. against the Bank, LaMattina & Associates, Inc. (LAI)
and various individuals and entities alleged to be officers, directors or
otherwise to have relationships with LAI. LAI was a deposit customer of the
Bank engaged in the business of providing real estate settlement services to
lenders making residential mortgage loans. The plaintiff alleges that it was
such a lender and that it had provided funds to LAI by wiring those funds to an
account of LAI at the Bank to use to fund mortgage loans to be made by the
plaintiff, only to have LAI not use those funds for their intended purpose. The
action was commenced in August 2005. In November 2005, the plaintiff amended
its complaint to add the Bank as a defendant. The plaintiff amended its
complaint again and the Bank moved to dismiss the claims. In February 2007, the
court dismissed two of the claims against the Bank but allowed the Plaintiff to
proceed and conduct discovery with respect to two claims, one for negligence
and the other for conversion. The parties are in the process of conducting
discovery regarding the claims asserted in the case.

The amended
complaint requests monetary damages against the Bank of $1,817,041 plus
recovery of attorneys fees. The Bank intends to defend aggressively the
amended claims and has referred the litigation to its insurance carrier, which
has indicated that at least some of the claims asserted against the Bank are
covered by insurance. The Bank has also asserted cross-claims against various
former customers, principals of those customers, and other related persons on
the grounds that if the Bank is held liable to the plaintiff, then the
liability is the result of the misdeeds or negligence of those other parties.

IndyMac Bank,
F.S.B. (Old IndyMac), was closed by the Office of Thrift Supervision (OTS)
and the Federal Deposit Insurance Corporation (FDIC) was appointed as its
conservator in July 2008. The OTS then created a new bank (New IndyMac) and
many of the assets of Old IndyMac were transferred to New IndyMac. The Bank has
been advised by opposing legal counsel that the claim in the litigation is
owned by Old IndyMac, which is being liquidated by the FDIC. The Bank has been
advised that the holder of the claim against the Bank intends to continue to
pursue its claim against the Bank. The Bank intends to diligently defend the
litigation. The litigation is in the discovery phase and depositions have not
yet been held.

VSB Bancorp,
Inc. is not involved in any pending legal proceedings. The Bank, from time to
time, is involved in routine collection proceedings in the ordinary course of
business on loans in default. Management believes that such other routine legal
proceedings in the aggregate are immaterial to our financial condition or
results of operations.

Item 4, Submission of Matters to a Vote of
Security Holders.

None

PART II

Item 5. Market for Common Equity and Related
Stockholder Matters.

Our common
stock is quoted on the NASDAQ Global Market (NADAQ GM) under the symbol
VSBN. We were listed on the NASDAQ Global Market effective August 4, 2008,
having been formerly listed on the NASDAQ Capital Market.

The following
table reflects the high and low bid price for our common stock during each
calendar quarter of the last two fiscal years. Such information is derived from
quotations published by Bloomberg LP. These quotations reflect inter-dealer
prices, without retail mark-up, mark-down or commission and may not represent
actual transactions.

29

---



|         |  |               |   |                |  |               |  |                |       |  |  |  |   |       |  |  |  |   |       |  | 
|-------- |  | ------------- | - | -------------- |  | ------------- |  | -------------- | ----- |  |  |  | - | ----- |  |  |  | - | ----- |  | 
|         |  | 2008          |  
|         |  |               |  
|         |  | First Quarter |   | Second Quarter |  | Third Quarter |  | Fourth Quarter |      
|         |  |               |   |                |  |               |  |                |      
|High Bid |  |               | $ | 12.25          |  |               |  | $              | 10.25 |  |  |  | $ | 13.00 |  |  |  | $ | 11.24 |  | 
|Low Bid  |  |               | $ | 10.00          |  |               |  | $              | 9.09  |  |  |  | $ | 9.09  |  |  |  | $ | 8.00  |  | 

|         |  |               |   |                |  |               |  |                |       |  |  |  |   |       |  |  |  |   |       |  | 
|-------- |  | ------------- | - | -------------- |  | ------------- |  | -------------- | ----- |  |  |  | - | ----- |  |  |  | - | ----- |  | 
|         |  | 2007          |  
|         |  |               |  
|         |  | First Quarter |   | Second Quarter |  | Third Quarter |  | Fourth Quarter |      
|         |  |               |   |                |  |               |  |                |      
|High Bid |  |               | $ | 15.20          |  |               |  | $              | 14.75 |  |  |  | $ | 13.65 |  |  |  | $ | 12.15 |  | 
|Low Bid  |  |               | $ | 14.27          |  |               |  | $              | 13.36 |  |  |  | $ | 11.76 |  |  |  | $ | 11.00 |  | 

We have
approximately 151 stockholders of record. We paid our first cash dividend of
$0.06 per common share on January 2, 2008 to stockholders of record on November
29, 2007, and we paid quarterly dividends of $0.06 per share with respect to
each calendar quarter thereafter through the end of 2008.

ISSUER PURCHASES OF EQUITY SECURITIES

|                     |  |                                      |        |                                  |  |                                                                                         |   |                                                                                                                             |  |  |  |        |  |  |  |        |  | 
|-------------------- |  | ------------------------------------ | ------ | -------------------------------- |  | --------------------------------------------------------------------------------------- | - | --------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------ |  |  |  | ------ |  | 
|Period               |  | (a) Total Number of
Shares Purchased |        | (b) Average Price
Paid Per Share |  | (c) Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs(1) |   | (d) Maximum
Number (or
Approximate Dollar
Value) of Shares (or
Units) that May Yet
Be Purchased Under
the Plans or
Programs | 
|October 1,
 2008 to  |  |                                      |        |                                  |  |                                                                                         |   |                                                                                                                             |  |  |  |        |  |  |  |        |  | 
|October 31,
 2008    |  |                                      | 24,900 |                                  |  |                                                                                         | $ | 9.68                                                                                                                        |  |  |  | 24,900 |  |  |  | 75,100 |  | 
|November 1,
 2008 to |  |                                      |        |                                  |  |                                                                                         |   |                                                                                                                             |  |  |  |        |  |  |  |        |  | 
|November 30,
 2008   |  |                                      | 2,700  |                                  |  |                                                                                         | $ | 9.75                                                                                                                        |  |  |  | 27,600 |  |  |  | 72,400 |  | 
|December 1,
 2008 to |  |                                      |        |                                  |  |                                                                                         |   |                                                                                                                             |  |  |  |        |  |  |  |        |  | 
|December 31,
 2008   |  |                                      | 13,823 |                                  |  |                                                                                         | $ | 9.15                                                                                                                        |  |  |  | 41,423 |  |  |  | 58,577 |  | 
|                     |  |                                      |        |                                  |  |                                                                                         |   |                                                                                                                             |  |  |  |        |  |  |  |        |  | 
|                    
|Total                |  |                                      | 41,423 |                                  |  |                                                                                         | $ | 9.56                                                                                                                        |  |  |  | 41,423 |  |  |  | 58,577 |  | 
|                     |  |                                      |        |                                  |  |                                                                                         |   |                                                                                                                             |  |  |  |        |  |  |  |        |  | 

(1) On September 8, 2008, we
announced a stock repurchase program for the repurchase of up to 100,000 shares
of our common stock. All purchases shown in the table were pursuant to such
plan.

Item 7. Managements Discussion and Analysis
of Financial Condition and Results of Operations

General

VSB Bancorp,
Inc. (referred to using terms such as we, us, or the Company) is the
holding company for Victory State Bank (the Bank), a New York State chartered
commercial bank. Our primary business is owning all of the issued and
outstanding stock of the Bank. Victory State Bank is a New York State chartered
commercial bank, founded in November 1997. The Bank is supervised by the New
York State Banking Department and the Federal Deposit Insurance Corporation
(FDIC). The Bank gathers deposits from individuals and businesses primarily
in Staten Island and makes loans throughout that community. The Bank invests
funds that are not used for lending primarily in government securities,
mortgage backed securities and collateralized mortgage obligations. Customer
deposits are insured, up to the applicable limit, by the FDIC. VSB Bancorp,
Inc. common stock is quoted on the NASDAQ Global Market (NASDAQ GM) under the
symbol VSBN.

Our results of
operations are dependent primarily on net interest income, which is the
difference between the income we earn on our loan and investment portfolios and
our costs of funds, consisting primarily of interest paid on our deposits. Our
operating expenses principally consist of employee compensation and benefits,
occupancy expenses, professional fees, advertising and marketing expenses and
other general and administrative expenses. Our results of operations are
significantly affected by general economic and competitive conditions,
particularly changes in market interest rates, government policies and actions
of regulatory authorities.

30

---



Since the Bank
opened for business in 1997, the Board of Directors and management have pursued
a strategy of growth and expansion in order to enhance the long term value of
our banking franchise. The Board of Directors and management anticipate that an
increase in customer deposits, and the resulting increase in funds we would
have available to fund asset growth, will generate an increase in net interest
income.

We experienced
an overall increase in deposits in 2008 due to factors we discuss below. We
opened our new main office in 2007. We anticipate that our existing branch
network will generate an increase in funds for investment in the future.

In order to
support branch expansion and asset growth, we had not paid cash dividends prior
to the fourth quarter of 2007. Our Board of Directors approved our first $0.06
cash dividend to stockholders of record on November 29, 2007, payable on
January 2, 2008 and we paid quarterly dividends of $0.06 per share with respect
to each calendar quarter thereafter through the end of 2008. We paid $443,996
of dividends out of net income of $1,931,774, for a dividend payout ratio of
23%. Thus, we retained the majority of our net income to increase our capital
base to support our efforts to expand our franchise in the future.

During 2008,
we faced a number of challenges, including reduction in market interest rates
that pushed down our yields on assets faster than our cost of funds, due to the
downward pressure of deposit rates. The real estate market continued to soften,
which reduced loan originations and deposit balances from our attorney customer
base. However, the decrease in the prime rate also caused a decrease in yields
on our existing prime based loans and originated new loans at lower initial
interest rates.

Also important
in 2008 was a shift in our deposit mix as we experienced a decline in
non-interest bearing demand deposits accounts. This decline resulted from a
number of factors including a reduction in real estate activity, which reduced
demand deposits held in connection with pending real estate transactions; and a
shift in customer preferences towards interest bearing accounts as the yields
on those accounts increased to the point where they became desirable
alternatives.

Management
intends to exert efforts to continue growing our company in the future.
However, both internal and external factors could adversely affect our future
growth. The recent down turn in the economy has made it more difficult for us
to originate new loans that meet our underwriting standards. Not only does that
cause us to invest available funds in lower-yielding securities and deposits
with other banks, but it also slows the development of non-loan relationships
which sometimes flow from cross-selling to loan customers.

A continuation
of adverse general economic conditions could make it difficult for us to
execute our growth plans. Furthermore, regulatory capital requirements could
have a negative effect on our ability to grow if growth outpaces our ability to
support that growth with increased capital.

Critical Accounting Policies

We are
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and the amounts of revenues and
expenses during the reporting period. The allowance for loan losses, prepayment
estimates on the mortgage-backed securities and Collateralized Mortgage
Obligation portfolios, contingencies and fair values of financial instruments
are particularly subject to change and to managements estimates. Actual
results can differ from those estimates and may have an impact on our financial
statements.

31

---



Asset/Liability Management

We maintain
the interest rate sensitivity of our assets by investing primarily in CMOs and
MBSs with short and intermediate average lives to generate cash flows and by
originating and retaining primarily loans with interest rates based on the
prime rate. As of December 31, 2008, prime based loans totaled $49,880,240, or
79.7% of total loans. Many of these prime based loans are subject to interest
rate floors of 7.00% to 8.00%. We anticipate that we will continue to
concentrate on originating prime based loans in our principal market areas. We
also expect to continue to invest other available funds that we cannot invest
in loans in short-term investment grade securities.

Cash Flow Sensitivity Analysis.
The matching of assets and liabilities may be analyzed by examining our cash
flow sensitivity gap. An asset or liability is said to be cash flow sensitive
within a specific time period if it will mature or reprice within that time
period. The cash flow sensitivity gap is defined as the difference between the
amount of interest-earning assets maturing within a specific time period and
the amount of interest-bearing liabilities maturing within that time period. A
gap is considered positive when the amount of interest earning assets exceeds
the amount of interest bearing liabilities. A gap is considered negative when
the amount of interest bearing liabilities exceeds the amount of interest
earning assets.

During a
period of falling interest rates, the net income of an institution with a
positive gap can be expected to be adversely affected because the yield on its
interest-earning assets should reprice downward faster than the decline in its
cost of funds. Conversely, during a period of rising interest rates, the net
income of an institution with a positive gap position can be expected to
increase as it is able to invest in higher yielding interest-earning assets at
a more rapid rate than its interest-earning liabilities reprice. A positive gap
may not protect an institution with a large portfolio of adjustable rate based
loans or mortgage-backed securities from increases in interest rates for
extended time periods if such loans or securities have annual and lifetime
interest rate caps. The increase in the cost of funds in a rapidly increasing
rate environment could exceed the cap on assets yields, negatively impacting
net interest income. However, our prime rate based loans and our securities
investments generally do not have any annual or lifetime caps.

In the current
interest rate environment, we generally have been investing available funds not
needed for lending in CMOs and MBSs with estimated average lives of four and
one-half years or less. As a result of this strategy, and based upon the
assumptions used in the following table at December 31, 2008, our total
interest-bearing liabilities maturing within one year exceeded our total
interest-earning assets maturing in the same period by $28,841,502,
representing a one year cumulative gap ratio of negative 14.53%. In many cases,
a negative gap ratio means that in a falling rate environment, the interest
that we pay on deposits will reprice downward faster than the rates we earn on
assets. However, for a number of important reasons, that is not our recent
experience during periods of declining interest rates.

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The gap
 analysis shown in the table measures repricing during time periods of three
 months, one year, or longer. However, since most of our loans have interest
 rates based upon the prime rate and the interest rate adjusts immediately
 based upon the prime rate, a reduction in the target federal funds rate,
 which normally presages an immediate reduction in the prime rate, will have
 an immediate negative effect on our earnings the next business day if the
 loans do not have or have not reached an interest rate floor. It will take
 longer for that decline in market interest rates to affect deposit costs.                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | The gap
 table does not measure the magnitude of a change in yields earned or rates
 paid, but only whether they are expected to change. A 1% decline in the prime
 rate normally causes a 1% decline in our loan yields, unless the loan is at
 an interest rate floor. However, a 1% decline in the prime rate would
 normally result in less than a one percent decline in the rate we pay on
 deposits because deposit rates are only a fraction of the prime rate. For
 example, if we offer a deposit for one-half the prime rate, then a 1% decline
 in the prime rate will result in a 1% decline in a loan yield, but only a
 0.5% decline in the rate we offer on deposits. This effect, known as spread
 compression, can be especially significant at low market interest rates
 because the rate on deposits can not be less than zero.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | The gap
 table does not consider the effects of customer discretion. Thus, a customer
 may elect to switch a deposit from one category to the other as market rates
 change, thus changing the cost of that deposit. Our cost of funds on a particular
 deposit could go up even though market rates are declining if a customer
 decides to move money from, for example, a low-rate NOW account to a
 higher-rate time deposit.                                                                                                                                                                                                                                                                                                                                                                                                                     

32

---



| |   |                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The gap
 table does not take into account discretion by the Bank in making deposit
 pricing decisions, which may cause the Bank not to reflect interest rate
 declines by lowering deposit rates. There are many reasons why the Bank may
 decide to do so. Examples of reasons include competitive pressures,
 irrational pricing by other institutions, and the need to maintain customer
 loyalty.

We closely
monitor our interest rate risk as such risk relates to our operational
strategies. The Victory State Bank Board of Directors has established an
Asset/Liability Committee, responsible for reviewing our asset/liability
policies and interest rate risk position, which generally meets quarterly and
reports back to the Board on interest rate risk and trends on a quarterly
basis. In light of the current interest rate environment, we are attempting to
maintain a position in which our assets reprice more quickly than our
liabilities. There can be no assurance, however, that we will be able to
achieve that result or that we will be able to avoid further spread compression
or avoid negative consequences from interest rate fluctuations. Although we
have not experienced a material runoff in our core deposits, there can be no
assurances that such a runoff will not occur in the future if depositors seek
higher yielding investments.

Our
substantial level of non-interest-bearing demand deposits also furthers our
goal of maintaining a positive gap because the interest cost of those deposits
will not increase as market rates increase. However an increase in market
interest rates could cause our customers to shift funds from demand deposits
into interest earning deposits if interest rates are high enough to justify
maintaining multiple accounts. Furthermore, there have been frequent proposals
in Congress to permit the payment of interest on commercial demand deposits.
The adoption of such legislation could have a significant effect on our net
income by forcing us to pay interest on business demand deposits to maintain
parity with our competitors.

The following
table sets forth the amounts of interest-earning assets and interest-bearing
liabilities outstanding at December 31, 2008 which we estimate, based upon
certain assumptions, will mature in each of the future time periods shown.
Except as stated below, the amount of assets and liabilities shown which mature
during a particular period were determined in accordance with the earlier of
estimated repayment or runoff or the contractual terms of the asset or
liability. There can be no assurance that deposits would reprice to peer banks
historical levels if interest rates were to increase. 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,
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 may
have features which restrict changes in interest rates on a short-term basis
and over the life of the asset. For example, if a prime rate loan has a minimum
interest rate of 7.5%, an increase in a very low prime rate might not be
sufficient to increase the interest rate on the loan to more than the minimum.
Further, in the event of a change in interest rates, prepayment and early
withdrawal levels would likely deviate significantly from those assumed in
calculating the table. Finally, the ability of many borrowers to service their
prime rate loans may decrease in the event of an interest rate increase.

33

---



|                                                                                              |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|--------------------------------------------------------------------------------------------- |  | ---------------------- | ----------- | ----------------------- | - | ---------------------------------- | - | --------------------- | ----------- | ----- | - | ---------- | - | - | ----------- | -
|                                                                                              |  | At December 31, 2008   |            
|                                                                                              |  |                        |            
|                                                                                              |  | Three
 months
 or less |             | Four
 to twelve
 months |   | More than
 One year to
 five years |   | More than
 five years |             | Total |  
|                                                                                              |  |                        |             |                         |   |                                    |   |                       |             |       |  
|Interest-earning
 assets:                                                                     |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Commercial loans (1)                                                                          |  | $                      | 58,689,472  |                         | $ | 115,806                            |   | $                     | 486,008     |       | $ | 81,051     |   | $ | 59,372,337  |  
|Consumer loans (1)                                                                            |  |                        | 4,545,019   |                         |   | 452                                |   |                       | 97,446      |       |   | 162,015    |   |   | 4,804,932   |  
|Mortgage-backed securities                                                                    |  |                        | 4,884,270   |                         |   | 14,652,810                         |   |                       | 99,812,207  |       |   |           |   |   | 119,349,287 |  
|Other interest-earning assets                                                                 |  |                        | 14,909,325  |                         |   |                                   |   |                       |            |       |   |           |   |   | 14,909,325  |  
|Investment securities                                                                         |  |                        |            |                         |   |                                   |   |                       |            |       |   |           |   |   |            |  
|                                                                                              |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Total interest-earning assets                                                                 |  |                        | 83,028,086  |                         |   | 14,769,068                         |   |                       | 100,395,661 |       |   | 243,066    |   |   | 198,435,881 |  
|Less:                                                                                         |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Unearned (discount) and deferred fees(2)                                                      |  |                        | (57,616     | )                       |   | (172,848                           | ) |                       | (115,717    | )     |   |           |   |   | (346,181    | )
|                                                                                              |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Net interest-earning assets                                                                   |  |                        | 82,970,470  |                         |   | 14,596,220                         |   |                       | 100,279,944 |       |   | 243,066    |   |   | 198,089,700 |  
|                                                                                              |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Interest-bearing
 liabilities:                                                                |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Savings accounts                                                                              |  |                        | 12,412,561  |                         |   |                                   |   |                       |            |       |   |           |   |   | 12,412,561  |  
|NOW accounts                                                                                  |  |                        | 17,636,154  |                         |   |                                   |   |                       |            |       |   |           |   |   | 17,636,154  |  
|Money market accounts                                                                         |  |                        | 22,829,789  |                         |   |                                   |   |                       |            |       |   |           |   |   | 22,829,789  |  
|Certificate accounts                                                                          |  |                        | 51,844,257  |                         |   | 21,685,431                         |   |                       | 2,793,806   |       |   |           |   |   | 76,323,494  |  
|Subordinated debt                                                                             |  |                        |            |                         |   |                                   |   |                       |            |       |   |           |   |   |            |  
|                                                                                              |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Total interest-bearing liabilities                                                            |  |                        | 104,722,761 |                         |   | 21,685,431                         |   |                       | 2,793,806   |       |   |           |   |   | 129,201,998 |  
|                                                                                              |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Interest sensitivity gap                                                                      |  | $                      | (21,752,291 | )                       | $ | (7,089,211                         | ) | $                     | 97,486,138  |       | $ | 243,066    |   | $ | 68,887,702  |  
|                                                                                              |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Cumulative
 gap                                                                               |  | $                      | (21,752,291 | )                       | $ | (28,841,502                        | ) | $                     | 68,644,636  |       | $ | 68,887,702 |   | $ | 68,887,702  |  
|                                                                                              |  |                        |             |                         |   |                                    |   |                       |             |       |   |            |   |   |             |  
|Cumulative gap as a percentage of total
 interest-earning assets                              |  |                        | -10.96      | %                       |   | -14.53                             | % |                       | 34.59       | %     |   | 34.72      | % |   | 34.72       | %
|Cumulative net interest-earning assets as a
 percentage of total interest-bearing liabilities |  |                        | 79.23       | %                       |   | 77.18                              | % |                       | 153.13      | %     |   | 153.32     | % |   | 153.32      | %

|    |                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For purposes of the gap
 analysis, mortgage and other loans are reduced for non-performing loans but
 are not reduced for the allowance for possible loan losses.
|    |                                                                                                                                                                  
|(2) | For purposes of the gap
 analysis, unearned discount and deferred fees are pro-rated.                                                                            

Analysis of Net Interest Income

Our
profitability is primarily dependent upon net interest income. Net interest
income represents the difference between interest income on interest-earning
assets and the interest expense on interest-bearing liabilities. Net interest
income depends primarily upon the volume of interest-earning assets and
interest-bearing liabilities and the interest rates earned or paid on them.

