**CONTENTS**

| CORPORATE PROFILE AND  RELATED INFORMATION                                                      |   | 1      |   |
|-------------------------------------------------------------------------------------------------|--------|--------|--------|
| SELECTED FINANCIAL INFORMATION AND OTHER DATA                                                   |   | 3      |   |
| MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  POSITION AND RESULTS OF OPERATIONS      |   | 4      |   |
| REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING  FIRM                                        |   | 16     |   |
| FINANCIAL  STATEMENTS                                                                           |   |   |   |
| CONSOLIDATED STATEMENTS OF FINANCIAL POSITION                                                   |   | 17     |   |
| CONSOLIDATED STATEMENTS OF INCOME                                                               |   | 18     |   |
| CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’  EQUITY AND COMPREHENSIVE INCOME (LOSS) |   | 19     |   |
| CONSOLIDATED STATEMENTS OF CASH FLOWS                                                           |   | 20     |   |
| NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                      |   | 22     |   |
| BOARD OF DIRECTORS AND EXECUTIVE OFFICERS                                                       |   | 51     |   |

 

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**CORPORATE PROFILEAND RELATED INFORMATION**

TF Financial Corporation(the “Company”) is the parent company of Third Federal Bank and itssubsidiaries Third Delaware Corporation and Teragon Financial Corporation(collectively, “Third Federal” or the “Bank”), TF Investments Corporation, andPenns Trail Development Corporation. At December 31, 2006, total assetswere approximately $652.6 million. The Company was formed as a Delawarecorporation in March 1994 at the direction of the Bank to acquire all ofthe capital stock that Third Federal issued upon its conversion from the mutualto stock form of ownership (the “Conversion”) and concurrent $52.9 millioninitial public offering effective July 13, 1994. At December 31,2006, total stockholders’ equity was approximately $65.6 million. TheCompany is a unitary savings and loan holding company which, under existinglaws, generally is not restricted in the types of business activities in whichit may engage, provided that Third Federal retains a specified amount of itsassets in housing-related investments. Third Federal is a federally charteredstock savings bank headquartered in Newtown, Pennsylvania, which was originallychartered in 1921 under the name “Polish American Savings Building and LoanAssociation.” Deposits of Third Federal have been federally insured since 1935and are currently insured up to the maximum amount allowable by the FederalDeposit Insurance Corporation (the “FDIC”). Third Federal is acommunity-oriented institution offering a variety of financial services to meetthe needs of the communities that it serves. As of December 31, 2006,Third Federal operated branch offices in Bucks and Philadelphia counties,Pennsylvania and Mercer County, New Jersey. Third Federal attracts deposits(approximately $478.1 million at December 31, 2006) from the generalpublic and uses such deposits, together with borrowings mainly from the FederalHome Loan Bank of Pittsburgh (approximately $101.7 million at December 31,2006) and other funds, to originate loans secured by first mortgages and juniorliens on owner-occupied, one-to-four family residences, and to originate loanssecured by commercial real estate, including construction loans.

**Stock MarketInformation**

Since its issuance in July 1994,the Company’s common stock has been traded on the Nasdaq National Market. Thedaily stock quotation for the Company is listed in the Nasdaq National Marketpublished in The Wall Street Journal, The Philadelphia Inquirer, and otherleading newspapers under the trading symbol of “THRD.” The number ofshareholders of record of common stock as of March 7, 2007, wasapproximately 500. This does not reflect the number of persons or entities whoheld stock in nominee or “street” name through various brokerage firms.

**Dividend Policy**

The Company’s ability topay dividends to stockholders is dependent in part upon the dividends itreceives from Third Federal. Among other limitations, Third Federal may notdeclare or pay a cash dividend on any of its stock if the effect thereof wouldcause Third Federal’s regulatory capital to be reduced below (1) theamount required for the liquidation account established in connection withThird Federal’s conversion from mutual to stock form, or (2) theregulatory capital requirements imposed by the Office of Thrift Supervision (“OTS”).It is the Company’s policy to pay dividends when it is deemed prudent to do so.The Board of Directors will consider the payment of a dividend on a quarterlybasis, after giving consideration to the level of profits for the previousquarter and other relevant information.

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**Stock Price and Dividend History**

| ** **               | ** ** | **Quoted market price** | ** ** | **Dividend paid** | ** ** |
|--------------------------|------------|-----------------------------------|------------|------------------------|------------|
| **Quarter ended**   | ** ** | **High**                          | ** ** | **Low**                | ** ** | **per share** | ** ** |
| December 31,  2006  |       | $                                 | 32.00      |                   | $          | 30.25 |   |   | $ | 0.19 |   |   |
| September 30,  2006 |       | $                                 | 33.00      |                   | $          | 27.00 |   |   | $ | 0.19 |   |   |
| June 30,  2006      |       | $                                 | 30.86      |                   | $          | 28.40 |   |   | $ | 0.19 |   |   |
| March 31,  2006     |       | $                                 | 30.99      |                   | $          | 27.90 |   |   | $ | 0.19 |   |   |
| December 31,  2005  |       | $                                 | 29.67      |                   | $          | 27.50 |   |   | $ | 0.18 |   |   |
| September 30,  2005 |       | $                                 | 28.97      |                   | $          | 27.25 |   |   | $ | 0.18 |   |   |
| June 30,  2005      |       | $                                 | 29.64      |                   | $          | 26.75 |   |   | $ | 0.18 |   |   |
| March 31, 2005      |       | $                                 | 32.09      |                   | $          | 28.71 |   |   | $ | 0.18 |   |   |

 

**Stock Performance Graph**

Set forth below is aperformance graph for the Common Stock for the period from December 31,2001 through December 31, 2006. The performance graph compares thecumulative total stockholder return on the Common Stock with (a) thecumulative total stockholder return on stocks included in the Nasdaq U.S. StockMarket Index, (b) the cumulative total stockholder return on stocksincluded in the SNL Nasdaq Thrift Index and (c) the cumulative totalstockholder return on stocks included in the SNL $500 million-$1 billion ThriftIndex. The Nasdaq U.S. Stock Market Index was prepared by the Center forResearch in Security Prices (CRSP) at the University of Chicago, and the SNLindices were prepared by SNL Securities, LC, Charlottesville, Virginia. The SNL$500 million-$1 billion Thrift and Nasdaq Indices are included in theperformance graph because these indices track the performance of thriftinstitutions similar to the Company. Comparison with the Nasdaq U. S. StockMarket Index and the thrift indices assumes the investment of $100 as of December 31,2001. The cumulative total return for each index and for the Company iscomputed with the reinvestment of dividends that were paid during the period.

| ** **                 | ** ** | **Period ending** | ** ** |         |
|----------------------------|------------|-------------------|------------|--------------|
| ** **                 | ** ** | **12/31/01**      | ** ** | **12/31/02** | ** ** | **12/31/03** | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** |   |
| Nasdaq U. S.  Market Index |       |              | $          | 100          |   |   |   | $ | 69 |   |   |   | $ | 103 |   |   |   | $ | 113 |   |   |   | $ | 115 |   |   |   | $ | 126 |   |   |
| SNL OTC Thrift  Index      |       |              | 100        |         |   |   | 128 |   |   |   | 193 |   |   |   | 217 |   |   |   | 217 |   |   |   | 258 |   |   |
| SNL $.5B-$1B  Thrift Index |       |              | 100        |         |   |   | 140 |   |   |   | 199 |   |   |   | 221 |   |   |   | 210 |   |   |   | 257 |   |   |
| TF Financial Corporation   |       |              | 100        |         |   |   | 120 |   |   |   | 170 |   |   |   | 163 |   |   |   | 149 |   |   |   | 166 |   |   |

 

There can be no assurancethat the Company’s future stock performance will be the same or similar to thehistorical stock performance shown in the graph above. The Company neithermakes nor endorses any predictions as to stock performance.