34

---



Average Balance Sheet

The following table sets
forth certain information relating to our consolidated statements of financial
condition and the consolidated statements of earnings for the fiscal years
ended December 31, 2008, 2007 and 2006 and reflects the average yield on assets
and average cost of liabilities for the period indicated. Such yields and costs
are derived by dividing income or expense by the average balance of assets or
liabilities, respectively, for the periods shown. Average balances are derived
from average daily balances. The average balance of loans receivable does not
include loans on which we have discontinued accruing interest. The yields and
costs include net fees, which are considered adjustments to yields. No tax
equivalent adjustments have been made.

|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|------------------------------------------------------------------- |  | ---------------------------- | ----------- | ---------------------------- | - | ---------------------------- |  | --------------- | ----- | -------- | - | ----------- | - | --------------- | ---------- | -------- |  | ----------- | - | - | ----------- | - | - | ---------- |  |  | ----- | -
|                                                                    |  | Year Ended December 31, 2008 |             | Year Ended December 31, 2007 |   | Year Ended December 31, 2006 | 
|                                                                    |  |                              |             |                              |   |                              | 
|                                                                    |  | Average
Balance              |             | Interest                     |   | Yield/
Cost                  |  | Average
Balance |       | Interest |   | Yield/
Cost |   | Average
Balance |            | Interest |  | Yield/
Cost |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |  
|Assets:                                                             |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Interest-earning assets:                                            |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Loans receivable                                                    |  | $                            | 64,186,215  |                              | $ | 5,078,576                    |  |                 | 7.91  | %        | $ | 61,107,477  |   | $               | 5,980,133  |          |  | 9.79        | % | $ | 69,711,760  |   | $ | 6,985,200  |  |  | 10.02 | %
|Other interest earning assets                                       |  |                              | 14,864,864  |                              |   | 237,490                      |  |                 | 1.60  |          |   | 20,652,598  |   |                 | 994,334    |          |  | 4.81        |   |   | 18,737,570  |   |   | 887,663    |  |  | 4.74  |  
|Investment securities                                               |  |                              | 119,976,379 |                              |   | 5,699,228                    |  |                 | 4.75  |          |   | 112,178,675 |   |                 | 5,303,886  |          |  | 4.73        |   |   | 114,180,350 |   |   | 5,201,089  |  |  | 4.56  |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Total interest-earning assets                                       |  |                              | 199,027,458 |                              |   | 11,015,294                   |  |                 | 5.53  |          |   | 193,938,750 |   |                 | 12,278,353 |          |  | 6.33        |   |   | 202,629,680 |   |   | 13,073,952 |  |  | 6.45  |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Non-interest earning assets                                         |  |                              | 11,105,146  |                              |   |                              |  |                 |       |          |   | 14,624,973  |   |                 |            |          |  |             |   |   | 14,291,015  |   |   |            |  |  |       |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Total assets                                                        |  | $                            | 210,132,604 |                              |   |                              |  |                 |       |          | $ | 208,563,723 |   |                 |            |          |  |             |   | $ | 216,920,695 |   |   |            |  |  |       |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Liabilities and equity:                                             |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Interest-bearing liabilities:                                       |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Savings accounts                                                    |  | $                            | 12,046,954  |                              |   | 76,011                       |  |                 | 0.63  |          | $ | 11,942,515  |   |                 | 97,900     |          |  | 0.82        |   | $ | 13,421,670  |   |   | 85,413     |  |  | 0.64  |  
|Time accounts                                                       |  |                              | 69,562,982  |                              |   | 1,615,142                    |  |                 | 2.32  |          |   | 66,237,498  |   |                 | 2,436,688  |          |  | 3.68        |   |   | 70,221,095  |   |   | 2,301,764  |  |  | 3.28  |  
|Money market accounts                                               |  |                              | 21,092,188  |                              |   | 310,714                      |  |                 | 1.47  |          |   | 21,366,204  |   |                 | 439,236    |          |  | 2.06        |   |   | 19,357,106  |   |   | 352,956    |  |  | 1.82  |  
|Now accounts                                                        |  |                              | 17,607,727  |                              |   | 127,066                      |  |                 | 0.72  |          |   | 19,258,479  |   |                 | 131,634    |          |  | 0.68        |   |   | 21,508,418  |   |   | 107,973    |  |  | 0.50  |  
|Short Term Borrowings                                               |  |                              |            |                              |   |                             |  |                 |      |          |   |            |   |                 |           |          |  |            |   |   | 19,178      |   |   | 1,112      |  |  | 5.80  |  
|Subordinated debt                                                   |  |                              | 3,098,634   |                              |   | 214,685                      |  |                 | 6.91  |          |   | 5,155,000   |   |                 | 356,159    |          |  | 6.91        |   |   | 5,155,000   |   |   | 356,159    |  |  | 6.91  |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Total interest-bearing liabilities                                  |  |                              | 123,408,485 |                              |   | 2,343,618                    |  |                 | 1.90  |          |   | 123,959,696 |   |                 | 3,461,617  |          |  | 2.79        |   |   | 129,682,467 |   |   | 3,205,377  |  |  | 2.47  |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Checking accounts                                                   |  |                              | 63,545,525  |                              |   |                              |  |                 |       |          |   | 63,596,060  |   |                 |            |          |  |             |   |   | 68,870,282  |   |   |            |  |  |       |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Total                                                               |  |                              | 186,954,010 |                              |   |                              |  |                 |       |          |   | 187,555,756 |   |                 |            |          |  |             |   |   | 198,552,749 |   |   |            |  |  |       |  
|Other liabilities                                                   |  |                              | 1,308,257   |                              |   |                              |  |                 |       |          |   | 1,909,693   |   |                 |            |          |  |             |   |   | 2,529,839   |   |   |            |  |  |       |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Total liabilities                                                   |  |                              | 188,262,267 |                              |   |                              |  |                 |       |          |   | 189,465,449 |   |                 |            |          |  |             |   |   | 201,082,588 |   |   |            |  |  |       |  
|Equity                                                              |  |                              | 21,870,337  |                              |   |                              |  |                 |       |          |   | 19,098,274  |   |                 |            |          |  |             |   |   | 15,838,107  |   |   |            |  |  |       |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Total liabilities and equity                                        |  | $                            | 210,132,604 |                              |   |                              |  |                 |       |          | $ | 208,563,723 |   |                 |            |          |  |             |   | $ | 216,920,695 |   |   |            |  |  |       |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Net interest income/net interest rate spread                        |  |                              |             |                              | $ | 8,671,676                    |  |                 | 3.63  | %        |   |             |   | $               | 8,816,736  |          |  | 3.54        | % |   |             |   | $ | 9,868,575  |  |  | 3.98  | %
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Net interest earning assets/net interest margin                     |  | $                            | 75,618,973  |                              |   |                              |  |                 | 4.36  | %        | $ | 69,979,054  |   |                 |            |          |  | 4.55        | % | $ | 72,947,213  |   |   |            |  |  | 4.87  | %
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Ratio of interest-earning assets to to interest-bearing
liabilities |  |                              | 1.61        | x                            |   |                              |  |                 |       |          |   | 1.56        | x |                 |            |          |  |             |   |   | 1.56        | x |   |            |  |  |       |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Return On Average Assets:                                           |  |                              |             |                              |   |                              |  |                 | 0.92  | %        |   |             |   |                 |            |          |  | 0.98        | % |   |             |   |   |            |  |  | 1.17  | %
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Return On Average Equity:                                           |  |                              |             |                              |   |                              |  |                 | 8.83  | %        |   |             |   |                 |            |          |  | 10.72       | % |   |             |   |   |            |  |  | 16.07 | %
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  
|Equity To Assets:                                                   |  |                              |             |                              |   |                              |  |                 | 10.91 | %        |   |             |   |                 |            |          |  | 10.25       | % |   |             |   |   |            |  |  | 8.18  | %
|                                                                    |  |                              |             |                              |   |                              |  |                 |       |          |   |             |   |                 |            |          |  |             |   |   |             |   |   |            |  |  |       |  

35

---



Rate/Volume Analysis

The following table presents
the extent to which changes in interest rates and changes in the volume of
interest-earning assets and interest-bearing liabilities have affected our
interest income and interest expense during the periods indicated. Information
is provided in each category with respect to (i) changes attributable to
changes in volume (changes in volume multiplied by prior rate), (ii) changes
attributable to changes in rate (changes in rate multiplied by prior volume),
and (iii) the net change. The changes attributable to the combined impact of
volume and rate have been allocated proportionately to the changes due to
volume and the changes due to rate.

|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |   |    |          |   |   |           |  |   |           | 
|--------------------------------- |  | ----------------------------------------------------------------------------------------------------- | -------- | ----------------------------------------------------------------------------------------------------- | -- | ----------------------------------------------------------------------------------------------------- | - | ------ | ---------- | ------ | -- | -------- | - | ------ | ------- | ---- | -- | --------- | - | -- | -------- | - | - | --------- |  | - | --------- | 
|                                  |  | Year Ended December 31, 2008
Compared to
December 31, 2007
Increase/(Decrease)
In Net Interest Income |          | Year Ended December 31, 2007
Compared to
December 31, 2006
Increase/(Decrease)
In Net Interest Income |    | Year Ended December 31, 2006
Compared to
December 31, 2005
Increase/(Decrease)
In Net Interest Income |  
|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |  
|                                  |  | Due to                                                                                                |          |                                                                                                       |    | Due to                                                                                                |   |        |            | Due to |    |          |  
|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |  
|                                  |  | Volume                                                                                                |          | Rate                                                                                                  |    | Net                                                                                                   |   | Volume |            | Rate   |    | Net      |   | Volume |         | Rate |    | Net       |  
|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |  
|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |  
|Interest-earning
 assets:         |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |   |    |          |   |   |           |  |   |           | 
|Loans receivable                  |  | $                                                                                                     | 301,408  |                                                                                                       | ($ | 1,202,965                                                                                             | ) | ($     | 901,557    | )      | ($ | 862,149  | ) | ($     | 142,918 | )    | ($ | 1,005,067 | ) | ($ | 147,482  | ) | $ | 1,304,344 |  | $ | 1,156,862 | 
|Other interest-earning assets     |  |                                                                                                       | (278,390 | )                                                                                                     |    | (478,454                                                                                              | ) |        | (756,844   | )      |    | 90,772   |   |        | 15,899  |      |    | 106,671   |   |    | 17,438   |   |   | 284,713   |  |   | 302,151   | 
|Investment securities, afs        |  |                                                                                                       | 368,831  |                                                                                                       |    | 26,511                                                                                                |   |        | 395,342    |        |    | (91,276  | ) |        | 194,073 |      |    | 102,797   |   |    | (27,019  | ) |   | 357,473   |  |   | 330,454   | 
|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |   |    |          |   |   |           |  |   |           | 
|Total                             |  |                                                                                                       | 391,850  |                                                                                                       |    | (1,654,909                                                                                            | ) |        | (1,263,059 | )      |    | (862,653 | ) |        | 67,054  |      |    | (795,599  | ) |    | (157,062 | ) |   | 1,946,529 |  |   | 1,789,467 | 
|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |   |    |          |   |   |           |  |   |           | 
|Interest-bearing
 liabilities:    |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |   |    |          |   |   |           |  |   |           | 
|Savings accounts                  |  |                                                                                                       | 856      |                                                                                                       |    | (22,745                                                                                               | ) |        | (21,889    | )      |    | (9,467   | ) |        | 21,954  |      |    | 12,487    |   |    | (11,619  | ) |   | 17,959    |  |   | 6,340     | 
|Time accounts                     |  |                                                                                                       | 122,378  |                                                                                                       |    | (943,924                                                                                              | ) |        | (821,546   | )      |    | (130,662 | ) |        | 265,586 |      |    | 134,924   |   |    | 202,996  |   |   | 898,202   |  |   | 1,101,198 | 
|Money market accounts             |  |                                                                                                       | (5,645   | )                                                                                                     |    | (122,877                                                                                              | ) |        | (128,522   | )      |    | 36,566   |   |        | 49,714  |      |    | 86,280    |   |    | (16,260  | ) |   | 139,310   |  |   | 123,050   | 
|Now accounts                      |  |                                                                                                       | (11,225  | )                                                                                                     |    | 6,657                                                                                                 |   |        | (4,568     | )      |    | (11,250  | ) |        | 34,911  |      |    | 23,661    |   |    | (12,967  | ) |   | 16,320    |  |   | 3,353     | 
|Short term borrowings             |  |                                                                                                       |         |                                                                                                       |    |                                                                                                      |   |        |           |        |    | (1,112   | ) |        |        |      |    | (1,112    | ) |    | 1,112    |   |   |          |  |   | 1,112     | 
|Subordinated debt                 |  |                                                                                                       | (141,474 | )                                                                                                     |    |                                                                                                      |   |        | (141,474   | )      |    |         |   |        |        |      |    |          |   |    |         |   |   |          |  |   |          | 
|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |   |    |          |   |   |           |  |   |           | 
|Total                             |  |                                                                                                       | (35,110  | )                                                                                                     |    | (1,082,889                                                                                            | ) |        | (1,117,999 | )      |    | (115,925 | ) |        | 372,165 |      |    | 256,240   |   |    | 163,262  |   |   | 1,071,792 |  |   | 1,235,053 | 
|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |   |    |          |   |   |           |  |   |           | 
|Net change in net interest income |  | $                                                                                                     | 426,959  |                                                                                                       | ($ | 572,019                                                                                               | ) | ($     | 145,060    | )      | ($ | 746,728  | ) | ($     | 305,110 | )    | ($ | 1,051,839 | ) | ($ | 320,324  | ) | $ | 874,737   |  | $ | 554,414   | 
|                                  |  |                                                                                                       |          |                                                                                                       |    |                                                                                                       |   |        |            |        |    |          |   |        |         |      |    |           |   |    |          |   |   |           |  |   |           | 

Effect of Adverse Conditions in the
Residential Mortgage Market

We do not
expect that adverse conditions in the residential mortgage market throughout
the United States will have a direct adverse effect on our financial condition
or results of operations. We are not a residential mortgage lender. At December
31, 2008, we owned $120.3 million of securities that are either collateralized
by residential mortgage loans or that represent shares in pools of such loans.
However, 95.0% of those securities are issued or guaranteed by FNMA, GNMA or
FHLMC. The remainder of the securities portfolio are all investment grade
fixed-rate securities rated AAA that are at least five years old. None of those
securities have experienced ratings downgrades. We do not hold any loans in our
portfolio of the type that are commonly known as subprime residential mortgage
loans

However, many
of our customers, both loan and deposit customers, are involved in the
residential construction business in Staten Island. We believe that the turmoil
in the national housing and residential mortgage markets has had an adverse
effect on some of our customers. An apparent slow down in the local housing
market and a noticeable reduction in the availability of residential mortgage
loans seems to have had an adverse effect on our customers and reduced their
business activity. We believe that this, in turn, has caused a reduction in
their demand for loans from us, such as construction loans to build new homes.
It also appears to have adversely affected the level of deposits they maintain.
Furthermore, as the housing market has slumped, we have become more selective
in our origination of construction loans, making it more difficult to deploy
funds from lower yielding securities investments into higher yielding loans.

The Effect of Declining Market Interest
Rates.

Market
interest rates, especially short term market interest rates, declined
substantially from September 2007 to April 2008 as the Federal Reserve reduced
the target federal funds rate, which resulted in an immediate and equal
reduction in the prime lending rate. The prime rate and the target overnight
federal funds rate both declined by 325 basis points during that period, with
the most dramatic decline being a 200 basis point decline in the two months
from January 22, 2008 through March 18, 2008. As a result, our loan yields
(usually based on the prime rate) and our overnight investment yields (based
upon the target federal funds rate) declined as market interest rates declined.

36

---



The decline in
loan yields and earnings on overnight investments was more rapid than the decline
in our cost of funds for a number of reasons. Approximately one-third of our
deposits are interest-free checking accounts and the rates on those accounts
(already at zero) do not decline as market rates decline. The rates we pay on
interest-bearing deposits, because of their lower starting point, cannot be
reduced by as much as the basis point decline in market rates because of the
need to maintain customer relationships, competitive pressures and the simple
fact that if we price our time deposit rate at, hypothetically, 50% of the
prime rate, and the prime rate declines 100 basis points, then the time deposit
rate only declines 50 basis points. In addition, customers have the ability to
exercise discretion in moving funds between different types of deposits to
maximize their interest earnings.

One tool we
use to manage market interest rate declines is the imposition of interest rate
floors on our prime-based loans. For most of our loans, once the prime rate
falls below 6% (which occurred on March 18, 2008), the interest rate remains at
7% per annum regardless of further declines in interest rates. The interest
rate floors are one reason for the increase in our spread that we have recently
experienced, with spread being 3.13% for the first quarter of 2008, increasing
to 3.50% in the second quarter, 3.84% in the third quarter and dropping to
3.73% in the fourth quarter.

We have some
flexibility in allocating our investment choices between the three categories
of earning assets  loans, investment securities and other investments
(principally overnight investments). As interest rates declined, we elected to
invest more of our available liquid assets into investment securities instead
of overnight investments. This shift in the mix of our investments allowed us
to reduce the effect of declining interest rates because investment securities
tend to have higher yields that overnight investments. We were also able to
reinvest the payments we received on existing investment securities in
securities with rates comparable to the rates we were earning on the securities
being repaid because many of the securities being repaid were purchased a
number of years ago before market interest rates reached their recent peak
towards the end of 2006.

Comparative Results for the Years Ended
December 31, 2008 and December 31, 2007

General. We had net
income of $1,931,744 for the year ended December 31, 2008, as compared to net
income of $2,047,226 for the year ended December 31, 2007. The principal
categories which make up the 2008 net income are:

| | Interest income of $11,015,294                   
|- | -------------------------------------------------
|  |                                                  
| | Reduced by
 interest expense of $2,343,618       
|  |                                                  
| | Reduced by
 provision for loan losses of $285,000
|  |                                                  
| | Increased by
 non-interest income of $2,400,915  
|  |                                                  
| | Reduced by
 non-interest expense of $7,339,594   
|  |                                                  
| | Reduced by
 $1,516,253 in income tax expense.    

We
discuss each of these categories individually and the reasons for the
differences between the years ended December 31, 2008 and 2007 in the following
paragraphs. The most significant factors that caused changes in net interest
income from 2007 to 2008 were a reduction in the yield on interest-earning
assets, primarily in the loan portfolio and other-interest earning assets,
which reduced interest income, partially offset by the decrease in interest
expense due to the drop in the cost of deposits and further partially offset by
an increase in average interest-earning assets.

37

---



Interest
Income.Interest income was $11,015,294 for the year
ended December 31, 2008, compared to $12,278,353 for the year ended December
31, 2007, a decrease of $1,263,059, or 10.3%. The principal reasons for this
decrease were a 188 basis point decrease in the yield on our loan portfolio and
a 321 basis point decrease in the yield of other-interest earning assets
(principally overnight investments), due principally to declines in market
interest rates. The decrease was partially offset by the higher average balance
of the investment security portfolio with a higher yield, as we reduced other
interest earning assets and reallocated the funds to increase the average
balance of investment securities. As a result, the average balance of overnight
investments decreased by $5,787,734.

The average
yield on our investment securities portfolio increased 2 basis points, from
4.73% to 4.75%, due to the purchase of new investment securities at slightly
higher market rates than the yields on the principal paydowns we received. The
yield on investment securities did not decrease as did the yields on other interest
earning assets because most of the bonds and notes in our investment portfolio
have either fixed interest rates or interest rates that react more slowly to
changes in market interest rate conditions. The average balance of our
investment portfolio increased by $7,797,704, or 7.0%, between the periods. The
increase in volume and the increase in yield resulted in an overall $395,342
increase in interest income from investment securities. The investment
securities portfolio represented 89.0% of average non-loan interest earning
assets in the 2008 period compared to 84.5% in the 2007 period.

Interest Expense. Interest expense was
$2,343,618 for 2008, compared to $3,461,617 for 2007, a decrease of $1,117,999
or 32.3%. The decrease was primarily the result of the repayment of the
subordinated debt in August 2008 coupled with a decrease in the rates we paid
on deposits, specifically time deposits (136 basis point decrease) and money
market accounts (59 basis point decrease). Our average cost of funds, excluding
the effect of interest-free demand deposits, decreased to 1.90% from 2.79%
between the periods due to the decline in market interest rates.

Net Interest Income Before Provision for Loan
Losses.
Net interest income before the provision for loan losses was $8,671,676 for
2008, a decrease of $145,060, or 1.7%, compared to $8,816,736 of net interest
income we had for 2007. The decrease was driven primarily by the decrease in
the yield on average interest-earning assets coupled with the decrease in the
average cost of funds. Our interest rate spread increased by 9 basis points
from 3.54% at December 31, 2007 to 3.63% at December 31, 2008. We were able to
increase the spread due to our ability to maintain the yield on our investment
securities portfolio and the re-allocation of lower yielding overnight deposits
to investment securities. Our net interest margin, which includes the effect of
interest-free demand deposits and capital as funding sources, decreased to
4.36% in the year end 2008 from 4.55% in the same period of 2007, principally
because interest free deposits and capital are less valuable as funding sources
when they are invested at the lower yields available in 2008. The prime rate,
which is the index used to adjust interest rates on many of our loans, was
3.25% at the end of 2008, as compared to 7.25% at the end of 2007. Although our
prime-based loans primarily have interest rates with a margin of 100 to 150
basis points above the prime rate, many have interest rate floors so that the
rates on the loans cannot decline below 7.00% to 7.50%.