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**SELECTED FINANCIALINFORMATION AND OTHER DATAAt December 31,(Dollars in thousands, except per share data)**

| **Financial Position**                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Total assets                                               |       | $        | 652,603    |     | $          | 660,839  |       | $        | 628,966    |     | $          | 606,752 |   | $ | 721,032 |   |
| Loans receivable,  net, held for investment                     |       | 483,570  |       | 490,891  |       | 441,515  |       | 404,649  |       | 370,092  |       |
| Loans receivable,  available for sale                           |       | 969      |       | 68       |       | 680      |       | —   |       | —   |       |
| Mortgage-backed  securities available for sale, at fair value   |       | 74,338   |       | 83,511   |       | 103,610  |       | 106,774  |       | 115,243  |       |
| Mortgage-backed  securities held to maturity, at amortized cost |       | 7,697    |       | 10,177   |       | 14,900   |       | 23,630   |       | 54,592   |       |
| Investment  securities available for sale, at fair value        |       | 34,524   |       | 30,401   |       | 17,625   |       | 14,443   |       | 27,243   |       |
| Investment  securities held to maturity, at amortized cost      |       | 677      |       | 4,690    |       | 7,027    |       | 10,389   |       | 14,563   |       |
| Cash and cash  equivalents(1)                                   |       | 12,364   |       | 3,821    |       | 7,900    |       | 8,241    |       | 100,580  |       |
| Deposits                                                        |       | 478,087  |       | 470,521  |       | 459,903  |       | 459,343  |       | 442,558  |       |
| Advances from the  Federal Home Loan Bank and other borrowings  |       | 101,701  |       | 121,260  |       | 102,747  |       | 86,853   |       | 207,359  |       |
| Retained earnings                                               |       | 65,075   |       | 61,610   |       | 57,428   |       | 52,626   |       | 59,978   |       |
| Total  stockholders’ equity                                |       | 65,639   |       | 62,648   |       | 61,155   |       | 55,480   |       | 62,840   |       |
| Book value per  common share                                    |       | $        | 24.29      |     | $          | 23.08    |       | $        | 22.30      |     | $          | 21.37 |   | $ | 25.31 |   |
| Tangible book  value per common share(3)                        |       | $        | 22.68      |     | $          | 21.46    |       | $        | 20.57      |     | $          | 19.56 |   | $ | 23.34 |   |

 

**At or for the year ended December 31,**

| **Summary of Operations**            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Interest income                                |       | $        | 38,019     |     | $          | 33,965   |       | $        | 31,221     |     | $          | 32,377 |   | $ | 40,455 |   |
| Interest expense                               |       | 15,861   |       | 11,532   |       | 8,866    |       | 15,252   |       | 22,660   |       |
| Net interest income                            |       | 22,158   |       | 22,433   |       | 22,355   |       | 17,125   |       | 17,795   |       |
| Provision for loan  losses                     |       | 150      |       | 540      |       | 600      |       | 330      |       | 988      |       |
| Non-interest income                            |       | 2,810    |       | 2,728    |       | 2,608    |       | 2,690    |       | 3,304    |       |
| Non-interest expense                           |       | 17,168   |       | 16,168   |       | 15,329   |       | 28,703   |       | 13,414   |       |
| Net income (loss)                              |       | $        | 5,514      |     | $          | 6,153    |       | $        | 6,567      |     | $          | (5,834 | ) | $ | 5,092 |   |
| Earnings (loss) per  common share—basic   |       | $        | 2.04       |     | $          | 2.25     |       | $        | 2.44       |     | $          | (2.30 | ) | $ | 2.06 |   |
| Earnings (loss) per  common share—diluted |       | $        | 2.03       |     | $          | 2.20     |       | $        | 2.33       |     | $          | (2.30 | ) | $ | 1.91 |   |