Provision
for Loan Losses.We took a provision for loan losses
of $285,000 for the year ended December 31, 2008 compared to a credit provision
for loan losses of $5,000 for the year ended December 31, 2007. The increase in
the provision was the result of an increase in loan delinquencies and
charge-offs. The provision for loan losses in any period depends upon the
amount necessary to bring the allowance for loan losses to the level management
believes is appropriate, after taking into account charge offs and recoveries.
Our allowance for loan losses is based on managements evaluation of probable
incurred losses on loans. Management periodically evaluates both broad
categories of performing loans and problem loans individually to assess the
appropriate level of the allowance.

Although
management uses available information to assess the appropriateness of the
allowance on a quarterly basis in consultation with outside advisors and the
board of directors, changes in national or local economic conditions, the
circumstances of individual borrowers, or other factors, may change, increasing
the level of problem loans and requiring an increase in the level of the
allowance. The allowance for loan losses represented 1.49% of total loans at
December 31, 2008, but there can be no assurance that a higher level, or a
higher provision for loan losses, will not be necessary in the future.

38

---



Non-interest Income.Non-interest income
was $2,400,915 for the year ended December 31, 2008, compared to $2,173,392
during the same period last year, an increase of 10.5%. The $227,523, or 10.8%,
increase in non-interest income was a direct result of a $326,070 increase in
service charges on deposits and an increase in net rental income of $52,710,
partially offset by a decrease of $151,257 in other income. Service fees on
deposit accounts, principally non-sufficient funds fees, increased from 2007 to
2008 due to an increase in the number of non-sufficient fund transactions
coupled with our decision to increase per item charges for both insufficient
fund and bounced check fees and other deposit fees in March of 2008. The
increase in net rental income was due to the occupancy of one of the Banks subleased
properties. The decrease in other income was a result of the loss of a check
cashing customer and the fee income associated with that business.

Non-interest
Expense. Non-interest expense was $7,339,594 for the
year ended December 31, 2008, compared to $7,274,391 for the year ended
December 31, 2007, an increase of 0.9%. The principal causes of the $65,203
increase were:

| |   |                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $116,262
 increase in occupancy expenses principally due to higher utility bills;                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                        
| |  | $86,798
 increase in legal expenses primarily due to increased collection costs and in
 2007 we received reimbursement from our insurance company of legal fees
 previously expensed;                                                                                                  
| |   |                                                                                                                                                                                                                                                                                        
| |  | $111,466
 increase in other expenses due to an increase in advertising expenses in
 connection with the Banks new advertising campaign and a $40,110 recovery in
 2007 of part of a reserve expensed in 2005 for a legal claim that we settled
 for less than the reserve in 2007; and
| |   |                                                                                                                                                                                                                                                                                        
| |  | $286,056
 decrease in salaries and benefits expense, due in part to the retirement of
 the former president and reduced incentive and ESOP compensation expense.                                                                                                                       

Income Tax Expense. Income tax expense was
$1,516,253 for the year ended December 31, 2008, compared to income tax expense
of $1,673,511 for the year ended December 31, 2007, a decrease of 9.4%. The
decrease in income tax expense was due to the $272,740 decrease in income
before income taxes in the 2008 and a decrease in our effective tax rate for
the year ended December 31, 2008 to 44.0% from 45.0% for the year ended
December 31, 2007.

Changes in Financial Condition

Total
assets were $212,657,728 at December 31, 2008, an increase of $8,864,159 or,
4.4%, from December 31, 2007. The increase resulted from the investment of
funds available to us as the result of an increase in deposits. The deposit
increase was caused generally by our efforts to grow our franchise and
specifically by the deposit increases at our branch offices. We invested these
funds primarily in investment securities available for sale. The net increase
in assets can be summarized as follows:

|  |                                                                           
|- | --------------------------------------------------------------------------
| | A $3,543,344
 net increase in cash and cash equivalents.                  
|  |                                                                           
| | A $2,474,471
 net increase in investment securities available for sale and
|  |                                                                           
| | A $3,960,909
 net increase in net loans receivable.                       

In
addition, we also experienced changes in other asset categories due to normal
fluctuations in operations.

Our
deposits (including escrow deposits) were $188,109,449 at December 31, 2008, an
increase of $11,775,006 or 6.9%, from December 31, 2007. The increase in
deposits resulted from increases of $11,584,930 in time deposits, $1,063,450 in
savings accounts, $2,295,068 in money market and $705,041 in NOW, partially
offset by a decrease of $3,873,483 in non-interest demand deposits.

Total
stockholders equity was $23,203,767 at December 31, 2008, an increase of
$2,319,962, or 11.1%, from December 31, 2007. The increase reflected (i) net
income of $1,931,744 for the year ended December 31, 2008, (ii) an increase of
additional paid in capital of $164,857 due to the exercise by management and
directors of 23,375 options previously granted under our stock option plans,
(iii) an increase of net unrealized gain on securities available for sale of
$966,135 and (iv) a reduction of $169,077 in Unearned ESOP shares reflecting
the gradual payment of the loan we made to fund the ESOPs purchase of our
stock. These increases were partially offset by $443,996 of dividends paid,
representing the four $0.06 per share quarterly, cash dividends declared in
2008.

39

---



The
unrealized gain on securities available for sale is excluded from the
calculation of regulatory capital. Management does not anticipate selling
securities in this portfolio, but changes in market interest rates or in the
demand for funds may change managements plans with respect to the securities
portfolio. If there is a material increase in interest rates, the market value
of the available for sale portfolio may decline. Management believes that the
principal and interest payments on this portfolio, combined with the existing
liquidity, will be sufficient to fund loan growth and potential deposit
outflow.

For
financial statement reporting purposes, we record the compensation expense
related to the ESOP when shares are committed to be released from the security
interest for the loan. The amount of the compensation expense is based upon the
fair market value of the shares at that time, not the original purchase price.
The initial sale of shares to the ESOP did not increase our capital by the
amount of the purchase price because the purchase price was paid by the loan we
made to the ESOP. Instead, capital increases as the shares are allocated or
committed to be allocated to employee accounts (i.e., as the ESOP loan is
gradually repaid), based upon the fair market value of the shares at that time.
When we calculate earnings per share, only shares allocated or committed to be
allocated to employee accounts are considered to be outstanding. However, all
shares that the ESOP owns are legally outstanding, so they have voting rights
and, if we pay dividends, dividends will be paid on all ESOP shares.

Liquidity and Capital Resources

Our
primary sources of funds are increases in deposits and proceeds from the
repayment of investment securities. We use these funds principally to purchase
new investment securities and to fund increases in our loan portfolio.

In
2008, we had a net increase in total deposits of $11,775,006 due to increases
of $11,584,930 in time deposits, $1,063,450 in savings accounts, $2,295,068 in
money market and $705,041 in NOW, partially offset by a decrease of $3,873,483
in non-interest demand deposits. We also received proceeds from repayment of
investment securities of $25,554,513. We used $26,157,422 of available funds to
purchase new investment securities, $5,155,000 to repay our subordinated debt
and we had a net loan increase of $3,960,909.

In
2007, we had a net decrease in total deposits of $10,348,707 as a result of a
$4,846,529 decrease in demand deposit accounts, a $3,490,680 decrease in time
deposits, a $3,004,656 decrease in NOW accounts and a $1,177,374 decrease in
savings accounts, partially offset by a $2,175,714 increase in money market
accounts. We received proceeds from repayment of investment securities of
$36,847,421, which we used to fund the deposit outflow, net loan reduction of
$4,023,211 and the purchase of $38,972,061 of investment securities.

In
2008, we experienced an increase of $3,543,344 in cash and equivalents because
of the increase in deposits. Total cash and equivalents at December 31, 2008
were $21,240,223.

In
2007, we experienced a net decline of $7,666,190 in cash and equivalents
because of our strategy to invest available cash in investments as opposed to
lower yielding overnight deposits to the extent not needed to fund the deposit
outflow. Total cash and equivalents at December 31, 2007 were $17,696,879.

At
year end 2008, cash and cash equivalents represented 10% of total assets. We
anticipate, based upon historical experience that these funds, combined with
cash inflows we anticipate from payments on our loan and investment securities
portfolios, will be sufficient to fund loan growth and unanticipated deposit
outflows. As a secondary source of liquidity, at year end 2008 we had in excess
of $120 million of investment securities classified available for sale. The
disposition of these securities prior to maturity is an option available to us
in the event, which we believe is unlikely, that our primary sources of
liquidity and expected cash flows are insufficient to meet our need for funds.
We do not anticipate a need for additional capital resources and do not expect
to raise funds through a stock offering in the near future. As a result of our
strong capital resources and available liquidity, we did not participate in the
Treasury Departments TARP Capital Purchase Program. We have sufficient
resources to allow us to continue to make loans as appropriate opportunities
arise without having to rely on government funds to support our lending
activities.

40

---



In
August 2008, we unwound our trust preferred securities transaction by calling
(and repaying) the $5,155,000 subordinated debenture we had on our balance
sheet at June 30, 2008. We used available cash to repay the debenture and we
expect that the repayment will have no material adverse effect on our
liquidity. We elected to repay the debenture and end the trust preferred
transaction because we believe that the future cost to us (3 month LIBOR plus
300 basis points per annum, adjusted every three months) would have exceeded
the value of the additional capital that the transaction gave us for regulatory
capital purposes. Victory State Bank and VSB Bancorp, Inc. were both
well-capitalized for regulatory capital purposes after the debenture was
repaid.

The
FDIC has recently instituted the Temporary Liquidity Guarantee Program in which
the FDIC will guarantee, with certain limitations, all senior unsecured debt of
eligible financial institutions. We do not expect to avail ourselves of this
program because we believe that our liquid assets and our ability to obtain
funds through traditional channels are more than sufficient to provide the
liquidity we need.

The following
table sets forth our contractual obligations and commitments for future lease
payments, time deposit maturities and loan commitments.

Contractual Obligations and Commitments at December 31, 2008

|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |   |           |  |   |            | 
|-------------------------------------------------------------------- |  | ----------------------------------------- | ---------- | ------------------ | - | ------------------ |  | ---------------- | --------- | ----------------------- | - | --------- |  | - | ---------- | 
|Contractual
Obligations                                              |  | Payment due by Period                     |           
|                                                                     |  |                                           |           
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |  
|                                                                     |  | Less than
One Year                        |            | One to three
years |   | Four to five
years |  | After
five years |           | Total Amounts
committed |  
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |  
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |   |           |  |   |            | 
|Minimum annual rental payments under non-cancelable operating
leases |  | $                                         | 399,063    |                    | $ | 818,018            |  | $                | 846,968   |                         | $ | 1,790,340 |  | $ | 3,854,389  | 
|Remaining contractual maturities of time deposits                    |  |                                           | 73,529,688 |                    |   | 1,141,951          |  |                  | 1,651,855 |                         |   |          |  |   | 76,323,494 | 
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |   |           |  |   |            | 
|Total contractual cash obligations                                   |  | $                                         | 73,928,751 |                    | $ | 1,959,969          |  | $                | 2,498,823 |                         | $ | 1,790,340 |  | $ | 80,177,883 | 
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |   |           |  |   |            | 
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |   |           |  |   |            | 
|Other commitments                                                    |  | Amount of commitment Expiration by Period |           
|                                                                     |  |                                           |           
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |  
|                                                                     |  | Less than
One Year                        |            | One to three
years |   | Four to five
years |  | After
five years |           | Total Amounts
committed |  
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |  
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |   |           |  |   |            | 
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |   |           |  |   |            | 
|Loan commitments                                                     |  | $                                         | 21,583,258 |                    | $ | 3,637,653          |  | $                | 499,000   |                         | $ |          |  | $ | 25,719,911 | 
|                                                                     |  |                                           |            |                    |   |                    |  |                  |           |                         |   |           |  |   |            | 

Impact of Inflation and Changing Prices

The
consolidated financial statements and related notes presented herein have been
prepared in accordance with accounting principles generally accepted in the
United States, which require the measurement of financial position and
operating results in terms of historical dollars without considering the
changes in the relative purchasing power of money over time and due to
inflation. Unlike industrial companies, nearly all of our assets and
liabilities are monetary. As a result, interest rates have a greater impact on
our performance than do the general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the price of
goods and services.

41

---



Item 8.

The companys
financial statements appear on the following pages:

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                |  |    
|----------------------------------------------------------------------------------------------- |  | ---
|Report of Independent Registered Public Accounting Firm                                         |  | F-1
|                                                                                                |  |    
|Consolidated Statements of Financial Condition as of December 31,
 2008 and 2007                |  | F-2
|                                                                                                |  |    
|Consolidated Statements of Earnings for the Years Ended December 31,
 2008 and 2007             |  | F-3
|                                                                                                |  |    
|Consolidated Statements of Stockholders Equity for the Years Ended
 December 31, 2008 and 2007 |  | F-4
|                                                                                                |  |    
|Consolidated Statements of Cash Flows for the Years Ended December
 31, 2008 and 2007           |  | F-5
|                                                                                                |  |    
|Notes to Consolidated Financial Statements                                                      |  | F-6

42

---



Report of Independent
Registered Public Accounting Firm

Board of
Directors and Stockholders
VSB Bancorp, Inc. 
Staten Island, New York

We have
audited the accompanying consolidated statements of financial condition of VSB
Bancorp, Inc. as of December 31, 2008 and 2007, and the related consolidated
statements of earnings, stockholders equity and comprehensive income, and cash
flows for the years then ended. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted
our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over financial
reporting. Our audit included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Companys internal control over financial reporting.
Accordingly, we express no such opinion. An audit 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 financial statements referred to above present fairly, in all
material respects, the financial position of VSB Bancorp, Inc. as of December
31, 2008 and 2007, and the results of its operations and its cash flows for the
years then ended in conformity with U.S. generally accepted accounting
principles.

| |                       
| | ----------------------
| | /s/ Crowe
 Horwath LLP

Livingston,
New Jersey 
March 16, 2009

F-1

---



VSB BANCORP, INC.

|                                              
|----------------------------------------------
|CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
|DECEMBER
 31, 2008 AND 2007                   
|                                              

|                                                                                                                                                                                    |  |      |             |      |   |             |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | ---- | - | ----------- | -
|                                                                                                                                                                                    |  | 2008 |             | 2007 |  
|                                                                                                                                                                                    |  |      |             |      |  
|                                                                                                                                                                                    |  |      |             |      |  
|ASSETS                                                                                                                                                                              |  |      |             |      |  
|Cash and cash equivalents                                                                                                                                                           |  | $    | 21,240,223  |      | $ | 17,696,879  |  
|Investment securities, available for sale                                                                                                                                           |  |      | 120,288,588 |      |   | 117,814,117 |  
|Loans receivable (net of allowance for loan losses of $987,876 and
 $927,161, respectively)                                                                                         |  |      | 65,258,776  |      |   | 61,445,917  |  
|Accrued interest receivable                                                                                                                                                         |  |      | 723,473     |      |   | 799,249     |  
|Premises and equipment, net                                                                                                                                                         |  |      | 3,695,822   |      |   | 3,931,679   |  
|Prepaid and other assets                                                                                                                                                            |  |      | 925,007     |      |   | 1,114,431   |  
|Deferred income taxes, net                                                                                                                                                          |  |      | 525,839     |      |   | 991,297     |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|Total
 assets                                                                                                                                                                       |  | $    | 212,657,728 |      | $ | 203,793,569 |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                |  |      |             |      |   |             |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|LIABILITIES:                                                                                                                                                                        |  |      |             |      |   |             |  
|Deposits                                                                                                                                                                            |  |      |             |      |   |             |  
|Non-interest bearing                                                                                                                                                                |  | $    | 58,907,451  |      | $ | 62,780,934  |  
|Interest bearing                                                                                                                                                                    |  |      | 129,201,998 |      |   | 113,553,509 |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|Total deposits                                                                                                                                                                      |  |      | 188,109,449 |      |   | 176,334,443 |  
|Subordinated debt                                                                                                                                                                   |  |      |            |      |   | 5,155,000   |  
|Accounts payable, accrued expenses and other liabilities                                                                                                                            |  |      | 1,344,512   |      |   | 1,420,321   |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|Total
 liabilities                                                                                                                                                                  |  |      | 189,453,961 |      |   | 182,909,764 |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|                                                                                                                                                                                   
|Commitments and contigent liabilities (Note 12)                                                                                                                                     |  |      |            |      |   |            |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|STOCKHOLDERS EQUITY                                                                                                                                                                |  |      |             |      |   |             |  
|Common stock ($.0001 par value, 3,000,000 shares authorized, 1,923,884
 issued, 1,882,461 outstanding at December 31, 2008; 1,900,509 issued and
 outstanding at December 31, 2007) |  |      | 192         |      |   | 190         |  
|Additional paid-in capital                                                                                                                                                          |  |      | 9,200,010   |      |   | 9,107,119   |  
|Retained earnings                                                                                                                                                                   |  |      | 14,714,143  |      |   | 13,226,395  |  
|Treasury stock, at cost (41,423 shares at December 31,
2008)                                                                                                                        |  |      | (395,891    | )    |   |            |  
|Unearned Employee Stock Ownership Plan shares                                                                                                                                       |  |      | (901,750    | )    |   | (1,070,827  | )
|Accumulated other comprehensive gains(loss), net of taxes of $488,735
 and ($330,668), respectively                                                                                 |  |      | 587,063     |      |   | (379,072    | )
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|Total
 stockholders equity                                                                                                                                                         |  |      | 23,203,767  |      |   | 20,883,805  |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  
|Total liabilities and stockholders
equity                                                                                                                                          |  | $    | 212,657,728 |      | $ | 203,793,569 |  
|                                                                                                                                                                                    |  |      |             |      |   |             |  

F-2

---



|                                                                                   
|-----------------------------------------------------------------------------------
|VSB
 BANCORP, INC.                                                                 
|                                                                                   
|CONSOLIDATED STATEMENTS OF EARNINGS FOR THE
 YEARS ENDED DECEMBER 31, 2008 AND 2007
|                                                                                   

|                                                    |  |      |            |      |   |            |  
|--------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
|                                                    |  | 2008 |            | 2007 |  
|                                                    |  |      |            |      |  
|INTEREST INCOME:                                    |  |      |            |      |   |            |  
|Loans receivable                                    |  | $    | 5,078,576  |      | $ | 5,980,133  |  
|Investment securities                               |  |      | 5,699,228  |      |   | 5,303,886  |  
|Other interest income                               |  |      | 237,490    |      |   | 994,334    |  
|                                                    |  |      |            |      |   |            |  
|Total interest income                               |  |      | 11,015,294 |      |   | 12,278,353 |  
|INTEREST EXPENSE:                                   |  |      |            |      |   |            |  
|Deposits                                            |  |      | 2,128,933  |      |   | 3,105,458  |  
|Subordinated Debt                                   |  |      | 214,685    |      |   | 356,159    |  
|                                                    |  |      |            |      |   |            |  
|Total interest expense                              |  |      | 2,343,618  |      |   | 3,461,617  |  
|Net interest income                                 |  |      | 8,671,676  |      |   | 8,816,736  |  
|PROVISION (CREDIT) PROVISION FOR LOAN LOSSES        |  |      | 285,000    |      |   | (5,000     | )
|                                                    |  |      |            |      |   |            |  
|Net interest income after provision for loan
losses |  |      | 8,386,676  |      |   | 8,821,736  |  
|                                                    |  |      |            |      |   |            |  
|NON-INTEREST INCOME:                                |  |      |            |      |   |            |  
|Deposit service fees                                |  |      | 2,120,769  |      |   | 1,794,699  |  
|Other income                                        |  |      | 280,146    |      |   | 378,693    |  
|                                                    |  |      |            |      |   |            |  
|Total non-interest income                           |  |      | 2,400,915  |      |   | 2,173,392  |  
|                                                    |  |      |            |      |   |            |  
|NON-INTEREST EXPENSES:                              |  |      |            |      |   |            |  
|Salaries and employee benefits                      |  |      | 3,514,898  |      |   | 3,800,954  |  
|Occupancy and equipment                             |  |      | 1,469,898  |      |   | 1,353,636  |  
|Data processing service fees                        |  |      | 245,014    |      |   | 258,881    |  
|Legal fees                                          |  |      | 189,118    |      |   | 102,320    |  
|Professional fees                                   |  |      | 256,500    |      |   | 207,200    |  
|Director fees                                       |  |      | 217,450    |      |   | 216,150    |  
|Supplies and service                                |  |      | 324,546    |      |   | 349,737    |  
|Checkbook charges                                   |  |      | 124,196    |      |   | 156,007    |  
|Other                                               |  |      | 997,974    |      |   | 829,506    |  
|                                                    |  |      |            |      |   |            |  
|Total non-interest expenses                         |  |      | 7,339,594  |      |   | 7,274,391  |  
|                                                    |  |      |            |      |   |            |  
|INCOME BEFORE INCOME TAXES                          |  |      | 3,447,997  |      |   | 3,720,737  |  
|                                                    |  |      |            |      |   |            |  
|PROVISION/(BENEFIT) FOR INCOME TAXES:               |  |      |            |      |   |            |  
|Current                                             |  |      | 1,870,198  |      |   | 1,507,173  |  
|Deferred                                            |  |      | (353,945   | )    |   | 166,338    |  
|                                                    |  |      |            |      |   |            |  
|Total income taxes                                  |  |      | 1,516,253  |      |   | 1,673,511  |  
|                                                    |  |      |            |      |   |            |  
|NET INCOME                                          |  | $    | 1,931,744  |      | $ | 2,047,226  |  
|                                                    |  |      |            |      |   |            |  
|Earnings per share:                                 |  |      |            |      |   |            |  
|Basic                                               |  | $    | 1.04       |      | $ | 1.12       |  
|                                                    |  |      |            |      |   |            |  
|Diluted                                             |  | $    | 1.03       |      | $ | 1.09       |  
|                                                    |  |      |            |      |   |            |  
|Comprehensive income                                |  | $    | 2,897,879  |      | $ | 3,048,032  |  
|                                                    |  |      |            |      |   |            |  

See notes to consolidated financial
statements.

F-3

---



|                                                                             
|-----------------------------------------------------------------------------
|VSB BANCORP, INC.                                                            
|CONSOLIDATED
 STATEMENTS OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME FOR
|THE YEARS
 ENDED DECEMBER 31, 2008 AND 2007                                  
|                                                                             

|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|------------------------------------------------------------------------------- |  | ----------------------- | --------- | ------------ | - | -------------------------- |  | ----------------- | --------- | ----------------------- | - | -------------------- | - | --------------------------------- | -------- | -------------------------- | - | ---------- | - | - | ---------- | - | - | ---------- | -
|                                                                                |  | Number of
Common
Shares |           | Common
Stock |   | Additional
Paid-in
Capital |  | Retained
Earnings |           | Treasury
Stock,
at cost |   | Unearned
ESOP
Shares |   | Other
Comprehensive
Gain / (Loss) |          | Total
Stockholders
Equity |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Balance at December 31, 2006                                                    |  |                         | 1,891,759 |              | $ | 189                        |  | $                 | 8,667,665 |                         | $ | 11,293,200           |   | $                                 |         |                            | $ | (1,239,905 | ) | $ | (1,379,878 | ) | $ | 17,341,271 |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Exercise of stock options, including tax benefit                                |  |                         | 8,750     |              |   | 1                          |  |                   | 77,832    |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   | 77,833     |  
|Stock-based compensation                                                        |  |                         |           |              |   |                            |  |                   | 162       |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   | 162        |  
|Amortization of earned portion of ESOP common stock                             |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   | 169,078    |   |   |            |   |   | 169,078    |  
|Amortization of cost over fair value - ESOP                                     |  |                         |           |              |   |                            |  |                   | (37,566   | )                       |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   | (37,566    | )
|Transfer from ESOP repuchase obligation                                         |  |                         |           |              |   |                            |  |                   | 399,026   |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   | 399,026    |  
|Cash dividends declared ($0.06 per share)                                       |  |                         |           |              |   |                            |  |                   |           |                         |   | (114,031             | ) |                                   |          |                            |   |            |   |   |            |   |   | (114,031   | )
|Comprehensive income:                                                           |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Net income                                                                      |  |                         |           |              |   |                            |  |                   |           |                         |   | 2,047,226            |   |                                   |          |                            |   |            |   |   |            |   |   | 2,047,226  |  
|Other comprehensive income, net:                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Change in unrealized loss on securities available
for sale, net of tax
 effects |  |                         |          |              |   |                           |  |                   |          |                         |   |                     |   |                                   |         |                            |   |           |   |   | 1,000,806  |   |   | 1,000,806  |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Total comprehensive income                                                      |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   | 3,048,032  |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Balance at December 31, 2007                                                    |  |                         | 1,900,509 |              | $ | 190                        |  | $                 | 9,107,119 |                         | $ | 13,226,395           |   | $                                 |         |                            | $ | (1,070,827 | ) | $ | (379,072   | ) | $ | 20,883,805 |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Exercise of stock options, including tax benefit                                |  |                         | 23,375    |              |   | 2                          |  |                   | 164,857   |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   | 164,859    |  
|Stock-based compensation                                                        |  |                         |           |              |   |                            |  |                   | 1,278     |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   | 1,278      |  
|Amortization of earned portion of ESOP common stock                             |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   | 169,077    |   |   |            |   |   | 169,077    |  
|Amortization of cost over fair value - ESOP                                     |  |                         |           |              |   |                            |  |                   | (73,244   | )                       |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   | (73,244    | )
|Cash dividends declared ($0.24 per share)                                       |  |                         |           |              |   |                            |  |                   |           |                         |   | (443,996             | ) |                                   |          |                            |   |            |   |   |            |   |   | (443,996   | )
|Purchase of treasury stock, at cost                                             |  |                         | (41,423   | )            |   |                            |  |                   |           |                         |   |                      |   |                                   | (395,891 | )                          |   |            |   |   |            |   |   | (395,891   | )
|Comprehensive income:                                                           |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Net income                                                                      |  |                         |           |              |   |                            |  |                   |           |                         |   | 1,931,744            |   |                                   |          |                            |   |            |   |   |            |   |   | 1,931,744  |  
|Other comprehensive income, net:                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Change in unrealized loss on securities available
for sale, net of tax
 effects |  |                         |          |              |   |                           |  |                   |          |                         |   |                     |   |                                   |         |                            |   |           |   |   | 966,135    |   |   | 966,135    |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Total comprehensive income                                                      |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   | 2,897,879  |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  
|Balance at December 31, 2008                                                    |  |                         | 1,882,461 |              | $ | 192                        |  | $                 | 9,200,010 |                         | $ | 14,714,143           |   | $                                 | (395,891 | )                          | $ | (901,750   | ) | $ | 587,063    |   | $ | 23,203,767 |  
|                                                                                |  |                         |           |              |   |                            |  |                   |           |                         |   |                      |   |                                   |          |                            |   |            |   |   |            |   |   |            |  

See notes to consolidated
 financial statements.

F-4

---



|                                                                                     
|-------------------------------------------------------------------------------------
|VSB
 BANCORP, INC.                                                                   
|CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
 DECEMBER 31, 2008 and 2007
|                                                                                     

|                                                                                   |  |      |             |      |   |             |   | 
|---------------------------------------------------------------------------------- |  | ---- | ----------- | ---- | - | ----------- | - | 
|                                                                                   |  | 2008 |             | 2007 |   |            
|                                                                                   |  |      |             |      |   |            
|CASH FLOWS FROM OPERATING ACTIVITIES:                                              |  |      |             |      |   |             |   | 
|Net income                                                                         |  | $    | 1,931,744   |      | $ | 2,047,226   |   | 
|Adjustments to reconcile net income to net cash
provided by operating
 activities: |  |      |             |      |   |             |   | 
|Depreciation and amortization                                                      |  |      | 630,692     |      |   | 617,958     |   | 
|Accretion of discount, net amortization of
premium                                 |  |      | (222,974    | )    |   | (227,323    | ) | 
|ESOP compensation expense                                                          |  |      | 95,833      |      |   | 131,512     |   | 
|Stock-based compensation expense                                                   |  |      | 1,278       |      |   | 162         |   | 
|Provision/(credit) for loan losses                                                 |  |      | 285,000     |      |   | (5,000      | ) | 
|Gain loss on the sale of other assets                                              |  |      |            |      |   | (6,118      | ) | 
|Changes in operating assets and
liabilities:                                       |  |      |             |      |   |             |   | 
|Decrease/(increase) in prepaid and other
assets                                    |  |      | 189,424     |      |   | (178,762    | ) | 
|Decrease in accrued interest receivable                                            |  |      | 75,776      |      |   | 6,432       |   | 
|(Increase)/decrease in deferred income
taxes                                       |  |      | (353,945    | )    |   | 166,338     |   | 
|Decrease in accrued expenses, income tax payable and
other liabilities             |  |      | (75,809     | )    |   | (885,991    | ) | 
|                                                                                   |  |      |             |      |   |             |   | 
|Net cash provided by operating activities                                          |  |      | 2,557,019   |      |   | 1,666,434   |   | 
|                                                                                   |  |      |             |      |   |             |   | 
|CASH FLOWS FROM INVESTING ACTIVITIES:                                              |  |      |             |      |   |             |   | 
|Net (increase)/decrease in loans
receivable                                        |  |      | (3,960,909  | )    |   | 4,023,211   |   | 
|Proceeds from repayments and calls of investment
securities, available
 for sale   |  |      | 25,554,513  |      |   | 36,847,421  |   | 
|Purchase of investment securities, available for
sale                              |  |      | (26,157,422 | )    |   | (38,972,061 | ) | 
|Purchases of premises and equipment, net                                           |  |      | (394,835    | )    |   | (846,290    | ) | 
|                                                                                   |  |      |             |      |   |             |   | 
|Net cash (used in)/provided by investing
activities                                |  |      | (4,958,653  | )    |   | 1,052,281   |   | 
|                                                                                   |  |      |             |      |   |             |   | 
|CASH FLOWS FROM FINANCING ACTIVITIES:                                              |  |      |             |      |   |             |   | 
|Net increase/(decrease) in deposits                                                |  |      | 11,775,006  |      |   | (10,348,707 | ) | 
|Payment of subordinated debt                                                       |  |      | (5,155,000  | )    |   |            |   | 
|Cash dividends paid                                                                |  |      | (443,996    | )    |   | (114,031    | ) | 
|Exercise of stock options                                                          |  |      | 164,859     |      |   | 77,833      |   | 
|Purchase of treasury stock, at cost                                                |  |      | (395,891    | )    |   |            |   | 
|                                                                                   |  |      |             |      |   |             |   | 
|Net cash provided by/(used in) financing
activities                                |  |      | 5,944,978   |      |   | (10,384,905 | ) | 
|                                                                                   |  |      |             |      |   |             |   | 
|NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS                               |  |      | 3,543,344   |      |   | (7,666,190  | ) | 
|CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                                       |  |      | 17,696,879  |      |   | 25,363,069  |   | 
|                                                                                   |  |      |             |      |   |             |   | 
|CASH AND CASH EQUIVALENTS, END OF YEAR                                             |  | $    | 21,240,223  |      | $ | 17,696,879  |   | 
|                                                                                   |  |      |             |      |   |             |   | 
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                  |  |      |             |      |   |             |   | 
|Cash paid during the period for:                                                   |  |      |             |      |   |             |   | 
|Interest                                                                           |  | $    | 2,594,736   |      | $ | 3,584,628   |   | 
|                                                                                   |  |      |             |      |   |             |   | 
|Income taxes                                                                       |  | $    | 1,697,259   |      | $ | 1,829,292   |   | 
|                                                                                   |  |      |             |      |   |             |   | 
|Transfer of construction in progress to premises and equipment from
 other assets  |  | $    |            |      | $ | 2,142,866   |   | 
|                                                                                   |  |      |             |      |   |             |   | 

See notes to consolidated financial
statements.

F-5

---



|                                                                                         
|-----------------------------------------------------------------------------------------
|VSB
 BANCORP, INC.                                                                       
|                                                                                         
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2008 and 2007
|                                                                                         

|   |        
|-- | -------
|1. | GENERAL

VSB
Bancorp, Inc. (Bancorp or Company) is the holding company for Victory State
Bank (Bank), a New York State chartered commercial bank. On May 30, 2003 as
the result of a reorganization of the Bank into the holding company form of
organization, the stockholders of the Bank became the stockholders of VSB
Bancorp, Inc. As a result of the reorganization the stockholders of VSB
Bancorp, Inc. received three shares of VSB Bancorp, Inc. stock for each two
shares of Victory State Bank stock. Each stockholder owned the same percentage
interest in VSB Bancorp immediately after the reorganization that the
stockholder owned in the Bank immediately before the reorganization, subject to
immaterial differences due to adjustments for cash in lieu of fractional shares.
VSB Bancorp now owns 100% of the capital stock of the Bank. No stockholders of
the Bank exercised dissenters rights to receive cash instead of shares of the
Company. The transaction between these entities under common control was
accounted for at historical cost on an as if pooled basis. Our common stock
now trades on the NASDAQ Global Market (NASDAQ GM) effective August 4, 2008,
under the stock symbol VSBN.

Through
the Bank, the Company is primarily engaged in the business of commercial banking,
and to a lesser extent retail banking. The Bank gathers deposits from
individuals and businesses primarily in Staten Island, New York and makes loans
throughout that community. Therefore, the Companys exposure to credit risk is
significantly affected by changes in the local Staten Island economic and real
estate markets. The Bank invests funds that are not used for lending primarily
in government securities, mortgage backed securities and collateralized
mortgage obligations. Customer deposits are insured, up to the applicable
limit, by the Federal Deposit Insurance Corporation (FDIC). The Bank is
supervised by the New York State Banking Department and the FDIC.

|   |                                            
|-- | -------------------------------------------
|2. | SUMMARY
 OF SIGNIFICANT ACCOUNTING POLICIES

The
following is a description of the significant accounting and reporting policies
followed in preparing and presenting the accompanying consolidated financial
statements. These policies conform with accounting principles generally
accepted in the United States of America (GAAP).

Principles of Consolidation - The
consolidated financial statements of
the Company include the accounts of the Company, including its subsidiary
Victory State Bank. All significant inter-company accounts and transactions
between the Company and Bank have been eliminated in consolidation.

Use of Estimates - The preparation of
financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the amounts of revenues and expenses during the reporting period. Actual
results can differ from those estimates. The allowance for loan losses,
prepayment estimates on the mortgage-backed securities and Collateralized
Mortgage Obligation portfolios, contingencies and fair values of financial
instruments are particularly subject to change.

Reclassifications Some items in the
prior year financial statements
were reclassified to conform to the current presentation.

F-6

---



Cash and Cash Equivalents  Cash and
cash equivalents consists of cash
on hand, due from banks and interest-bearing deposits. Net cash flows are
reported for customer loan and deposit transactions and interest-bearing
deposits with original maturities of 90 days or less. Regulation D of the Board
of Governors of the Federal Reserve System requires that Victory State Bank
maintain non-interest-bearing deposits or cash on hand as reserves against its
demand deposits. The amount of reserves which Victory State Bank is required to
maintain depends upon its level of transaction accounts. During the fourteen
day period from December 18, 2008 through December 31, 2008, Victory State Bank
was required to maintain reserves, after deducting vault cash, of $2,922,000.
Reserves are required to be maintained on a fourteen day basis, so, from time
to time, Victory State Bank may use available cash reserves on a day to day
basis, so long as the fourteen day average reserves satisfy Regulation D
requirements. Victory State Bank is required to report transaction account
levels to the Federal Reserve on a weekly basis.

Interest-bearing bank balances
Interest-bearing bank balances mature
overnight and are carried at cost.

Investment Securities, Available for Sale -
Investment securities, available for sale,
are to be held for an unspecified period of time and include securities that
management intends to use as part of its asset/liability strategy. These
securities may be sold in response to changes in interest rates, prepayments or
other factors and are carried at estimated fair value. Gains or losses on the
sale of such securities are determined by the specific identification method.
Interest income includes amortization of purchase premium and accretion of
purchase discount. Premiums and discounts are recognized in interest income
using a method that approximates the level yield method without anticipating
prepayments, except for mortgage-backed securities where prepayments are
estimated. Unrealized holding gains or losses, net of deferred income taxes,
are excluded from earnings and reported as other comprehensive income in a
separate component of stockholders equity until realized. Declines in the fair
value of securities below their cost that are other than temporary are
reflected as realized losses. In estimating other-than-temporary losses,
management considers: (1) the length of time and extent that fair value has been
less than cost, (2) the financial condition and near term prospects of the
issuer, and (3) the Companys ability and intent to hold the security for a
period sufficient to allow for any anticipated recovery in fair value.

The
Company invests primarily in agency Collateralized Mortgage-Backed Obligations
(CMOs) with estimated average lives primarily under 4.5 years and
Mortgage-Backed Securities. These securities are primarily issued by the
Federal National Mortgage Association (FNMA), the Government National
Mortgage Association (GNMA) or the Federal Home Loan Mortgage Corporation
(FHLMC) and are primarily comprised of mortgage pools guaranteed by FNMA,
GNMA or FHLMC. The Company also invests in whole loan CMOs, all of which are
AAA rated. These securities expose the Company to risks such as interest rate,
prepayment and credit risk and thus pay a higher rate of return than comparable
treasury issues.

Loans Receivable - Loans receivable, that
management has the
intent and ability to hold for the foreseeable future or until maturity or
payoff, are stated at unpaid principal balances, adjusted for deferred net
origination and commitment fees and the allowance for loan losses. Interest
income on loans is credited as earned.

It
is the policy of the Company to provide a valuation allowance for probable
incurred losses on loans based on the Companys past loan loss experience,
known and inherent risks in the portfolio, adverse situations which may affect
the borrowers ability to repay, estimated value of underlying collateral and
current economic conditions in the Companys lending area. The allowance is
increased by provisions for loan losses charged to earnings and is reduced by
charge-offs, net of recoveries. While management uses available information to
estimate losses on loans, future additions to the allowance may be necessary
based upon the expected growth of the loan portfolio and any changes in
economic conditions beyond managements control. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Banks allowance for loan losses. Such agencies may require the Bank to
recognize additions to the allowance based on judgments different from those of
management. Management believes, based upon all relevant and available
information, that the allowance for loan losses is appropriate.

F-7

---



The Company has a policy
that all loans 90 days past due are placed on non-accrual status. It is the
Companys policy to cease the accrual of interest on loans to borrowers past
due less than 90 days where a probable loss is estimated and to reverse out of
income all interest that is due. The Company applies payments received on
non-accrual loans to the outstanding principal balance due before applying any
amount to interest, until the loan is restored to an accruing status. On a
limited basis, the Company may apply a payment to interest on a non-accrual
loan if there is no impairment or no estimated loss on this asset. The Company
continues to accrue interest on construction loans that are 90 days past
contractual maturity date if the loan is expected to be paid in full in the
next 60 days and all interest is paid up to date.

Loan
origination fees and certain direct loan origination costs are deferred and the
net amount recognized over the contractual loan terms using the level-yield
method, adjusted for periodic prepayments in certain circumstances.

The
Company considers a loan to be impaired when, based on current information, it
is probable that the Company will be unable to collect all principal and
interest payments due according to the contractual terms of the loan agreement.
Loans that experience insignificant payment delays and payment shortfalls generally
are not classified as impaired. Impairment is measured on a loan by loan basis
for commercial and construction loans. Impaired loans are measured based on the
present value of expected future cash flows discounted at the loans effective
interest rate or, as a practical expedient, at the loans observable market
price or the fair value of the collateral. The fair value of the collateral, as
reduced by costs to sell, is utilized if a loan is collateral dependent. Large
groups of smaller balance homogeneous loans, such as consumer loans and
residential loans, are collectively evaluated for impairment.

Long-Lived Assets - The Company
periodically evaluates the
recoverability of long-lived assets, such as premises and equipment, to ensure
the carrying value has not been impaired. In performing the review for
recoverability, the Company would estimate the future cash flows expected to
result from the use of the asset. If the sum of the expected future cash flows
is less than the carrying amount an impairment will be recognized. The Company
reports these assets at the lower of the carrying value or fair value.

Subordinated Debt - In August of 2003, the
Company formed VSB
Capital Trust I (the Trust). The Trust is a statutory business trust
organized under Delaware law and the Company owns all of its common securities.
The Trust issued $5.0 million of Trust Preferred Capital Securities to an
independent investor and $155,000 of common securities to the Company. The
Company issued a $5.16 million subordinated debenture to the Trust. The
subordinated debenture was the sole asset of the Trust. On August 8, 2008, the
Company repaid the subordinated debenture in full at par, received payment of
$155,000 on account of its common securities of the Trust, and all the
outstanding Trust Preferred Capital Securities were likewise redeemed, thereby
ending the entire arrangement. The Trust is not consolidated with the Company.

Premises and Equipment - Premises,
leasehold improvements, and
furniture and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are accumulated by the
straight-line method over the estimated useful lives of the respective assets,
which range from three to fifteen years. Leasehold improvements are amortized
at the lesser of their useful life or the term of the lease.

Federal Home Loan Bank (FHLB) Stock - The
Bank is a member of the FHLB system.
Members are required to own a certain amount of stock based on the level of
borrowings and other factors, and may invest in additional amounts. FHLB stock
is carried at cost, classified as a restricted security, and periodically
evaluated for impairment. Because this stock is viewed as a long term
investment, impairment is based on ultimate recovery of par value, which is the
price the Bank pays for the FHLB Stock. Both cash and stock dividends are
reported as income.

Income Taxes - The Company utilizes the
liability method
to account for income taxes. Under this method, deferred tax assets and
liabilities are determined on differences between financial reporting and the
tax bases of assets and liabilities and are measured using the enacted tax
rates and laws expected to be in effect when the differences are expected to
reverse. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes.

F-8

---



The
Company adopted FASB Interpretation 48, Accounting
for Uncertainty in Income Taxes (FIN 48), as of January 1, 2007. A
tax position is recognized as a benefit only if it is more likely than not
that the tax position would be sustained in a tax examination, with a tax
examination being presumed to occur. The amount recognized is the largest
amount of tax benefit that is greater than 50% likely of being realized on
examination. For tax positions not meeting the more likely than not test, no tax
benefit is recorded. The adoption had no affect on the Companys financial
statements.

The
Company recognizes interest and/or penalties related to income tax matters in
income tax expense.

Financial
Instruments - In the ordinary course of business,
the Company has entered into off-balance sheet financial instruments, primarily
consisting of commitments to extend credit.