 

| **Performance Ratios and Other Selected Data** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Return on average assets                                                |       |     | 0.83       | %        |       |     | 0.96       | %        |       |     | 1.06       | % |   |   | n.m. |   |   |   | 0.71 | % |   |
| Return on average equity                                                |       |     | 8.68       | %        |       |     | 10.16      | %        |       |     | 11.58      | % |   |   | n.m. |   |   |   | 8.47 | % |   |
| Average equity to  average assets                                       |       |     | 9.59       | %        |       |     | 9.40       | %        |       |     | 9.16       | % |   |   | 9.01 | % |   |   | 8.34 | % |   |
| Average interest rate  spread                                           |       |     | 3.45       | %        |       |     | 3.62       | %        |       |     | 3.79       | % |   |   | 2.57 | % |   |   | 2.44 | % |   |
| Non-performing loans to  total assets                                   |       |     | 0.32       | %        |       |     | 0.24       | %        |       |     | 0.15       | % |   |   | 0.38 | % |   |   | 0.53 | % |   |
| Non-performing loans to  total loans                                    |       |     | 0.43       | %        |       |     | 0.32       | %        |       |     | 0.22       | % |   |   | 0.56 | % |   |   | 1.03 | % |   |
| Allowance for loan  losses to non-performing loans                      |       |     | 135.78     | %        |       |     | 166.31     | %        |       |     | 240.31     | % |   |   | 92.51 | % |   |   | 53.86 | % |   |
| Allowance for loan  losses to total loans                               |       |     | 0.59       | %        |       |     | 0.54       | %        |       |     | 0.52       | % |   |   | 0.52 | % |   |   | 0.54 | % |   |
| Bank regulatory capital                                                 |       |     |       |     |       |     |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |
| Core                                                                    |       |     | 8.95       | %        |       |     | 8.26       | %        |       |     | 8.13       | % |   |   | 7.29 | % |   |   | 6.85 | % |   |
| Tangible                                                                |       |     | 8.95       | %        |       |     | 8.26       | %        |       |     | 8.13       | % |   |   | 7.29 | % |   |   | 6.85 | % |   |
| Risk based                                                              |       |     | 16.29      | %        |       |     | 14.82      | %        |       |     | 15.67      | % |   |   | 14.47 | % |   |   | 15.25 | % |   |
| Dividend payout ratio(2)                                                |       |     | 37.44      | %        |       |     | 32.73      | %        |       |     | 28.33      | % |   |   | n.m. |   |   |   | 31.41 | % |   |

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n.m.   = notmeaningful

(1)          Consistsof cash, cash due from banks, interest-bearing deposits with originalmaturities of less than three months, and federal funds sold.

(2)          Payoutratio is dividends paid for the period divided by earnings per common share—diluted.

(3)          Thisis a non-GAAP disclosure. Tangible book value per common share is computed byreducing stockholder equity by recorded intangible assets, divided by sharesoutstanding.

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**MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL POSITION ANDRESULTS OF OPERATIONS**

**General.  **Thefollowing discussion and analysis should be read in conjunction with theCompany’s consolidated financial statements and is intended to assist inunderstanding and evaluating the major changes in the financial position andresults of operations of the Company with a primary focus on an analysis ofoperating results.

The Company may from time to time make written or oral“forward-looking statements”, including statements contained in the Company’sfilings with the Securities and Exchange Commission, in its reports tostockholders and in other communications by the Company, which are made in goodfaith by the Company pursuant to the “Safe Harbor” Provisions of the PrivateSecurities Litigation Reform Act of 1995.

These forward-looking statements involve risks anduncertainties, such as statements of the Company’s plans, objectives,expectations, estimates and intentions that are subject to change based onvarious important factors (some of which are beyond the Company’s control). Thefollowing factors, among others, could cause the Company’s financialperformance to differ materially from the plans, objectives, expectations,estimates and intentions expressed in such forward-looking statements: thestrength of the United States economy in general and the strength of the localeconomies in which the Company conducts operations; the effects of, and changesin, trade, monetary and fiscal policies and laws, including interest ratepolicies of the Board of Governors of the Federal Reserve System, inflation,interest rate, market and monetary fluctuations; the timely development of andacceptance of new products and services of the Company and the perceivedoverall value of these products and services by users, including the features,pricing and quality compared to competitors’ products and services; thewillingness of users to substitute competitors’ products and services for theCompany’s products and services; the success of the Company in gainingregulatory approval of its products and services, when required; the impact ofchanges in financial services’ laws and regulations (including laws concerningtaxes, banking, securities and insurance); technological changes, acquisitions;changes in consumer spending and saving habits; and the success of the Companyat managing the risks involved in the foregoing.