Basic
and Diluted Net Income Per Common Share - Basic
net income per share of common stock is based on 1,854,339 shares and 1,831,180
shares, the weighted average number of common shares outstanding for the years
ended December 31, 2008 and 2007, respectively. Diluted net income per share of
common stock is based on 1,881,782 and 1,877,605, the weighted average number
of common shares and potentially dilutive common shares outstanding for the
years ended December 31, 2008 and 2007, respectively. The weighted average
number of potentially dilutive common shares excluded in calculating diluted
net income per common share due to the anti-dilutive effect is 50,207 and
54,013 shares for the years ended December 31, 2008 and 2007, respectively.
Common stock equivalents were calculated using the treasury stock method.

The
reconciliation of the numerators and the denominators of the basic and diluted
per share computations for the years ended December 31, are as follows:

|                                            |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 
|------------------------------------------- |  | ---------- | --------- | ----------------------- |  | ---------------- |  | ---------- | ---- | ----------------------- | - | ---------------- |  |  | --------- |  | - | ---- | 
|                                            |  | 2008       |           | 2007                    | 
|                                            |  |            |           |                         | 
|                                            |  | Net
Income |           | Weighted
Average
Shares |  | Per Share
Amount |  | Net
Income |      | Weighted
Average
Shares |   | Per Share
Amount | 
|                                            |  |            |           |                         |  |                  |  |            |      |                         |   |                  | 
|Basic earnings per common share             |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 
|                                            |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 
|Net income available to common stockholders |  | $          | 1,931,744 |                         |  | 1,854,339        |  | $          | 1.04 |                         | $ | 2,047,226        |  |  | 1,831,180 |  | $ | 1.12 | 
|                                            |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 
|Effect of dilutive shares                   |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 
|                                            |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 
|Weighted average shares, if converted       |  |            |           |                         |  | 27,443           |  |            |      |                         |   |                  |  |  | 46,425    |  |   |      | 
|                                            |  |            |           |                         |  |                  |  |            |      |                         |   |                  | 
|                                            |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 
|Diluted earnings per common share           |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 
|                                            |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 
|Net income available to common stockholders |  | $          | 1,931,744 |                         |  | 1,881,782        |  | $          | 1.03 |                         | $ | 2,047,226        |  |  | 1,877,605 |  | $ | 1.09 | 
|                                            |  |            |           |                         |  |                  |  |            |      |                         |   |                  |  |  |           |  |   |      | 

Stock
Based Compensation - FAS 123, Revised, requires
companies to record compensation expense for stock options provided to
employees in return for employment service. The cost is measured at the fair
value of the options when granted, and this cost is expensed over the
employment service period, which is normally the vesting period of the options.
This applies to awards granted or modified in fiscal years beginning in 2006.

Employee
Stock Ownership Plan (ESOP)- The cost of shares issued to the ESOP,
but not yet allocated to participants, is shown as a reduction of stockholders
equity. Compensation expense is based on the market price of shares as they are
committed to be released to participant accounts. Cash dividends on allocated
ESOP shares reduce retained earnings; cash dividends on unearned ESOP shares
reduce debt and accrued interest. As of August 4, 2008, the Company listed its
common stock on the NASDAQ Global Market. We are no longer required to
reclassify out of stockholders equity an amount equal to the put option of the
allocated ESOP shares and we re-classed the 2006 put option allocation in the
first quarter of 2007.

F-9

---



Stock
Repurchase ProgramOn September 8, 2008, the Company announced that its Board of
Directors had authorized a Rule 10b5-1 stock repurchase program for the
repurchase of up to 100,000 shares of the Companys common stock. Stock
repurchases under the program will be accounted for using the cost method, in
which the Company will reflect the entire cost of repurchased shares as a
separate reduction of stockholders equity on its balance sheet.

Comprehensive
Income-
Comprehensive income consists of net income and other comprehensive income.
Other comprehensive income includes unrealized gains and losses, net of taxes,
on securities available for sale which are also recognized as separate
components of equity.

Fair
Value Option and Fair Value Measurement - In
September 2006, the FASB issued Statement No. 157, Fair Value Measurements. This Statement defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements. This Statement establishes a fair value hierarchy
about the assumptions used to measure fair value and clarifies assumptions
about risk and the effect of a restriction on the sale or use of an asset. The
standard is effective for fiscal years beginning after November 15, 2007. In
February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157.
This FSP delays the effective date of FAS 157 for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value on a recurring basis (at least annually) to fiscal years beginning after
November 15, 2008, and interim periods within those fiscal years. The impact of
adoption was not material.

Recently-Adopted
Accounting Standards - SFAS No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities-Including an amendment of FASB Statement No. 115. SFAS
159 permits entities to choose to measure eligible items at fair value at
specified election dates. Unrealized gains and losses on items for which the
fair value option has been elected are reported in earnings at each subsequent
reporting date. The fair value option (i) may be applied instrument by
instrument, with certain exceptions, (ii) is irrevocable (unless a new election
date occurs) and (iii) is applied only to entire instruments and not to
portions of instruments. SFAS 159 is effective for the Company on January 1,
2008. The Company chose not to exercise the fair value option permitted it
under SFAS 159.

On
November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value
through Earnings(SAB 109). Previously, SAB 105, Application of Accounting Principles to Loan
Commitments, stated that in
measuring the fair value of a derivative loan commitment, a company should not
incorporate the expected net future cash flows related to the associated
servicing of the loan. SAB 109 supersedes SAB 105 and indicates that the
expected net future cash flows related to the associated servicing of the loan
should be included in measuring fair value for all written loan commitments
that are accounted for at fair value through earnings. SAB 105 also indicated
that internally-developed intangible assets should not be recorded as part of
the fair value of a derivative loan commitment, and SAB 109 retains that view.
SAB 109 is effective for derivative loan commitments issued or modified in
fiscal quarters beginning after December 15, 2007. The adoption of this
standard was not material.

In
December 2007, the SEC issued SAB No. 110, which expresses the views of the SEC
regarding the use of a simplified method, as discussed in SAB No. 107, in
developing an estimate of expected term of plain vanilla share options in
accordance with SFAS No. 123(R), Share-Based Payment. The SEC concluded that a
company could, under certain circumstances, continue to use the simplified
method for share option grants after December 31, 2007. The Company does not
use the simplified method for share options and therefore SAB No. 110 has no
impact on the Companys consolidated financial statements.

Recently-Issued
Accounting Standards - In December 2007, the FASB
issued FAS No. 141 (revised 2007), Business Combinations (FAS 141(R)), which
establishes principles and requirements for how an acquirer recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in an acquiree, including
the recognition and measurement of goodwill acquired in a business combination.
FAS No. 141(R) is effective for fiscal years beginning on or after December 15,
2008. Earlier adoption is prohibited. The adoption of this standard is not expected
to have a material effect on the Corporations results of operations or
financial position.

F-10

---



In
December 2007, the FASB issued SFAS No. 160,Noncontrolling Interest in Consolidated Financial Statements, an amendment of
ARB No. 51 (SFAS No. 160), which will change the accounting and
reporting for minority interests, which will be recharacterized as
noncontrolling interests and classified as a component of equity within the
consolidated balance sheets. FAS No. 160 is effective as of the beginning of
the first fiscal year beginning on or after December 15, 2008. Earlier adoption
is prohibited and the Corporation does not expect the adoption of FAS No. 160
to have a significant impact on its results of operations or financial
position.

In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of SFAS No. 133. FAS No. 161
amends and expands the disclosure requirements of SFAS No. 133 for derivative
instruments and hedging activities. FAS No. 161 requires qualitative disclosure
about objectives and strategies for using derivative and hedging instruments,
quantitative disclosures about fair value amounts of the instruments and gains
and losses on such instruments, as well as disclosures about credit-risk
features in derivative agreements. FAS No. 161 is effective for financial
statements issued for fiscal years and interim periods beginning after November
15, 2008, with early application encouraged. The adoption of this standard is
not expected to have a material effect on the Corporations results of
operations or financial position.

|   |                                          
|-- | -----------------------------------------
|3. | INVESTMENT SECURITIES, AVAILABLE FOR SALE

The
fair value of available for sale securities and the related gross unrealized
gains and losses recognized in accumulated other comprehensive income/(loss)
were as follows at December 31, 2008 and 2007:

|                                     |  |                      |             |                        |   |                         |  |   |          |  
|------------------------------------ |  | -------------------- | ----------- | ---------------------- | - | ----------------------- |  | - | -------- | -
|                                     |  | December 31, 2008    |            
|                                     |  |                      |            
|                                     |  | Estimated
Fair
Value |             | Gross
Unrealized
Gains |   | Gross
Unrealized
Losses | 
|                                     |  |                      |             |                        |   |                         | 
|                                     |  |                      |             |                        |   |                         | 
|US Government Agency                 |  | $                    |            |                        | $ |                        |  | $ |         |  
|FNMA MBS                             |  |                      | 6,690,594   |                        |   | 82,351                  |  |   | (38,079  | )
|FHLMC MBS                            |  |                      | 37,642      |                        |   | 232                     |  |   |         |  
|GNMA MBS                             |  |                      | 1,632,790   |                        |   | 56,026                  |  |   |         |  
|Whole Loan
 MBS                      |  |                      | 2,559,037   |                        |   |                        |  |   | (61,928  | )
|Collateralized
 mortgage obligations |  |                      | 109,368,525 |                        |   | 1,477,051               |  |   | (439,855 | )
|                                     |  |                      |             |                        |   |                         |  |   |          |  
|                                     |  | $                    | 120,288,588 |                        | $ | 1,615,660               |  | $ | (539,862 | )
|                                     |  |                      |             |                        |   |                         |  |   |          |  

F-11

---



|                                     |  |                      |             |                        |   |                         |  |   |            |  
|------------------------------------ |  | -------------------- | ----------- | ---------------------- | - | ----------------------- |  | - | ---------- | -
|                                     |  | December 31, 2007    |            
|                                     |  |                      |            
|                                     |  | Estimated
Fair
Value |             | Gross
Unrealized
Gains |   | Gross
Unrealized
Losses | 
|                                     |  |                      |             |                        |   |                         | 
|                                     |  |                      |             |                        |   |                         | 
|US
 Government Agency                |  | $                    |            |                        | $ |                        |  | $ |           |  
|FNMA MBS                             |  |                      | 5,746,955   |                        |   | 22,013                  |  |   | (37,741    | )
|FHLMC MBS                            |  |                      | 162,752     |                        |   | 1,239                   |  |   |           |  
|GNMA MBS                             |  |                      | 1,849,267   |                        |   |                        |  |   | (43,682    | )
|Whole Loan
 MBS                      |  |                      | 3,103,907   |                        |   |                        |  |   | (31,195    | )
|Collateralized
 mortgage obligations |  |                      | 106,951,236 |                        |   | 512,550                 |  |   | (1,132,924 | )
|                                     |  |                      |             |                        |   |                         |  |   |            |  
|                                     |  | $                    | 117,814,117 |                        | $ | 535,802                 |  | $ | (1,245,542 | )
|                                     |  |                      |             |                        |   |                         |  |   |            |  

The
tax benefits related to these net unrealized gains and losses were $488,735 and
$330,668 at December 31, 2008 and 2007, respectively.

The
following table shows the gross unrealized losses and estimated fair value of
the Companys investments, aggregated by investment category and length of time
that an individual security has been in the continuous unrealized loss position
at December 31, 2008 and 2007:

|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |   |   |            |  |   |            |  
|------------------------------------ |  | ------------------- | ---------- | ------------------- | - | ---------- | - | --------------- | ---------- | ---------- | - | --------------- | - | - | ---------- |  | - | ---------- | -
|December
31, 2008                    |  | Less than 12 months |            | More than 12 months |   | Total      |  
|                                     |  |                     |            |                     |   |            |  
|                                     |  | Fair
Value          |            | Unrealized
Loss     |   | Fair
Value |   | Unrealized
Loss |            | Fair
Value |   | Unrealized
Loss |  
|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |  
|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |  
|US Government Agency                 |  | $                   |           |                     | $ |           |   | $               |           |            | $ |                |   | $ |           |  | $ |           |  
|FHLMC MBS                            |  |                     |           |                     |   |           |   |                 |           |            |   |                |   |   |           |  |   |           |  
|FNMA MBS                             |  |                     | 3,674,817  |                     |   | (34,814    | ) |                 | 251,470    |            |   | (3,265          | ) |   | 3,926,287  |  |   | (38,079    | )
|GNMA MBS                             |  |                     |           |                     |   |           |   |                 |           |            |   |                |   |   |           |  |   |           |  
|Whole Loan MBS                       |  |                     | 1,451,015  |                     |   | (54,787    | ) |                 | 1,108,022  |            |   | (7,141          | ) |   | 2,559,037  |  |   | (61,928    | )
|Collateralized mortgage
 obligations |  |                     | 13,662,143 |                     |   | (76,957    | ) |                 | 8,808,164  |            |   | (362,898        | ) |   | 22,470,307 |  |   | (439,855   | )
|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |   |   |            |  |   |            |  
|                                     |  | $                   | 18,787,975 |                     | $ | (166,558   | ) | $               | 10,167,656 |            | $ | (373,304        | ) | $ | 28,955,631 |  | $ | (539,862   | )
|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |   |   |            |  |   |            |  
|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |   |   |            |  |   |            |  
|December
31, 2007                    |  | Less than 12 months |            | More than 12 months |   | Total      |  
|                                     |  |                     |            |                     |   |            |  
|                                     |  | Fair
Value          |            | Unrealized
Loss     |   | Fair
Value |   | Unrealized
Loss |            | Fair
Value |   | Unrealized
Loss |  
|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |  
|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |   |   |            |  |   |            |  
|US Government Agency                 |  | $                   |           |                     | $ |           |   | $               |           |            | $ |                |   | $ |           |  | $ |           |  
|FHLMC MBS                            |  |                     |           |                     |   |           |   |                 |           |            |   |                |   |   |           |  |   |           |  
|FNMA MBS                             |  |                     |           |                     |   |           |   |                 | 3,008,560  |            |   | (37,741         | ) |   | 3,008,560  |  |   | (37,741    | )
|GNMA MBS                             |  |                     |           |                     |   |           |   |                 | 1,849,267  |            |   | (43,682         | ) |   | 1,849,267  |  |   | (43,682    | )
|Whole Loan MBS                       |  |                     |           |                     |   |           |   |                 | 3,103,907  |            |   | (31,195         | ) |   | 3,103,907  |  |   | (31,195    | )
|Collateralized mortgage
 obligations |  |                     | 3,494,339  |                     |   | (10,274    | ) |                 | 52,924,757 |            |   | (1,122,650      | ) |   | 56,419,096 |  |   | (1,132,924 | )
|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |   |   |            |  |   |            |  
|                                     |  | $                   | 3,494,339  |                     | $ | (10,274    | ) | $               | 60,886,491 |            | $ | (1,235,268      | ) | $ | 64,380,830 |  | $ | (1,245,542 | )
|                                     |  |                     |            |                     |   |            |   |                 |            |            |   |                 |   |   |            |  |   |            |  

F-12

---



The
Company evaluates securities for other-than-temporary impairment at least on a
quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to the length of time and the extent to
which the fair value has been less than cost, the financial condition and
near-term prospects of the issuer, and the intent and ability of the Company to
retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value. In analyzing an issuers financial
condition, the Company may consider whether the securities are issued by the
federal government or its agencies, whether downgrades by bond rating agencies
have occurred, and the results of reviews of the issuers financial condition.

At
December 31, 2008, the unrealized loss on investment securities was caused by
interest rate increases. We expect that these securities, at maturity, will not
be settled for less than the amortized cost of the investment. Because the
decline in fair value is attributable to changes in interest rates and not
credit quality, and because the Company has the ability and intent to hold
these securities until a market price recovery or maturity, these investments
are not considered other-than-temporarily impaired. At December 31, 2008, there
were thirty three debt securities with unrealized losses with aggregate
depreciation of 5% or more from the Companys amortized cost basis. As the
market value decline of these securities is caused by interest rate increases
and management has the ability to hold these securities until maturity, or for
the foreseeable future, if classified as available for sale, these securities
are not deemed to be other-than-temporarily impaired.

The
maturity schedule of all investment securities available for sale at amortized
cost and estimated fair values for December 31, 2008 was as follows:

|                                                 |  |                |             |                      |   |             | 
|------------------------------------------------ |  | -------------- | ----------- | -------------------- | - | ----------- | 
|Securities,
Available for Sale
Expected Maturity |  | Amortized
Cost |             | Estimated
Fair
Value |  
|                                                 |  |                |             |                      |  
|                                                 |  |                |             |                      |   |             | 
|Less than one year                               |  | $              | 37,411      |                      | $ | 37,643      | 
|Due after one year through
 five years           |  |                | 4,084,755   |                      |   | 4,108,703   | 
|Due after five years
 through ten years          |  |                | 54,005,951  |                      |   | 54,539,994  | 
|Due after ten years                              |  |                | 61,084,673  |                      |   | 61,602,248  | 
|                                                 |  |                |             |                      |   |             | 
|                                                 |  | $              | 119,212,790 |                      | $ | 120,288,588 | 
|                                                 |  |                |             |                      |   |             | 

Expected
maturities may differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without penalties.

Securities
pledged at year end 2008 and 2007 had a carrying amount of $48,483,833 and
$49,131,585, respectively and were pledged to secure public deposits and
balances in excess of the deposit insurance limit on certain customer accounts.

F-13

---



|   |                      
|-- | ---------------------
|4. | LOANS RECEIVABLE, NET

Loans
receivable, net at December 31, 2008 and 2007 are summarized as follows:

|                                                                                          |  |      |            |      |   |            |  
|----------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
|                                                                                          |  | 2008 |            | 2007 |  
|                                                                                          |  |      |            |      |  
|                                                                                          |  |      |            |      |  
|Commercial loans
 (principally variable rate):                                            |  |      |            |      |   |            |  
|Secured                                                                                   |  | $    | 1,177,796  |      | $ | 1,171,152  |  
|Unsecured                                                                                 |  |      | 9,558,296  |      |   | 10,981,044 |  
|                                                                                          |  |      |            |      |   |            |  
|Total commercial loans                                                                    |  |      | 10,736,092 |      |   | 12,152,196 |  
|                                                                                         
|Real estate loans:                                                                        |  |      |            |      |   |            |  
|Commercial                                                                                |  |      | 39,918,879 |      |   | 31,607,039 |  
|One-to-four family                                                                        |  |      | 2,548,159  |      |   | 2,314,716  |  
|                                                                                          |  |      |            |      |   |            |  
|Total real estate loans                                                                   |  |      | 42,467,038 |      |   | 33,921,755 |  
|                                                                                         
|Construction loans (net of undisbursed funds of $5,270,500 and
 $7,717,362, respectively) |  |      | 11,896,432 |      |   | 15,109,593 |  
|                                                                                         
|Consumer loans                                                                            |  |      | 599,293    |      |   | 566,356    |  
|Other loans                                                                               |  |      | 757,481    |      |   | 827,122    |  
|                                                                                          |  |      |            |      |   |            |  
|                                                                                          |  |      | 1,356,774  |      |   | 1,393,478  |  
|                                                                                          |  |      |            |      |   |            |  
|Total loans receivable                                                                    |  |      | 66,456,336 |      |   | 62,577,022 |  
|                                                                                         
|Less:                                                                                     |  |      |            |      |   |            |  
|Unearned loans fees, net                                                                  |  |      | (209,684   | )    |   | (203,944   | )
|Allowance for loan losses                                                                 |  |      | (987,876   | )    |   | (927,161   | )
|                                                                                          |  |      |            |      |   |            |  
|                                                                                         
|Total                                                                                     |  | $    | 65,258,776 |      | $ | 61,445,917 |  
|                                                                                          |  |      |            |      |   |            |  

The
activity in the allowance for loan losses, for the years ended December 31,
2008 and 2007 are summarized as follows:

|                  |  |      |          |      |   |           |  
|----------------- |  | ---- | -------- | ---- | - | --------- | -
|                  |  | 2008 |          | 2007 |  
|                  |  |      |          |      |  
|                  |  |      |          |      |   |           |  
|Beginning balance |  | $    | 927,161  |      | $ | 1,128,824 |  
|Charge-offs       |  |      | (494,788 | )    |   | (263,625  | )
|Recoveries        |  |      | 270,503  |      |   | 66,962    |  
|Provision(Credit) |  |      | 285,000  |      |   | (5,000    | )
|                  |  |      |          |      |   |           |  
|                 
|Ending balance    |  | $    | 987,876  |      | $ | 927,161   |  
|                  |  |      |          |      |   |           |  

Nonaccrual
loans outstanding at December 31, 2008 and 2007 are summarized as follows:

|                                                                                                                                             |                            |   |         |           |      |        |         | 
|-------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | - | ------- | --------- | ---- | ------ | ------- | 
|                                                                                                                                             |                            |   | 2008    |           | 2007 |       
|                                                                                                                                             |                            |   |         |           |      |       
|                                                                                                                                             | Nonaccrual loans:          |   |         |           |      |        |         | 
|                                                                                                                                             | Unsecured commercial loans |   | $       | 345,221   |      | $      | 14,970  | 
|                                                                                                                                             | Commercial real estate     |   |         | 1,453,846 |      |        | 459,371 | 
|                                                                                                                                             | Construction               |   |         | 480,000   |      |        | 480,000 | 
|                                                                                                                                             | Consumer loans             |   |         |          |      |        | 5,877   | 
|                                                                                                                                             |                            |   |         |           |      |        |         | 
|                                                                                                                                             | Total nonaccrual loans     |   | $       | 2,279,067 |      | $      | 960,218 | 
|                                                                                                                                             |                            |   |         |           |      |        |         | 
|                                                                                                                                             |                            |   |         |           |      |        |         | 
|                                                                                                                                             |                            |   | 2008    |           | 2007 |       
|                                                                                                                                             |                            |   |         |           |      |       
|Interest income that would have been recorded during the year on
 nonaccrual loans outstanding at year-end in accordance with original terms |                            | $ | 114,464 |           | $    | 27,115 |        
|                                                                                                                                             |                            |   |         |           |      |        |        