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The Company cautions that the foregoing list ofimportant factors is not exclusive. The Company does not undertake to updateany forward-looking statement, whether written or oral, that may be made fromtime to time by or on behalf of the Company.

The Company’s income on a consolidated basis isderived substantially from its investment in its subsidiary, Third Federal. Theearnings of Third Federal depend primarily on its net interest income. Netinterest income is affected by the interest income that Third Federal receivesfrom its loans and investments and by the interest expense that Third Federalincurs on its deposits, borrowings and other sources of funds. In addition, themix of Third Federal’s interest-bearing assets and liabilities can have asignificant effect on Third Federal’s net interest income; loans generally havehigher yields than securities; retail deposits generally have lower interestrates than other borrowings.

Third Federal alsoreceives income from service charges and other fees and occasionally from salesof investment securities and real estate owned. Third Federal incurs expensesin addition to interest expense in the form of salaries and benefits, depositinsurance premiums, property operations and maintenance, advertising and otherrelated business expenses.

**Critical AccountingPolicies**

Certain critical accounting policies of the Companyrequire the use of significant judgment and accounting estimates in thepreparation of the consolidated financial statements and related data of theCompany. These accounting estimates require management to make assumptionsabout matters that are highly uncertain at the time the accounting estimate ismade.

Management believes thatthe most critical accounting policy requiring the use of a significant amountof accounting estimates and judgment is the determination of the allowance forloan losses. Allowances are established based on pools of similar loans,delinquencies, loss experience, economic conditions generally and as they mayaffect individual borrowers, and other factors. Individual loans are evaluatedbased on cash flows or value of the underlying collateral, or both. All ofthese evaluation factors are subject to a high degree of uncertainty. If thefinancial condition and collateral values of a significant amount of debtorsshould deteriorate more than the Company has estimated, present allowances forloan losses may be insufficient and additional provisions for loan losses maybe required. In addition, a single loan loss of a substantial amount maysignificantly reduce the allowance. The allowance for loan losses was $2,865,000at December 31, 2006.

**Financial Conditionand Changes in Financial Condition**

**Assets.  **TheCompany’s total assets at December 31, 2006 were $652.6 million, adecrease of $8.2 million during the year. This decrease in total assetswas mainly the combined result of the net change in various asset and liabilitycategories discussed below.

The Company’s loans receivable held for investment at December 31,2006 were $483.6 million, a $7.3 million or 1.5% decrease since December 31,2005. During 2006, there were $109.6 million of principal payments ofexisting loans in the loans receivable portfolio and the Company sold $16.3 millionof previously purchased loans as well as $7.2 million of commercial loanparticipation. Offsetting this reduction was the origination of $125.7 millionin predominately commercial real estate loans and single-family residentialfirst and second mortgage loans. Mortgage loans available for sale at December 31,2006 were $969,000, the result of loan origination efforts of $14.0 millionand related sale proceeds of $13.0 million.

Mortgage-backed securities available for saledecreased by $9.2 million during 2006 due to sales of $5.0 millionand repayments of $14.3 million of the underlying mortgages comprisingsuch securities, partially offset by the purchases of $10.1 million ofsuch securities. Mortgage-backed securities held to 

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maturity decreased by $2.5 millionduring 2006 due to prepayment of the underlying mortgages comprising thesecurities.

Investment securities available for sale increased by$4.1 million during the year. The Company purchased $3.8 million ofsuch securities, mainly bank-qualified municipal bonds, during 2006. Theremaining net change in the portfolio was caused by $0.3 millionamortization of purchase premiums and fair value adjustments.