F-14

---



The
Companys recorded investment in impaired loans at December 31 is as follows:

|                                         |  |                                |         |                                      |   |                                |  |                                      |        |  |   |        | 
|---------------------------------------- |  | ------------------------------ | ------- | ------------------------------------ | - | ------------------------------ |  | ------------------------------------ | ------ |  | - | ------ | 
|                                         |  | 2008                           |         | 2007                                 |  
|                                         |  |                                |         |                                      |  
|                                         |  | Investment
 in Impaired
 Loans |         | Related
 Allowance
 for loan
 losses |   | Investment
 in Impaired
 Loans |  | Related
 Allowance
 for loan
 losses |       
|                                         |  |                                |         |                                      |   |                                |  |                                      |       
|Impaired loans                           |  |                                |         |                                      |   |                                |  |                                      |        |  |   |        | 
|With a related allowance for loan losses |  |                                |         |                                      |   |                                |  |                                      |        |  |   |        | 
|Commercial and financial                 |  | $                              | 316,775 |                                      | $ | 63,355                         |  | $                                    | 50,476 |  | $ | 8,320  | 
|Commercial real estate                   |  |                                | 145,241 |                                      |   | 60,241                         |  |                                      |       |  |   |       | 
|Consumer loans                           |  |                                |        |                                      |   |                               |  |                                      | 5,877  |  |   | 2,939  | 
|                                         |  |                                |         |                                      |   |                                |  |                                      |        |  |   |        | 
|                                         |  | $                              | 462,016 |                                      | $ | 123,596                        |  | $                                    | 56,353 |  | $ | 11,259 | 
|                                         |  |                                |         |                                      |   |                                |  |                                      |        |  |   |        | 

The
following table sets forth certain information about impaired loans at December
31:

|                                                                                                               |  |                               |        |      |   |        | 
|-------------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------ | ---- | - | ------ | 
|                                                                                                               |  | Investment in
 Impaired Loans |       
|                                                                                                               |  |                               |       
|                                                                                                               |  | 2008                          |        | 2007 |  
|                                                                                                               |  |                               |        |      |  
|                                                                                                              
|Average recorded investment                                                                                    |  | $                             | 53,833 |      | $ | 16,305 | 
|                                                                                                               |  |                               |        |      |   |        | 
|                                                                                                              
|Interest income recognized during time period that loans were
 impaired, using cash-basis method of accounting |  | $                             |       |      | $ |       | 
|                                                                                                               |  |                               |        |      |   |        | 

The
Companys loan portfolios are primarily comprised of commercial and commercial
real estate loans made to small businesses and individuals located in the
Borough of Staten Island. As of December 31, 2008 and 2007, the Company had no
restructured loans.

|   |                            
|-- | ---------------------------
|5. | ACCRUED INTEREST RECEIVABLE

Accrued
interest receivable at December 31, 2008 and 2007 are summarized as follows:

|                                           |  |      |         |      |   |         | 
|------------------------------------------ |  | ---- | ------- | ---- | - | ------- | 
|                                           |  | 2008 |         | 2007 |  
|                                           |  |      |         |      |  
|                                           |  |      |         |      |   |         | 
|Loans
 receivable                          |  | $    | 469,938 |      | $ | 330,551 | 
|Investment
 securities, available for sale |  |      | 253,535 |      |   | 468,698 | 
|                                           |  |      |         |      |   |         | 
|                                          
|Total                                      |  | $    | 723,473 |      | $ | 799,249 | 
|                                           |  |      |         |      |   |         | 

|   |                       
|-- | ----------------------
|6. | PREMISES AND EQUIPMENT

Premises
and equipment at December 31, 2008 and 2007 are summarized as follows:

|                                                |  |      |            |      |   |            |  
|----------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
|                                                |  | 2008 |            | 2007 |  
|                                                |  |      |            |      |  
|                                               
|Leasehold
 improvements                         |  | $    | 4,238,498  |      | $ | 4,186,755  |  
|Computer
 equipment and software                |  |      | 342,290    |      |   | 337,430    |  
|Furniture,
 fixtures and equipment              |  |      | 1,308,825  |      |   | 1,100,631  |  
|Other                                           |  |      | 52,697     |      |   | 52,697     |  
|                                                |  |      |            |      |   |            |  
|                                                |  |      | 5,942,310  |      |   | 5,677,513  |  
|                                               
|Less
 accumulated depreciation and amortization |  |      | (2,246,488 | )    |   | (1,745,834 | )
|                                                |  |      |            |      |   |            |  
|                                               
|Total                                           |  | $    | 3,695,822  |      | $ | 3,931,679  |  
|                                                |  |      |            |      |   |            |  

F-15

---



Depreciation
and amortization expense amounted to $630,692 and $617,958 for the years ended
December 31, 2008 and 2007, respectively.

At
December 31, 2008 and 2007, the Company was obligated under five non-cancelable
operating leases on property used for banking purposes. Rental expense under
these leases was $407,002 and $437,089 for the years ended December 31, 2008
and 2007, respectively.

The
projected minimum rental payments under the terms of the leases at December 31,
2008 are summarized as follows:

|                           |  |        |           | 
|-------------------------- |  | ------ | --------- | 
|Year Ending 
 December 31, |  | Amount |          
|                           |  |        |          
|2009                       |  | $      | 399,063   | 
|2010                       |  |        | 404,951   | 
|2011                       |  |        | 413,067   | 
|2012                       |  |        | 420,988   | 
|2013                       |  |        | 425,980   | 
|Thereafter                 |  |        | 1,790,340 | 
|                           |  |        |           | 
|Total                      |  | $      | 3,854,389 | 
|                           |  |        |           | 

|   |                         
|-- | ------------------------
|7. | PREPAID AND OTHER ASSETS

Prepaid
and other assets at December 31, 2008 and 2007 are summarized as follows:

|                                          |  |      |         |      |   |           | 
|----------------------------------------- |  | ---- | ------- | ---- | - | --------- | 
|                                          |  | 2008 |         | 2007 |  
|                                          |  |      |         |      |  
|Accounts receivable and
 other assets     |  | $    | 120,437 |      | $ | 28,508    | 
|Security deposit
 receivable              |  |      | 11,200  |      |   | 11,200    | 
|Prepaid assets                            |  |      | 278,875 |      |   | 264,478   | 
|Equity securities,
 primarily FHLB stock  |  |      | 320,400 |      |   | 312,500   | 
|Investment in
 unconsolidated subsidiary  |  |      |        |      |   | 155,000   | 
|Subordinated debt related
 placement cost |  |      |        |      |   | 18,763    | 
|Income tax receivable                     |  |      | 157,978 |      |   | 273,972   | 
|Late charges receivable                   |  |      | 36,117  |      |   | 50,010    | 
|                                          |  |      |         |      |   |           | 
|                                          |  | $    | 925,007 |      | $ | 1,114,431 | 
|                                          |  |      |         |      |   |           | 

F-16

---



|   |         
|-- | --------
|8. | DEPOSITS

Deposits
are summarized, according to their original terms, at December 31, 2008 and
2007 as follows:

|                           |  |        |             |         |  |                              |   |        |      |         |   |                              |  |  |        |   |  |      |  
|-------------------------- |  | ------ | ----------- | ------- |  | ---------------------------- | - | ------ | ---- | ------- | - | ---------------------------- |  |  | ------ | - |  | ---- | -
|                           |  | 2008   |             | 2007    | 
|                           |  |        |             |         | 
|                           |  | Amount |             | Percent |  | Weighted
Average
Stated Rate |   | Amount |      | Percent |   | Weighted
Average
Stated Rate | 
|                           |  |        |             |         |  |                              |   |        |      |         |   |                              | 
|                           |  |        |             |         |  |                              |   |        |      |         |   |                              | 
|Checking                   |  | $      | 58,598,579  |         |  | 31.15                        | % |        |     | %       | $ | 62,525,053                   |  |  | 35.45  | % |  |     | %
|Variable-rate money market |  |        | 22,829,789  |         |  | 12.14                        |   |        | 0.71 |         |   | 20,534,721                   |  |  | 11.65  |   |  | 1.43 |  
|Statement savings          |  |        | 12,412,561  |         |  | 6.60                         |   |        | 0.55 |         |   | 11,349,111                   |  |  | 6.44   |   |  | 0.82 |  
|Interest-bearing checking  |  |        | 17,636,154  |         |  | 9.38                         |   |        | 0.30 |         |   | 16,931,113                   |  |  | 9.60   |   |  | 0.32 |  
|                           |  |        |             |         |  |                              |   |        |      |         |   |                              |  |  |        |   |  |      |  
|                           |  |        | 111,477,083 |         |  | 59.27                        |   |        | 0.25 |         |   | 111,339,998                  |  |  | 63.14  |   |  | 0.40 |  
|                          
|Time deposits:             |  |        |             |         |  |                              |   |        |      |         |   |                              |  |  |        |   |  |      |  
|Less than six months       |  |        | 32,788,378  |         |  | 17.43                        |   |        | 1.69 |         |   | 32,789,627                   |  |  | 18.59  |   |  | 3.28 |  
|Six months to one year     |  |        | 39,017,479  |         |  | 20.74                        |   |        | 2.50 |         |   | 27,706,849                   |  |  | 15.71  |   |  | 4.12 |  
|More than one year         |  |        | 4,517,637   |         |  | 2.40                         |   |        | 3.45 |         |   | 4,242,088                    |  |  | 2.41   |   |  | 4.14 |  
|                           |  |        |             |         |  |                              |   |        |      |         |   |                              |  |  |        |   |  |      |  
|                          
|                           |  |        | 76,323,494  |         |  | 40.57                        |   |        | 2.21 |         |   | 64,738,564                   |  |  | 36.71  |   |  | 3.70 |  
|                          
|Other deposits             |  |        | 308,872     |         |  | 0.16                         |   |        |     |         |   | 255,881                      |  |  | 0.15   |   |  |     |  
|                           |  |        |             |         |  |                              |   |        |      |         |   |                              |  |  |        |   |  |      |  
|                          
|Total                      |  | $      | 188,109,449 |         |  | 100.00                       | % |        | 0.54 | %       | $ | 176,334,443                  |  |  | 100.00 | % |  | 0.90 | %
|                           |  |        |             |         |  |                              |   |        |      |         |   |                              |  |  |        |   |  |      |  

The
aggregate amount of jumbo certificates of deposit with a minimum denomination
of $100,000 was approximately $65,526,186 and $53,753,833 at December 31, 2008
and 2007 respectively.

Scheduled
maturities of time deposits at December 31, 2008 are as follows:

|                       |  |        |            |         |  |        |  
|---------------------- |  | ------ | ---------- | ------- |  | ------ | -
|                       |  | Amount |            | Percent | 
|                       |  |        |            |         | 
|                       |  |        |            |         | 
|Within six months      |  | $      | 67,389,210 |         |  | 88.29  | %
|Six months to one year |  |        | 6,140,478  |         |  | 8.05   |  
|One to five years      |  |        | 2,793,806  |         |  | 3.66   |  
|                       |  |        |            |         |  |        |  
|                       |  |        |            |         |  |        |  
|Total                  |  | $      | 76,323,494 |         |  | 100.00 | %
|                       |  |        |            |         |  |        |  

|   |             
|-- | ------------
|9. | INCOME TAXES

The
Company files consolidated federal, state and local income tax returns on a
calendar-year basis. For federal, state and local income tax purposes, the
Company uses the specific charge-off method in computing its federal, state and
local tax bad debt deduction.

The
basis for the determination of state and local tax is the greater of a tax on
entire net income or a tax computed on taxable assets. Federal, state and city
income tax provisions were determined based on the tax computed on net income
for the years ended December 31, 2008 and 2007.

F-17

---



The
components of the income tax expense/(benefit) for the years ended December 31,
2008 and 2007 are summarized as follows:

|                |  |      |           |      |   |           | 
|--------------- |  | ---- | --------- | ---- | - | --------- | 
|                |  | 2008 |           | 2007 |  
|                |  |      |           |      |  
|                |  |      |           |      |  
|Current:        |  |      |           |      |   |           | 
|Federal         |  | $    | 1,168,969 |      | $ | 938,424   | 
|State and local |  |      | 701,229   |      |   | 568,749   | 
|                |  |      |           |      |   |           | 
|                |  |      | 1,870,198 |      |   | 1,507,173 | 
|                |  |      |           |      |   |           | 
|Deferred:       |  |      |           |      |   |           | 
|Federal         |  |      | (220,421  | )    |   | 103,582   | 
|State and local |  |      | (133,524  | )    |   | 62,756    | 
|                |  |      |           |      |   |           | 
|                |  |      | (353,945  | )    |   | 166,338   | 
|                |  |      |           |      |   |           | 
|                |  | $    | 1,516,253 |      | $ | 1,673,511 | 
|                |  |      |           |      |   |           | 

The
components of the deferred income tax asset, net as of December 31, 2008 and
2007 are summarized as follows:

|                                                 |  |      |          |      |   |         | 
|------------------------------------------------ |  | ---- | -------- | ---- | - | ------- | 
|                                                 |  | 2008 |          | 2007 |  
|                                                 |  |      |          |      |  
|                                                 |  |      |          |      |   |         | 
|Deferred loan fees                               |  | $    | 123,680  |      | $ | 115,736 | 
|Excess book allowance for
 loan losses           |  |      | 323,000  |      |   | 426,047 | 
|Unrealized (gain)/loss on
 investment securities |  |      | (488,735 | )    |   | 330,668 | 
|Other                                            |  |      | 567,894  |      |   | 118,846 | 
|                                                 |  |      |          |      |   |         | 
|                                                 |  |      |          |      |   |         | 
|Deferred tax asset, net                          |  | $    | 525,839  |      | $ | 991,297 | 
|                                                 |  |      |          |      |   |         | 

Management
evaluated the weight of available evidence and concluded that it is more likely
than not that the Company will realize the net deferred tax asset in future
years. Factors influencing managements judgment include, among other things,
changes in the levels of actual and expected future taxable income and
anticipated reversals of net deductible temporary differences. There are no
unrecognized tax benefits as of December 31, 2008.

The
Companys effective tax rates differ from the statutory Federal tax rate for
the years ended December 31, 2008 and 2007 and are as follows:

|                                                         |  |      |           |      |  |      |   |   |           |   |  |      |  
|-------------------------------------------------------- |  | ---- | --------- | ---- |  | ---- | - | - | --------- | - |  | ---- | -
|                                                         |  | 2008 |           | 2007 | 
|                                                         |  |      |           |      | 
|                                                         |  |      |           |      |  |      |   |   |           |   |  |      |  
|Federal income tax provision at statutory rates          |  | $    | 1,172,319 |      |  | 34.0 | % | $ | 1,265,051 |   |  | 34.0 | %
|State and local taxes, net of Federal income tax benefit |  |      | 383,527   |      |  | 11.1 |   |   | 457,651   |   |  | 12.3 |  
|ESOP MTM                                                 |  |      | (34,609   | )    |  | (1.0 | ) |   |          |   |  |     |  
|Other                                                    |  |      | (4,984    | )    |  | (0.1 | ) |   | (49,191   | ) |  | (1.3 | )
|                                                         |  |      |           |      |  |      |   |   |           |   |  |      |  
|                                                        
|                                                         |  | $    | 1,516,253 |      |  | 44.0 | % | $ | 1,673,511 |   |  | 45.0 | %
|                                                         |  |      |           |      |  |      |   |   |           |   |  |      |  

F-18

---



|    |                   
|--- | ------------------
|10. | REGULATORY MATTERS

The
Bank is a New York State chartered stock form commercial bank. The Banks
deposits are insured by the Federal Deposit Insurance Corporation (FDIC). The
Bank is subject to certain FDIC capital requirements. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly discretionary
actions by the regulators that, if undertaken, could have a direct material
effect on the Banks financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
certain specific capital guidelines that involve quantitative measures of the
Banks assets, liabilities and certain off-balance sheet items calculated under
regulatory accounting practices. The Banks capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weightings and other factors.

As
of the latest notification from the FDIC, the Bank was classified as well
capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, the Bank must maintain Tier 1 Leverage, Tier
1 Risk-Based and minimum Total Risk-based ratios as set forth in the table
below. There are no conditions or events since that notification that
management believes have changed the Banks category. Management believes, as
of December 31, 2008, that the Bank meets all capital adequacy requirements to
which it is subject.

The
Bank is subject to certain restrictions on the availability of its
undistributed earnings for payment of dividends to stockholders, including
prior regulatory approval.

In
accordance with the New York State Banking Law and the New York State Banking
Board Regulations, the Bank credits 10% of quarterly net income to regulatory
surplus and is required to do so until such time as shareholders equity is
equal to 10% of amounts due to depositors. As of December 31, 2008, regulatory
surplus equals 10% of deposits.

The
following table is the Banks actual capital amounts and ratios, as well as the
minimum required levels for both capital adequacy purposes and to be
considered well capitalized. No deductions were made for qualitative
judgments by regulators:

|                                         |  |        |            |                               |  |                                                                  |   |       |           |        |  |       |   |   |            |  |  |       |  
|---------------------------------------- |  | ------ | ---------- | ----------------------------- |  | ---------------------------------------------------------------- | - | ----- | --------- | ------ |  | ----- | - | - | ---------- |  |  | ----- | -
|                                         |  | Actual |            | For capital
adequacy purposes |  | To be well-capitalized
under prompt corrective
action provisions |  
|                                         |  |        |            |                               |  |                                                                  |  
|                                         |  | Amount |            | Ratio                         |  | Amount                                                           |   | Ratio |           | Amount |  | Ratio |  
|                                         |  |        |            |                               |  |                                                                  |   |       |           |        |  |       |  
|                                         |  |        |            |                               |  |                                                                  |   |       |           |        |  |       |  
|As of December 31, 2008:                 |  |        |            |                               |  |                                                                  |   |       |           |        |  |       |   |   |            |  |  |       |  
|Tier 1 Capital (to Average Assets)       |  | $      | 22,087,000 |                               |  | 10.45                                                            | % | $     | 8,516,543 |        |  | 4.00  | % | $ | 10,645,678 |  |  | 5.00  | %
|Tier 1 Capital (to Risk Weighted Assets) |  |        | 22,087,000 |                               |  | 24.34                                                            |   |       | 3,681,128 |        |  | 4.00  |   |   | 5,521,692  |  |  | 6.00  |  
|Total Capital (to Risk Weighted Assets)  |  |        | 23,075,000 |                               |  | 25.43                                                            |   |       | 7,362,255 |        |  | 8.00  |   |   | 9,202,819  |  |  | 10.00 |  

F-19

---



|                                        |  |        |            |                               |  |                                                                  |   |       |           |        |  |       |   |   |            |  |  |       |  
|--------------------------------------- |  | ------ | ---------- | ----------------------------- |  | ---------------------------------------------------------------- | - | ----- | --------- | ------ |  | ----- | - | - | ---------- |  |  | ----- | -
|                                        |  | Actual |            | For capital
adequacy purposes |  | To be well-capitalized
under prompt corrective
action provisions |  
|                                        |  |        |            |                               |  |                                                                  |  
|                                        |  | Amount |            | Ratio                         |  | Amount                                                           |   | Ratio |           | Amount |  | Ratio |  
|                                        |  |        |            |                               |  |                                                                  |   |       |           |        |  |       |  
|As of December 31, 2007:                |  |        |            |                               |  |                                                                  |   |       |           |        |  |       |   |   |            |  |  |       |  
|Tier 1 Capital(to Average Assets)       |  | $      | 22,821,000 |                               |  | 11.07                                                            | % | $     | 8,248,120 |        |  | 4.00  | % | $ | 10,310,150 |  |  | 5.00  | %
|Tier 1 Capital(to Risk Weighted Assets) |  |        | 22,821,000 |                               |  | 26.19                                                            |   |       | 3,484,840 |        |  | 4.00  |   |   | 5,227,260  |  |  | 6.00  |  
|Total Capital(to Risk Weighted Assets)  |  |        | 23,748,000 |                               |  | 27.26                                                            |   |       | 6,969,680 |        |  | 8.00  |   |   | 8,712,100  |  |  | 10.00 |  

The
Companys consolidated capital ratios as of December 31, 2008 were as follows:
Tier 1 Capital to Average Assets of 10.70%; Tier 1 Capital to Risk Weighted
Assets of 24.51%; and Total Capital to Risk Weighted Assets of 25.58%, which
are not substantially different than the Banks capital ratios at December 31,
2007 and therefore are not presented separately.

|    |                  
|--- | -----------------
|11. | EMPLOYEE BENEFITS

The
Company does not currently maintain a defined contribution benefit plan but
sponsors an incentive savings plan (401(k) plan) which started March 1, 1999.
All eligible employees, who have reached the age of 21, have at least one year
of service and work a minimum of 1,000 hours per year will be permitted to make
tax deferred contributions up to certain limits. The Bank may reduce or cease
matching contributions if it is determined that the current or accumulated net
earnings or undivided profits of the Bank are insufficient to pay the full
contributions in a plan year. The Bank contributed $126,072 to the 401(k) plan
in 2008 and $137,213 in 2007.

Stock Options

The
Company has granted options pursuant to five different stock option plans.
Options to buy stock are granted to directors, officers and employees under the
VSB Bancorp, Inc. 2000 Incentive Plan, the 1998 Incentive Plan, the 2004
Directors Plan, the 2000 Directors Plan and the 1998 Directors Plan which,
in the aggregate, provide for issue up to 243,750 options. Exercise price is
the market price at the date of grant, and compensation expense will be
recognized in the income statement in accordance with FAS 123, Revised. The
maximum option term is ten years, and the options vesting period is up to five
years.

Total
compensation expense charged against income for 2008 and 2007 was $1,278 and
$162.

In
November 2007, 3,250 options were granted from the 2000 Incentive Plan at an
exercise price of $11.75. There were no stock options granted in 2008.

The
fair value of each option award is estimated on the date of grant using a
closed form option valuation (Black-Scholes) model that uses the assumptions
noted in the table below. Expected volatilities are based on historical
volatilities of the Companys common stock. The Company uses historical data to
estimate option exercise and post-vesting termination behavior. Employee and
management options are tracked separately. The expected term of options granted
is based on historical data and represents the period of time that options
granted are expected to be outstanding, which takes into account that the
options are not transferable. The risk-free interest rate for the expected term
of the option is based on the U.S. Treasury yield curve in effect at the time
of the grant.

F-20

---



The
fair value of the options granted is estimated using the Black-Scholes option
pricing model with the following weighted average assumptions used for 2007:

|                         |  |      |         |                |      |  | 
|------------------------ |  | ---- | ------- | -------------- | ---- |  | 
|                         |  | 2007 |         | Exercise
 Rate |     
|                         |  |      |         |                |     
|                         |  |      |         |                |     
|Dividend
 yield          |  |      | 1.00    | %              |      |  | 
|Expected volatility      |  |      | 3.38    |                |      |  | 
|Risk-free
 interest rate |  |      | 3.55    |                |      |  | 
|Expected
 life           |  |      | 3 Years |                | 100% | 

The
stock option components of the 2000 Incentive Plan, the 1998 Incentive Plan and
the 2004 Directors Plan, the 2000 Directors Plan and the 1998 Directors
Plan, as of December 31, 2008, and 2007, and changes during the years ended,
consist of the following:

|                                                                                           |  |            |         |                                 |   |                          |  |   |          |  
|------------------------------------------------------------------------------------------ |  | ---------- | ------- | ------------------------------- | - | ------------------------ |  | - | -------- | -
|                                                                                           |  | 2008       |        
|                                                                                           |  |            |        
|                                                                                           |  | Shares     |         | Weighted
Average
Exercise
Price |   | Aggregate
Intrinsc
Value | 
|                                                                                           |  |            |         |                                 |   |                          | 
|                                                                                           |  |            |         |                                 |   |                          | 
|Options outstanding at the beginning of the year                                           |  |            | 172,498 |                                 | $ | 10.61                    |  |   |          |  
|Granted                                                                                    |  |            |        |                                 |   |                         |  |   |          |  
|Canceled                                                                                   |  |            | (3,125  | )                               |   | 6.40                     |  |   |          |  
|Exercised                                                                                  |  |            | (23,375 | )                               |   | 6.40                     |  |   |          |  
|                                                                                           |  |            |         |                                 |   |                          |  |   |          |  
|                                                                                           |  |            |         |                                 |   |                          |  |   |          |  
|Options outstanding at the end of the year                                                 |  |            | 145,998 |                                 | $ | 11.23                    |  | $ | (366,455 | )
|                                                                                           |  |            |         |                                 |   |                          |  |   |          |  
|                                                                                           |  |            |         |                                 |   |                          |  |   |          |  
|Options exercisable at the end of the year                                                 |  |            | 143,398 |                                 | $ | 11.35                    |  | $ | (377,137 | )
|                                                                                           |  |            |         |                                 |   |                          |  |   |          |  
|                                                                                           |  |            |         |                                 |   |                          |  |   |          |  
|Weighted average remaining contractual life of options outstanding at
 the end of the year |  | 2.8
 Years |        

|                                |  |        |       |                                       |   |      |  |  |  | 
|------------------------------- |  | ------ | ----- | ------------------------------------- | - | ---- |  |  |  | 
|Nonvested
Shares                |  | Shares |       | Weighted AverageGrant Date Fair Value |   |      |  | 
|                                |  |        |       |                                       |   |      |  | 
|                                |  |        |       |                                       |   |      |  | 
|Nonvested at January 1,
 2008   |  |        | 3,250 |                                       | $ | 1.18 |  |  |  | 
|Granted                         |  |        |      |                                       |   |      |  |  |  | 
|Vested                          |  |        | 650   |                                       |   | 1.18 |  |  |  | 
|Forfeited                       |  |        |      |                                       |   |      |  |  |  | 
|                                |  |        |       |                                       |   |      |  |  |  | 
|Nonvested at December 31,
 2008 |  |        | 2,600 |                                       | $ | 1.18 |  |  |  | 
|                                |  |        |       |                                       |   |      |  |  |  | 

All
non-exercisable options are expected to vest.

F-21

---



Information
related to the stock option plan during each year follows:

|                                                  |  |      |         |      |   |        | 
|------------------------------------------------- |  | ---- | ------- | ---- | - | ------ | 
|                                                  |  | 2008 |         | 2007 |  
|                                                  |  |      |         |      |  
|Intrinsic value of options
 exercised             |  | $    | 54,230  |      | $ | 46,863 | 
|Cash received from option
 exercise               |  | $    | 149,600 |      | $ | 56,000 | 
|Tax benefit realized from
 option exercise        |  | $    | 15,259  |      | $ | 21,833 | 
|Weighted average fair value
 of options exercised |  | $    | 2.32    |      | $ | 1.24   | 

As
of December 31, 2007, there was $3,673 of total unrecognized compensation cost
related to nonvested stock options granted under the Plan. The cost is expected
to be recognized over a weighted-average period of 3 years.

Described
below is the range of exercise prices for options granted under the following
option plans:

|                                  |  |                              |         |                                 |   |                                   |  |  |      | 
|--------------------------------- |  | ---------------------------- | ------- | ------------------------------- | - | --------------------------------- |  |  | ---- | 
|Plan
Description                  |  | Number of
Exercisable Shares |         | Weighted Average
Exercise Price |   | Weighted Average
Contractual Life | 
|                                  |  |                              |         |                                 |   |                                   | 
|                                  |  |                              |         |                                 |   |                                   |  |  |      | 
|1998 Director Stock Option
 Plan  |  |                              | 5,000   |                                 | $ | 4.90                              |  |  | 0.11 | 
|                                  |  |                              |         |                                 |   |                                   |  |  |      | 
|1998 Incentive Stock Option
 Plan |  |                              | 16,000  |                                 |   | 5.10                              |  |  | 0.06 | 
|                                  |  |                              |         |                                 |   |                                   |  |  |      | 
|2000 Director Stock Option
 Plan  |  |                              | 25,000  |                                 |   | 4.39                              |  |  | 1.40 | 
|                                  |  |                              |         |                                 |   |                                   |  |  |      | 
|2000 Incentive Stock Option
 Plan |  |                              | 44,998  |                                 |   | 10.50                             |  |  | 3.33 | 
|                                  |  |                              |         |                                 |   |                                   |  |  |      | 
|2004 Director Stock Option
 Plan  |  |                              | 55,000  |                                 |   | 17.60                             |  |  | 5.50 | 
|                                  |  |                              |         |                                 |   |                                   |  |  |      | 
|                                  |  |                              |         |                                 |   |                                   |  |  |      | 
|All Plans                         |  |                              | 145,998 |                                 | $ | 11.35                             |  |  | 2.80 | 
|                                  |  |                              |         |                                 |   |                                   |  |  |      | 

Stock Appreciation Rights

The
Company issued stock appreciation rights (SARs) to an officer of the Company
to advance the interests of the Company and its shareholders by providing this
key officer of the Company and its affiliates, upon whose judgment, initiative
and efforts were instrumental upon the formation and development of the Company
and its affiliates, with an additional incentive to perform in a superior
manner. Pursuant to the terms, 31,250 SARs with an exercise price of $4.00 per
SAR (as adjusted for prior stock dividends), as determined by the Board of
Directors, have been issued. There are no SARs available to be granted and
those SARs, which terminate, or are forfeited without being exercised, can not
be recycled into new grants. The term of each SAR is determined by the
Committee of the Board of Directors and may not exceed ten years after the date
of the grant. The SARs vest and are exercisable for the cash value between the
Companys stock price less the exercise price. The SARs vest over five years,
40% two years after the grant date and 20% per year after. In 2007, 17,500 SARs
were exercised. As of December 31, 2008 and 2007, there were no remaining SARs.

The
Company did not grant any SARs in 2008 and 2007.

|                                                                                            | 
|------------------------------------------------------------------------------------------- | 
|12.        COMMITMENTS, CONTINGENCIES AND FINANCIAL INSTRUMENTS WITH
OFF-BALANCE SHEET RISK

The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business in order to meet the financing needs of its
customers. Such financial instruments primarily include commitments to extend
credit.

F-22

---



A
summary of these commitments and contingent liabilities, all of which are
variable rate commitments, at December 31:

|                                                |  |        |            |        |   |            | 
|----------------------------------------------- |  | ------ | ---------- | ------ | - | ---------- | 
|                                                |  | 2008   |            | 2007   |  
|                                                |  |        |            |        |  
|                                                |  | Amount |            | Amount |  
|                                                |  |        |            |        |  
|                                               
|Commitments to fund secured
 construction loans |  | $      | 3,500,000  |        | $ | 7,687,362  | 
|Commitments to fund all
 other commercial loans |  |        | 22,219,911 |        |   | 17,175,024 | 
|                                                |  |        |            |        |   |            | 
|                                                |  | $      | 25,719,911 |        | $ | 24,862,386 | 
|                                                |  |        |            |        |   |            | 

Commitments
to extend credit are legally binding agreements to lend to a customer.
Commitments are issued following the Companys evaluation of each applicants
creditworthiness on a case-by-case basis. The Companys exposure to credit loss
in the event of nonperformance by the other party to the financial instrument
is represented by the contractual notional amount of those instruments.

Victory State Bank currently has a $2 million unsecured credit facility with
Atlantic Central Bankers Bank which the Bank has not drawn upon.

The Bank is a defendant in a lawsuit against a former customer brought by a
third party. The Bank intends to defend aggressively the claims made against
it.

VSB Bancorp, Inc. is not involved in any pending legal proceedings. The Bank,
from time to time, is involved in routine collection proceedings in the
ordinary course of business on loans in default. Management believes that such
other routine legal proceedings in the aggregate are immaterial to our
financial condition or results of operations.

|    |                                    
|--- | -----------------------------------
|13. | FAIR VALUE OF FINANCIAL INSTRUMENTS

The
following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, Disclosures about Fair Value of Financial Instruments.
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Company could realize
in a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.

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

| |                                                                                                                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Interest-bearing Bank Balances  Interest-bearing bank balances
 mature within one year and are carried at cost which are estimated to be
 reasonably close to fair value.                                                                                                                                                                                          
| |                                                                                                                                                                                                                                                                                                                                                                     
| | Money Market Investments  The fair value of these securities
 approximates their carrying value due to the relatively short time to
 maturity                                                                                                                                                                                                                      
| |                                                                                                                                                                                                                                                                                                                                                                     
| | Investment Securities, Available For Sale  The estimated fair value of these
 securities is determined by using available market information and
 appropriate valuation methodologies. The estimates presented herein are not
 necessarily indicative of the amounts that the Company could realize in a
 current market exchange.                                 
| |                                                                                                                                                                                                                                                                                                                                                                     
| | Loans Receivable - The fair value of commercial and
 construction loans are approximated by the carrying value as the loans are
 tied directly to the Prime Rate and are subject to change on a daily basis.
 The fair value of the remainder of the portfolio is determined by discounting
 the future cash flows of the loans using the appropriate discount rate.

F-23

---



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Other Financial Assets - The fair value of these assets,
 principally accrued interest receivable, approximates their carrying value
 due to their short maturity.                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | Non-Interest Bearing and Interest Bearing Deposits
 - The fair value disclosed for non-interest bearing deposits is equal to the
 amount payable on demand at the reporting date. The fair value of interest
 bearing deposits is based upon the current rates for instruments of the same
 remaining maturity. Interest bearing deposits with a maturity of greater than
 one year are estimated using a discounted cash flow approach that applies
 interest rates currently being offered.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | Subordinated Debt  The fair value of
 subordinated debt is based upon the current rates for such instruments of the
 same remaining maturity.                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | Other Liabilities - The estimated fair
 value of other liabilities, which primarily include accrued interest payable,
 approximates their carrying amount.                                                                                                                                                                                                                                                                                                                                   
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | Off-Balance Sheet Items - The estimated
 fair value of off-balance sheet items, including adjustable rate loan
 commitments, unused lines of credit and letters of credit are not material
 and are not included in the fair value table.                                                                                                                                                                                                                                                    

The
estimated fair values of the Companys financial instruments at December 31,
2008 and 2007 were as follows:

|                                          |  |                  |             |             |   |                  |  |             |             |  |   |             | 
|----------------------------------------- |  | ---------------- | ----------- | ----------- | - | ---------------- |  | ----------- | ----------- |  | - | ----------- | 
|                                          |  | 2008             |             | 2007        |  
|                                          |  |                  |             |             |  
|                                          |  | Carrying
 Amount |             | Fair
 Value |   | Carrying
 Amount |  | Fair
 Value |            
|                                          |  |                  |             |             |   |                  |  |             |            
|Financial Assets:                         |  |                  |             |             |   |                  |  |             |            
|Cash and cash equivalents                 |  | $                | 21,240,223  |             | $ | 21,240,223       |  | $           | 17,696,879  |  | $ | 17,696,879  | 
|Investment securities, available for sale |  |                  | 120,288,588 |             |   | 120,288,588      |  |             | 117,814,117 |  |   | 117,814,117 | 
|Loans receivable                          |  |                  | 65,258,776  |             |   | 63,767,118       |  |             | 61,445,917  |  |   | 64,711,536  | 
|Other financial assets                    |  |                  | 723,473     |             |   | 723,473          |  |             | 799,249     |  |   | 799,249     | 
|                                          |  |                  |             |             |   |                  |  |             |             |  |   |             | 
|                                         
|Total Financial Assets                    |  | $                | 207,511,060 |             | $ | 206,019,402      |  | $           | 197,756,162 |  | $ | 201,021,781 | 
|                                          |  |                  |             |             |   |                  |  |             |             |  |   |             | 
|Financial Liabilities:                    |  |                  |             |             |   |                  |  |             |             |  |   |             | 
|Non-interest bearing deposits             |  | $                | 58,907,451  |             | $ | 58,907,451       |  | $           | 62,780,934  |  | $ | 62,780,934  | 
|Interest bearing deposits                 |  |                  | 129,201,998 |             |   | 129,096,378      |  |             | 113,553,509 |  |   | 109,224,316 | 
|Subordinated debt                         |  |                  |            |             |   |                 |  |             | 5,155,000   |  |   | 5,247,510   | 
|Other liabilities                         |  |                  | 162,731     |             |   | 162,731          |  |             | 362,991     |  |   | 362,991     | 
|                                          |  |                  |             |             |   |                  |  |             |             |  |   |             | 
|                                         
|Total Financial Liabilities               |  | $                | 188,272,180 |             | $ | 188,166,560      |  | $           | 181,852,434 |  | $ | 177,615,751 | 
|                                          |  |                  |             |             |   |                  |  |             |             |  |   |             | 

Statement 157
establishes a fair value hierarchy which requires an entity to maximize the use
of observable inputs and minimize the use of unobservable inputs when measuring
fair value. The standard describes three levels of inputs that may be used to
measure fair value:

| |                                                                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Level 1:
 Quoted prices (unadjusted) for identical assets or liabilities in active
 markets that the entity has the ability to access as of the measurement date.                                                                                                      
| |                                                                                                                                                                                                                                                                        
| | Level 2:
 Significant other observable inputs other than Level 1 prices such as quoted
 prices for similar assets or liabilities; quoted prices in markets that are
 not active; or other inputs that are observable or can be corroborated by
 observable market data.
| |                                                                                                                                                                                                                                                                        
| | Level 3:
 Significant unobservable inputs that reflect a reporting entitys own
 assumptions about the assumptions that market participants would use in
 pricing and asset or liability.                                                                              

F-24

---



The fair value
of securities available for sale are determined by obtaining quoted prices on nationally
recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a
mathematical technique widely used to in the industry to value debt securities
without relying exclusively on quoted prices for the specific securities but
rather by relying on the securities relationship to other benchmark quoted
securities (Level 2 inputs).

Assets and Liabilities Measured on a Recurring Basis

Assets and
liabilities measured at fair value on a recurring basis are summarized below:

|                               |  |                                                    |             |                                                                |   |                                               |  |                                           |             |  |   |   | 
|------------------------------ |  | -------------------------------------------------- | ----------- | -------------------------------------------------------------- | - | --------------------------------------------- |  | ----------------------------------------- | ----------- |  | - | - | 
|                               |  | Fair Value Measurements at December 31, 2008 Using |            
|                               |  |                                                    |            
|                               |  | December 31,
2008                                  |             | Quoted Prices in
Active Markets for
Identical Assets
(Level 1) |   | Significant
Other
Observable
Inputs
(Level 2) |  | Significant
Unobservable
Inputs
(Level 3) |            
|                               |  |                                                    |             |                                                                |   |                                               |  |                                           |            
|Assets:                        |  |                                                    |             |                                                                |   |                                               |  |                                           |             |  |   |   | 
|Available for sale
 securities |  | $                                                  | 120,288,588 |                                                                | $ |                                              |  | $                                         | 120,288,588 |  | $ |  | 

Assets and
Liabilities Measured on a Non-Recurring Basis

Assets and
liabilities measured at fair value on a non-recurring basis are summarized
below:

|               |  |                                                    |        |                                                                |  |                                               |  |                                           |   |  |   |        | 
|-------------- |  | -------------------------------------------------- | ------ | -------------------------------------------------------------- |  | --------------------------------------------- |  | ----------------------------------------- | - |  | - | ------ | 
|               |  | Fair Value Measurements at December 31, 2008 Using |       
|               |  |                                                    |       
|               |  | December 31,
2008                                  |        | Quoted Prices in
Active Markets for
Identical Assets
(Level 1) |  | Significant
Other
Observable
Inputs
(Level 2) |  | Significant
Unobservable
Inputs
(Level 3) |  
|               |  |                                                    |        |                                                                |  |                                               |  |                                           |  
|Assets:        |  |                                                    |        |                                                                |  |                                               |  |                                           |   |  |   |        | 
|Impaired loans |  | $                                                  | 85,000 |                                                                |  |                                              |  |                                           |  |  | $ | 85,000 | 

Impaired loans
are reported at the fair value of the underlying collateral if repayment is
expected solely from the collateral. Collateral values are estimated using
Level 3 inputs based on internally customized discounting criteria.

As of December
31, 2008, we had one impaired loans that was collateral dependent. Impaired
loans, which are measured for impairment using the fair value of the collateral
for collateral dependent loans, had a carrying amount of $85,000, with a
valuation allowance of $60,241, resulting in an additional provision for loan
losses of $40,000 for the period.

Certain
financial assets and financial liabilities are measured at fair value on a
nonrecurring basis, that is, the instruments are not measured at fair value on
an ongoing basis but are subject to fair value adjustments in certain
circumstances (for example, when there is evidence of impairment). Financial
assets and financial liabilities measured at fair value on a non-recurring
basis were not significant at December 31, 2008.

F-25

---



|    |                               
|--- | ------------------------------
|14. | INTEREST RATE RISK (UNAUDITED)

The
Companys principal business of originating loans, issuing term certificates of
deposit and other interest-bearing deposit accounts and investing in short-term
investment securities inherently includes elements of interest rate risk and
requires careful application of interest rate management techniques to manage
such risks.

Because
the Company has a varied array of investment, loan and deposit products, which
differ as to maturity, repricing terms and interest rate spreads relative to
various rate indices, different interest rate risk management strategies are
utilized.

The
Company funds its assets primarily with deposits. A substantial portion of
these, mature or reprice within one year of their origination or last repricing
date.

In
view of the short maturity profile of the Companys funding sources, the
Company invests in loans and investments which have a maturity or repricing
date designed to match the Companys funding maturities and serve as a natural
hedge of the related interest rate risk.

Net
interest income will fluctuate based on changes in the general level of
interest rates, changes in the levels of interest sensitive assets and
liabilities, and changes in the relationships between different interest rate
indices. In addition, net interest income can also be affected by timing of
repricing dates and repayments and changes in estimated prepayments.

|    |                
|--- | ---------------
|15. | RELATED PARTIES

The
Bank at times has had loans, and other financial transactions, with its
executive officers and directors. At December 31, 2008, the aggregate amount of
loans outstanding to directors was $159,664. There were no loans granted to
executive officers.

The
change in aggregate amount of loans outstanding to directors as of December 31,
2008 and 2007 are as follows:

|                  |  |      |          |      |   |          |  
|----------------- |  | ---- | -------- | ---- | - | -------- | -
|                  |  | 2008 |          | 2007 |  
|                  |  |      |          |      |  
|                  |  |      |          |      |   |          |  
|Beginning balance |  | $    | 192,219  |      | $ | 174,754  |  
|Originations      |  |      | 84,514   |      |   | 333,505  |  
|Payments          |  |      | (117,069 | )    |   | (316,040 | )
|                  |  |      |          |      |   |          |  
|                  |  |      |          |      |   |          |  
|Ending balance    |  | $    | 159,664  |      | $ | 192,219  |  
|                  |  |      |          |      |   |          |  

The
interest income that was paid on these loans was $12,189 and $19,679 for 2008
and 2007, respectively.

Certain
officers and directors own, in the aggregate, 33.4% and 33.2% of the common
shares outstanding at December 31, 2008 and 2007, respectively.