The Company’s cash and cash equivalents were $12.4 millionat December 31, 2006. It is the Company’s current intent to keep cash andcash equivalents at a minimal level and use its line of credit at the FHLB tofund its day-to-day cash needs; however, the increase in cash was the directresult of commercial loan repayments in late December 2006 totaling $11.4 million.

**Liabilities.  **TheCompany’s total liabilities were $587.0 million at December 31, 2006,a decrease of $11.2 million during 2006. Total deposits increased by $7.6 millionincluding broker originated deposits of $11.7 million received during thesecond quarter of 2006. Advances from the FHLB decreased by $19.6 millionmostly related to the reduction of borrowings outstanding on the line of creditat year end. It is the current intent of the Company to fund a portion of itsinterest-bearing assets, not funded by deposits, with longer term advances fromthe FHLB, and fund its day-to-day cash needs and shorter term interest-bearingassets not otherwise funded with deposits using draws on its line of creditwith the FHLB. The Bank’s line of credit at the FHLB was $30 million ofwhich $0 was drawn at December 31, 2006.

**Stockholders’ equity.****  **Total consolidated stockholders’equity increased by $3.0 million to $65.6 million at December 31,2006. The increase is largely the result of $5.5 million in net incomeless $2.0 million in cash dividends paid to the Company’s commonstockholders. Other comprehensive loss of $0.3 million was the net resultof a $0.7 million loss related to the recognition of the funded status ofthe pension plan and a $0.4 million gain due to the fair value adjustmenton available for sale securities. In addition there was a $0.4 millionincrease in stockholders’ equity attributable to the exercise of stock optionsfor 21,415 shares. The Company also purchased 58,904 shares of common stock,held in treasury, reducing stockholders’ equity by $1.7 million. Finally,there was a $0.4 million increase due to the allocation of 13,495 sharesto participants in the Company’s employee stock ownership plan, and an increaseof $0.7 million attributable to stock grants and stock options.

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**Average Balance Sheet.****  **The following table sets forthinformation (dollars in thousands) relating to the Company’s average balancesheet and reflects the average yield on assets and average cost of liabilitiesfor the periods indicated. The yields and costs are computed by dividing incomeor expense by the average balance of interest-earning assets orinterest-bearing liabilities, respectively for the periods indicated.

| ** **                    | ** ** | **2006**             | ** ** | **2005**     | ** ** | **2004**              | ** ** |
|-------------------------------|------------|----------------------|------------|--------------|------------|-----------------------|------------|
| ** **                    | ** ** | **Average  balance** | ** ** | **Interest** | ** ** | **Average  yld/cost** | ** ** | **Average  balance** | ** ** | **Interest** | ** ** | **Average  yld/cost** | ** ** | **Average  balance** | ** ** | **Interest** | ** ** | **Average  yld/cost** | ** ** |
| **ASSETS**                    |       |                 |       |         |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-earning  assets:** |       |                 |       |         |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

| Loans receivable(1)                                                               |   | $       | 502,048 |   |   | $      | 32,342 |   |   |   | 6.44   | %       |   | $       | 462,389 |   |   | $      | 27,570 |   |   |    | 5.96   | %      |    | $      | 423,482 |   |   | $      | 24,359 |   |   |   | 5.75 | % |   |
|-----------------------------------------------------------------------------------|--------|---------|---------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|---------|---------|--------|--------|--------|--------|--------|--------|---------|--------|--------|---------|--------|---------|--------|--------|--------|--------|--------|--------|--------|------|---|--------|
| Mortgage-backed securities                                                        |   | 81,750  |    |   | 3,722  |   |   |   | 4.55   | %      |   | 108,029 |   |    | 4,875   |   |   |   | 4.51   | %      |   | 128,759 |   |   | 5,696   |   |    |   | 4.42   | %      |   |
| Investment securities(2)                                                          |   | 41,984  |    |   | 2,295  |   |   |   | 5.47   | %      |   | 37,357  |   |    | 1,774   |   |   |   | 4.75   | %      |   | 30,969  |   |   | 1,377   |   |    |   | 4.45   | %      |   |
| Other interest-earning assets(3)                                                  |   | 1,653   |    |   | 94     |   |   |   | 5.69   | %      |   | 1,910   |   |    | 59      |   |   |   | 3.09   | %      |   | 1,127   |   |   | 14      |   |    |   | 1.24   | %      |   |
| Total interest-earning assets                                                     |   | 627,435 |    |   | 38,453 |   |   |   | 6.13   | %      |   | 609,685 |   |    | 34,278  |   |   |   | 5.62   | %      |   | 584,337 |   |   | 31,446  |   |    |   | 5.38   | %      |   |
| Non interest-earning assets                                                       |   | 35,050  |    |   |   |   |   |   |   |   |   | 34,215  |   |    |    |   |   |   |   |   |   | 34,645  |   |   |    |   |    |   |   |   |   |
| Total assets                                                                      |   | $       | 662,485 |   |   |   |   |   |   |   |   |    | $      | 643,900 |    |   |   |   |   |   |   |    |   | $      | 618,982 |   |    |   |   |   |   |   |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                    |   |    |    |   |   |   |   |   |   |   |   |    |   |    |    |   |   |   |   |   |   |    |   |   |    |   |    |   |   |   |   |
| **Interest-bearing  liabilities:**                                                |   |    |    |   |   |   |   |   |   |   |   |    |   |    |    |   |   |   |   |   |   |    |   |   |    |   |    |   |   |   |   |
| Deposits                                                                          |   | 468,933 |    |   | 10,923 |   |   |   | 2.33   | %      |   | 465,521 |   |    | 7,599   |   |   |   | 1.63   | %      |   | 465,097 |   |   | 5,925   |   |    |   | 1.27   | %      |   |
| Advances from the FHLB                                                            |   | 122,671 |    |   | 4,938  |   |   |   | 4.03   | %      |   | 111,628 |   |    | 3,933   |   |   |   | 3.52   | %      |   | 91,660  |   |   | 2,941   |   |    |   | 3.21   | %      |   |
| Total interest-bearing liabilities                                                |   | 591,604 |    |   | 15,861 |   |   |   | 2.68   | %      |   | 577,149 |   |    | 11,532  |   |   |   | 2.00   | %      |   | 556,757 |   |   | 8,866   |   |    |   | 1.59   | %      |   |
| Non interest-bearing liabilities                                                  |   | 7,332   |    |   |   |   |   |   |   |   |   | 6,199   |   |    |    |   |   |   |   |   |   | 5,536   |   |   |    |   |    |   |   |   |   |
| Total liabilities                                                                 |   | 598,936 |    |   |   |   |   |   |   |   |   | 583,348 |   |    |    |   |   |   |   |   |   | 562,293 |   |   |    |   |    |   |   |   |   |
| Stockholders’ equity                                                         |   | 63,549  |    |   |   |   |   |   |   |   |   | 60,552  |   |    |    |   |   |   |   |   |   | 56,689  |   |   |    |   |    |   |   |   |   |
| Total liabilities and stockholders’ equity                                   |   | $       | 662,485 |   |   |   |   |   |   |   |   |    | $      | 643,900 |    |   |   |   |   |   |   |    |   | $      | 618,982 |   |    |   |   |   |   |   |   |   |
| Net interest income                                                               |   |    |    |   | $      | 22,592 |   |   |   |   |   |    |   |    |    | $      | 22,746 |   |   |   |   |    |   |   |    |   | $       | 22,580 |   |   |   |   |   |   |
| Interest rate spread(4)                                                           |   |    |    |   |   |   |   |   | 3.45   | %      |   |    |   |    |    |   |   |   | 3.62   | %      |   |    |   |   |    |   |    |   | 3.79   | %      |   |
| Net yield on interest-earning assets(5)                                           |   |    |    |   |   |   |   |   | 3.60   | %      |   |    |   |    |    |   |   |   | 3.73   | %      |   |    |   |   |    |   |    |   | 3.86   | %      |   |
| Ratio of average  interest-earning assets to average interest-bearing liabilities |   |    |    |   |   |   |   |   | 106    | %      |   |    |   |    |    |   |   |   | 106    | %      |   |    |   |   |    |   |    |   | 105    | %      |   |

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(1)             Nonaccrual loans have been included in the appropriateaverage loan balance category, but interest on nonaccrual loans has not beenincluded for purposes of determining interest income.