F-26

---



|    |                                                          
|--- | ---------------------------------------------------------
|16. | CONDENSED FINANCIAL STATEMENTS OF THE PARENT COMPANY ONLY

|                                  
|----------------------------------
|VSB BANCORP, INC.                 
|                                  
|STATEMENTS
 OF FINANCIAL CONDITION
|DECEMBER
 31, 2008 and 2007       
|                                  

|                                                                                                                                                                                       |  |      |            |      |   |            |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
|                                                                                                                                                                                       |  | 2008 |            | 2007 |  
|                                                                                                                                                                                       |  |      |            |      |  
|ASSETS                                                                                                                                                                                 |  |      |            |      |   |            |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|Cash and cash equivalents                                                                                                                                                              |  | $    | 542        |      | $ |           |  
|Money market                                                                                                                                                                           |  |      | 496,371    |      |   | 3,505,410  |  
|Investment in subsidiaries                                                                                                                                                             |  |      | 22,673,688 |      |   | 22,596,729 |  
|Deferred taxes                                                                                                                                                                         |  |      | 31,293     |      |   |           |  
|Other assets                                                                                                                                                                           |  |      | 20,332     |      |   | 43,570     |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|                                                                                                                                                                                      
|Total assets                                                                                                                                                                           |  | $    | 23,222,226 |      | $ | 26,145,709 |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                   |  |      |            |      |   |            |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|LIABILITIES:                                                                                                                                                                           |  |      |            |      |   |            |  
|Subordinated debt                                                                                                                                                                      |  | $    |           |      | $ | 5,155,000  |  
|Accounts payable, accrued expenses and other liabilities                                                                                                                               |  |      | 18,459     |      |   | 106,904    |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|                                                                                                                                                                                      
|Total liabilities                                                                                                                                                                      |  |      | 18,459     |      |   | 5,261,904  |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|COMMITMENTS AND CONTINGENT LIABILITIES                                                                                                                                                 |  |      |            |      |   |            |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|STOCKHOLDERS EQUITY                                                                                                                                                                   |  |      |            |      |   |            |  
|Common stock ($.0001 par value, 3,000,000 shares authorized, 1,923,884 issued and 1,882,461
 outstanding at December 31, 2008; 1,900,509 issued and outstanding
 at December 31, 2007) |  |      | 192        |      |   | 190        |  
|Additional paid-in capital                                                                                                                                                             |  |      | 9,200,010  |      |   | 9,107,119  |  
|Retained earnings                                                                                                                                                                      |  |      | 14,714,143 |      |   | 13,226,395 |  
|Treasury stock, at cost (41,423 shares at December 31,
2008)                                                                                                                           |  |      | (395,891   | )    |   |           |  
|Unearned Employee Stock Ownership Plan shares                                                                                                                                          |  |      | (901,750   | )    |   | (1,070,827 | )
|Accumulated other comprehensive gain/(loss), net of taxes of $488,735
 and ($330,668), respectively                                                                                    |  |      | 587,063    |      |   | (379,072   | )
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|                                                                                                                                                                                      
|Total stockholders equity                                                                                                                                                             |  |      | 23,203,767 |      |   | 20,883,805 |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  
|                                                                                                                                                                                      
|Total liabilities and
 stockholders equity                                                                                                                                            |  | $    | 23,222,226 |      | $ | 26,145,709 |  
|                                                                                                                                                                                       |  |      |            |      |   |            |  

F-27

---



|                                               
|-----------------------------------------------
|VSB
 BANCORP, INC.                             
|                                               
|STATEMENTS
 OF OPERATIONS                      
|FOR THE
 YEARS ENDED DECEMBER 31, 2008 AND 2007
|                                               

|                                               |  |      |           |      |   |           |  
|---------------------------------------------- |  | ---- | --------- | ---- | - | --------- | -
|                                               |  | 2008 |           | 2007 |  
|                                               |  |      |           |      |  
|INTEREST INCOME:                               |  |      |           |      |   |           |  
|Loans recievable                               |  | $    | 42,815    |      | $ | 49,578    |  
|Other interest income                          |  |      | 70,656    |      |   | 32,942    |  
|                                               |  |      |           |      |   |           |  
|Total interest income                          |  |      | 113,471   |      |   | 82,520    |  
|                                               |  |      |           |      |   |           |  
|INTEREST EXPENSE:                              |  |      |           |      |   |           |  
|Subordinated debt                              |  |      | 214,685   |      |   | 356,159   |  
|                                               |  |      |           |      |   |           |  
|Total interest expense                         |  |      | 214,685   |      |   | 356,159   |  
|                                               |  |      |           |      |   |           |  
|                                               |  |      |           |      |   |           |  
|Net interest loss                              |  |      | (101,214  | )    |   | (273,639  | )
|                                               |  |      |           |      |   |           |  
|                                               |  |      |           |      |   |           |  
|NON-INTEREST INCOME:                           |  |      |           |      |   |           |  
|Dividend income                                |  |      | 2,768,723 |      |   | 2,800,000 |  
|Other                                          |  |      | 6,455     |      |   | 10,709    |  
|                                               |  |      |           |      |   |           |  
|                                               |  |      | 2,775,178 |      |   | 2,810,709 |  
|                                               |  |      |           |      |   |           |  
|NON-INTEREST EXPENSES:                         |  |      |           |      |   |           |  
|Legal fees                                     |  |      | 56,000    |      |   | 19,000    |  
|Other                                          |  |      | 86,722    |      |   | 90,942    |  
|                                               |  |      |           |      |   |           |  
|Total non-interest expenses                    |  |      | 142,722   |      |   | 109,942   |  
|                                               |  |      |           |      |   |           |  
|                                               |  |      |           |      |   |           |  
|INCOME BEFORE INCOME TAXES                     |  |      | 2,531,242 |      |   | 2,427,128 |  
|                                               |  |      |           |      |   |           |  
|                                               |  |      |           |      |   |           |  
|PROVISION/(BENEFIT) FROM INCOME TAXES:         |  |      |           |      |   |           |  
|Current                                        |  |      | (104,725  | )    |   | (227,029  | )
|Deferred                                       |  |      | (72,768   | )    |   | 30,272    |  
|                                               |  |      |           |      |   |           |  
|                                              
|Total income taxes                             |  |      | (177,493  | )    |   | (196,757  | )
|                                               |  |      |           |      |   |           |  
|                                               |  |      |           |      |   |           |  
|EQUITY IN UNDISTRIBUTED EARNINGS, NET OF TAXES |  |      | (776,991  | )    |   | (576,659  | )
|                                               |  |      |           |      |   |           |  
|                                              
|NET INCOME                                     |  | $    | 1,931,744 |      | $ | 2,047,226 |  
|                                               |  |      |           |      |   |           |  

F-28

---



|                                                                        
|------------------------------------------------------------------------
|VSB
 BANCORP, INC.                                                      
|                                                                        
|STATEMENTS
 OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
|                                                                        

|                                                                               |  |      |            |      |   |            |  
|------------------------------------------------------------------------------ |  | ---- | ---------- | ---- | - | ---------- | -
|                                                                               |  | 2008 |            | 2007 |  
|                                                                               |  |      |            |      |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                          |  |      |            |      |   |            |  
|Net income                                                                     |  | $    | 1,931,744  |      | $ | 2,047,226  |  
|Adjustments to reconcile net income to net cash used
in operating
 activities: |  |      |            |      |   |            |  
|Changes in operating assets and
liabilities:                                   |  |      |            |      |   |            |  
|ESOP compensation expense                                                      |  |      | (71,966    | )    |   | (37,404    | )
|Undistributed income of subsidiaries                                           |  |      | 776,991    |      |   | 576,659    |  
|Decrease in other assets                                                       |  |      | 23,238     |      |   | 5,269      |  
|(Increase)/decrease in deferred income
taxes                                   |  |      | (31,293    | )    |   | 15,178     |  
|Decrease in accounts payable, accrued expenses, and
other liabilities          |  |      | (131,260   | )    |   | (22,443    | )
|                                                                               |  |      |            |      |   |            |  
|Net cash provided by operating activities                                      |  |      | 2,497,454  |      |   | 2,584,485  |  
|                                                                               |  |      |            |      |   |            |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                          |  |      |            |      |   |            |  
|Net decrease in loan receivable                                                |  |      | 169,077    |      |   | 169,078    |  
|Net decrease/(increase) in money market
deposit                                |  |      | 3,009,039  |      |   | (2,717,365 | )
|                                                                               |  |      |            |      |   |            |  
|Net cash provided by/(used in) investing
activities                            |  |      | 3,178,116  |      |   | (2,548,287 | )
|                                                                               |  |      |            |      |   |            |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                          |  |      |            |      |   |            |  
|Exercise stock option                                                          |  |      | 164,859    |      |   | 77,833     |  
|Payment of subordinated debt                                                   |  |      | (5,155,000 | )    |   |           |  
|Return of VSB Capital Trust - common stock                                     |  |      | 155,000    |      |   |           |  
|Purchase of treasury stock, at cost                                            |  |      | (395,891   | )    |   |           |  
|Payment of dividends                                                           |  |      | (443,996   | )    |   | (114,031   | )
|                                                                               |  |      |            |      |   |            |  
|Net cash used in financing activities                                          |  |      | (5,675,028 | )    |   | (36,198    | )
|                                                                               |  |      |            |      |   |            |  
|                                                                               |  |      |            |      |   |            |  
|NET INCREASE IN CASH AND CASH EQUIVALENTS                                      |  |      | 542        |      |   |           |  
|                                                                              
|CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                                   |  |      |           |      |   |           |  
|                                                                               |  |      |            |      |   |            |  
|CASH AND CASH EQUIVALENTS, END OF YEAR                                         |  | $    | 542        |      | $ |           |  
|                                                                               |  |      |            |      |   |            |  
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                              |  |      |            |      |   |            |  
|Cash paid during the period for:                                               |  |      |            |      |   |            |  
|Interest                                                                       |  | $    | 259,088    |      | $ | 345,450    |  
|                                                                               |  |      |            |      |   |            |  
|Income taxes                                                                   |  | $    |           |      | $ |           |  
|                                                                               |  |      |            |      |   |            |  

|    |                              
|--- | -----------------------------
|17. | EMPLOYEE STOCK OWNERSHIP PLAN

Employees
participate in an Employee Stock Ownership Plan (ESOP). VSB Bancorp, Inc.
ESOP Trust was formed on May 1, 2004. The ESOP borrowed from the Company to
purchase 92,900 shares of stock at $18.20 per share. The Company makes
discretionary contributions to the ESOP, as well as paying dividends on
unallocated shares to the ESOP, and the ESOP uses funds it receives to repay
the loan. When loan payments are made, ESOP shares are allocated to
participants based on relative compensation and expense is recorded. Dividends
on allocated shares increase participant accounts.

Shares
allocated to each participant, to the extent vested, are distributed to the
participant upon termination of employment. As required by federal law, a
participant may require the Company to repurchase shares so distributed unless
the stock is traded on an established market.

The
contribution to the ESOP was $169,078 for each of the years ended December 31,
2008 and 2007. ESOP expense was $97,112 and $131,674, for the years ended
December 31, 2008 and 2007, respectively.

F-29

---



Shares
held by the ESOP at December 31, 2008 and 2007 were as follows:

|                                 |  |      |         |      |   |         |  
|-------------------------------- |  | ---- | ------- | ---- | - | ------- | -
|                                 |  | 2008 |         | 2007 |  
|                                 |  |      |         |      |  
|                                 |  |      |         |      |   |         |  
|Shares allocated to participants |  |      | 47,151  |      |   | 37,602  |  
|Shares released to participants  |  |      | (3,885  | )    |   | (564    | )
|Unearned shares                  |  |      | 45,749  |      |   | 55,298  |  
|                                 |  |      |         |      |   |         |  
|                                 |  |      |         |      |   |         |  
|Total ESOP Shares                |  |      | 89,015  |      |   | 92,336  |  
|                                 |  |      |         |      |   |         |  
|Fair value of unearned shares    |  | $    | 398,931 |      | $ | 616,573 |  
|                                 |  |      |         |      |   |         |  

|    |                        
|--- | -----------------------
|18. | SUBORDINATED DEBENTURES

In
August of 2003, the Company formed VSB Capital Trust I (the Trust). The Trust
is a statutory business trust organized under Delaware law and the Company owns
all of its common securities. The Trust issued $5.0 million of Trust Preferred
Capital Securities to an independent investor and $155,000 of common securities
to the Company. The Company issued a $5.16 million subordinated debenture to
the Trust. The subordinated debenture is the sole asset of the Trust. The
subordinated debenture and the Trust Preferred Capital Securities pay interest
and dividends, respectively, on a quarterly basis, at a rate of 6.909%, for the
first five years. They mature thirty years after the issuance of the securities
and are non-callable for five years. After the first five years, the Trust
Preferred Securities may be called by the Company at any quarterly interest
payment date at par and the rate of interest that fluctuates quarterly based
upon 300 basis points over the 90 day LIBOR rate. On August 8, 2008, the
Company repaid the subordinated debenture in full at par, received payment of
$155,000 on account of its common securities of the Trust, and all the
outstanding Trust Preferred Capital Securities were likewise redeemed, thereby
ending the entire arrangement.

The Company reports as liabilities the subordinated debentures issued by the
Company and held by the Trust.

*****************

F-30

---



Item 9. Changes In and Disagreements With
Accountants on Accounting and Financial Disclosure

Not
applicable.

Item 9a (T) Controls and Procedures

Disclosure Controls and Procedures

Our principal
executive and principal financial officer evaluated our 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)), as of the
end of the period covered by this Annual Report, as required by paragraph (b)
of Rule 13a-15 of the Exchange Act. Based on such evaluation, our principal
executive and principal financial officer concluded that, as of the end of the
period covered by this Annual Report, our disclosure controls and procedures
are effective.

Managements Annual Report on Internal Control Over Financial Reporting

Our management
is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rule 13a-15(f) under the Securities Exchange
Act of 1934. Our internal control over financial reporting is designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles in the United States.

All internal
control systems, no matter how well designed, have inherent limitations.
Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and
presentation.

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

Management
assessed the effectiveness of our internal control over financial reporting as
of December 31, 2008. In making this assessment, management used the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal
Control-Integrated Framework as amplified by the Guidance for Smaller Public Companies.The
five principal components of the Framework that management analyzed in
connection with its assessment were our Control Environment, Risk Assessment,
Control Activities, Information and Communication, and Monitoring. Based on
that assessment, management believes that we maintained effective internal
control over financial reporting as of December 31, 2008.

This
annual report does not include an attestation report of the companys
registered public accounting firm regarding internal control over financial
reporting. Managements report was not subject to attestation by the companys
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit the company to provide only managements
report in this annual report.

Item 9B. Other Information.

Not
applicable.

---



PART III

Item 10. Directors, Executive Officers,
Promoters and Control Persons; Compliance with Section 16(a) of the Exchange
Act

Incorporated
by reference to pages 4 and 5 of the Proxy Statement under the caption General
Information Regarding Nominees and Our Other Directors; page 13 of the Proxy
Statement under the caption Section 16a Beneficial Ownership Reporting
Compliance; and pages 5 and 6 of the Proxy Statement under the caption Audit
Committee.

The Company
has a Code of Ethics that applies to all officers and employees. The Code of
Ethics is posted on our web site  www.victorystatebank.com  and can be found
under the Investor Relations tab.

Item 11. Executive Compensation

The
information required by this Item is incorporated by reference to pages 8
through 11 of the Proxy Statement under the caption Compensation through and
including the sub-caption Directors Compensation.

Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters

The
information required by this Item is incorporated by reference to page 11
through page 12 of the Proxy Statement under the caption Security Ownership of
Management and Certain Beneficial Owners.

Item 13. Certain Relationships and Related
Transactions, and Director Independence

The
information required by this Item is incorporated by reference to pages 12
through 13 of the Proxy Statement under the caption Transactions with Directors
and Officers and Their Related Interests.

Item 14. Principal Accounting Fees and
Services.

The
information required by this Item is incorporated by reference to pages 13
through 14 of the Proxy Statement under the caption Audit and Other Fees.

Item 15. Exhibits, Financial Statement
Schedules

(a) Financial
Statements

|                                                                                                 |  |    
|------------------------------------------------------------------------------------------------ |  | ---
|Report of Independent Registered Public Accounting Firm                                          |  | F-1
|Consolidated
 Statements of Financial Condition as of December 31, 2008 and 2007                 |  | F-2
|Consolidated
 Statements of Earnings for the Years Ended December 31, 2008 and 2007              |  | F-3
|Consolidated
 Statements of Stockholders Equity for the Years Ended December 31, 2008 and
 2007 |  | F-4
|Consolidated
 Statements of Cash Flows for the Years Ended December 31, 2008 and 2007            |  | F-5
|Notes to
 Consolidated Financial Statements                                                      |  | F-6

---



(b) Exhibits

|            |  |                                                                                              | 
|----------- |  | -------------------------------------------------------------------------------------------- | 
|Exhibit No. |  | Title of Exhibit                                                                             | 
|            |  |                                                                                              | 
|            |  |                                                                                             
|3.1         |  | Restated
 Certificate of Incorporation of VSB Bancorp, Inc.*                                
|3.2         |  | Bylaws of
 VSB Bancorp, Inc.*                                                               
|10.1        |  | Employment
 Agreement between Merton Corn and Victory State Bank*                           
|10.2        |  | Victory
 State Bank 2000 Incentive Stock Option Plan*                                       
|10.3        |  | Victory
 State Bank 2000 Directors Stock Option Plan*                                       
|10.4        |  | Victory
 State Bank 1998 Incentive Stock Option Plan*                                       
|10.5        |  | Victory
 State Bank 1998 Directors Stock Option Plan*                                       
|10.6        |  | VSB Bancorp,
 Inc. Restated 2000 Incentive Stock Option Plan*                               
|10.7        |  | VSB Bancorp,
 Inc. Restated 2000 Directors Stock Option Plan*                               
|10.8        |  | VSB Bancorp,
 Inc. Restated 1998 Incentive Stock Option Plan*                               
|10.9        |  | VSB Bancorp,
 Inc. Restated 1998 Directors Stock Option Plan*                               
|10.10       |  | VSB Bancorp,
 Inc. 2004 Directors Stock Option Plan**                                       
|10.11       |  | Employment
 Agreement among Raffaele M. Branca, VSB Bancorp, Inc. and Victory State
 Bank***
|21.         |  | Subsidiaries
 of the Registrant                                                             
|23.         |  | Consent of
 Independent Registered Public Accounting Firm                                   
|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 Principal Accounting Officer                     
|32.1        |  | Certification
 by CEO pursuant to 18 U.S.C. 1350                                            
|32.2        |  | Certification
 by Principal Accounting Officer pursuant to 18 U.S.C. 1350                   

* - previously
filed as an exhibit on Form 10-KSB (File No. 0-05237) as filed with the
Securities and Exchange Commission on March 26, 2008.


** -
previously filed as an exhibit included in the Issuers proxy statement for its
2004 Annual Meeting of Stockholders on Form 14A.


*** -
previously filed as exhibit on Form 8-K (File No. 0-50237) as filed with the
Securities and Exchange Commission on November 16, 2007.


---



SIGNATURES

Pursuant to
the requirements of Section 12 of the Securities Exchange Act of 1934, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized.

|                      |                    |                                           | 
|--------------------- | ------------------ | ----------------------------------------- | 
|                      | VSB Bancorp,
 Inc.
|                      | (Registrant)      
|                      |                    |                                          
|Date: March 24, 2009  | By:                | /s/ Raffaele
 M. Branca                   | 
|                      |                    |                                           | 
|                      |                    | Raffaele M.
 Branca, President & CEO,    
|                      |                    | Principal
 Executive Officer and         
|                      |                    | Principal
 Financial Officer             
|                      |                    |                                          
|Date: March
 24, 2009 |                    | /s/ Ronald
 Giampaolo                     | 
|                      |                    |                                           | 
|                      |                    | Ronald
 Giampaolo                        
|                      |                    | Vice
 President, Controller and Principal
|                      |                    | Accounting
 Officer                      

Pursuant to
the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant in the
capacities indicated below.

|                                                   |  |                 | 
|-------------------------------------------------- |  | --------------- | 
|/s/ Raffaele
 M. Branca                            |  | March 24,
 2009 | 
|                                                   |  |                 | 
|Raffaele M.
 Branca, President and Chief Executive |  | Date            | 
|Officer and
 Director                              |  |                 | 
|                                                   |  |                 | 
|/s/ Joseph J.
 LiBassi                             |  | March 24,
 2009 | 
|                                                   |  |                 | 
|Joseph J,
 LiBassi, Chairman of the Board          |  | Date            | 
|                                                   |  |                 | 
|/s/ Joan
 Nerlino Caddell                          |  | March 24, 2009  | 
|                                                   |  |                 | 
|Joan Nerlino
 Caddell, Director                    |  | Date            | 
|                                                   |  |                 | 
|/s/ Robert S.
 Cutrona, Sr.                        |  | March 24,
 2009 | 
|                                                   |  |                 | 
|Robert S.
 Cutrona, Sr., Director                  |  | Date            | 
|                                                   |  |                 | 
|/s/ Chaim
 Farkas                                  |  | March 24,
 2009 | 
|                                                   |  |                 | 
|Chaim
 Farkas, Director                            |  | Date            | 
|                                                   |  |                 | 
|/s/ Alfred C.
 Johnsen                             |  | March 24,
 2009 | 
|                                                   |  |                 | 
|Alfred C.
 Johnsen, Director                       |  | Date            | 
|                                                   |  |                 | 
|/s/ Carlos
 Perez                                  |  | March 24,
 2009 | 
|                                                   |  |                 | 
|Carlos
 Perez, Director                            |  | Date            | 
|                                                   |  |                 | 
|/s/ Bruno
 Savo                                    |  | March 24,
 2009 | 
|                                                   |  |                 | 
|Bruno Savo,
 Director                              |  | Date            | 

---