(2)             Tax equivalent adjustments to interest on investmentsecurities were $434,000, $313,000, and $225,000 for the years ended December 31,2006, 2005 and 2004, respectively. Tax equivalent interest income is based upona marginal effective tax rate of 34%.

(3)             Includes interest-bearing deposits in other banks.

(4)             Interest rate spread represents the difference betweenthe average yield on interest-earning assets and the average cost ofinterest-bearing liabilities.

(5)             Net yield on interest-earning assets represents netinterest income as a percentage of average interest-earning assets.

7

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**Rate/Volume Analysis.****  **The following table presents, forthe periods indicated, the change in interest income and interest expense (inthousands) attributed to (i) changes in volume (changes in the weightedaverage balance of the total interest-earning asset and interest-bearingliability portfolios multiplied by the prior year rate), and (ii) changesin rate (changes in rate multiplied by prior year volume). Changes attributableto the combined impact of volume and rate have been allocated proportionatelybased on the absolute value of changes due to volume and changes due to rate.

| ** **                          | ** ** | **2006 vs 2005  Increase (decrease) due to** | ** ** | **2005 vs 2004  Increase (decrease) due to** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                          | ** ** | **Volume**                                                            | ** ** | **Rate**                                                              | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| **Interest income:**                |       |                                                                  |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Loans receivable,  net              |       | $                                                                     | 2,463      |                                                                  | $          | 2,309 |   | $ | 4,772 |   | $ | 2,297 |   | $ | 914 |   | $ | 3,211 |   |
| Mortgage-backed  securities         |       | (1,196                                                                | )          | 43                                                                    |       | (1,153 | ) | (933 | ) | 112 |   | (821 | ) |
| Investment  securities(1)           |       | 235                                                                   |       | 286                                                                   |       | 521 |   | 299 |   | 98 |   | 397 |   |
| Other  interest-earning assets      |       | (9                                                                    | )          | 44                                                                    |       | 35 |   | 14 |   | 31 |   | 45 |   |
| Total  interest-earning assets      |       | 1,493                                                                 |       | 2,682                                                                 |       | 4,175 |   | 1,677 |   | 1,155 |   | 2,832 |   |
| **Interest expense:**               |       |                                                                  |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Deposits                            |       | 56                                                                    |       | 3,268                                                                 |       | 3,324 |   | 5 |   | 1,669 |   | 1,674 |   |
| Advances from the  FHLB             |       | 412                                                                   |       | 593                                                                   |       | 1,005 |   | 684 |   | 308 |   | 992 |   |
| Total  interest-bearing liabilities |       | 468                                                                   |       | 3,861                                                                 |       | 4,329 |   | 689 |   | 1,977 |   | 2,666 |   |
| Net change in net  interest income  |       | $                                                                     | 1,025      |                                                                  | $          | (1,179 | ) | $ | (154 | ) | $ | 988 |   | $ | (822 | ) | $ | 166 |   |

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(1)          Tax equivalentadjustments to interest on investment securities were $434,000, $313,000, and$225,000 for the years ended December 31, 2006, 2005 and 2004,respectively. Tax equivalent interest income is based upon a marginal effectiverate of 34%.

**Comparison of YearsEnded December 31, 2006 and December 31, 2005**

**NetIncome.****  **Netincome was $5.5 million for the year ended December 31, 2006 comparedwith net income of $6.2 million for the year ended December 31, 2005.The decrease in net income of $0.7 million when comparing the year 2006with 2005 is largely attributable a $1.0 million increase in non-interestexpense.

**TotalInterest Income.****  **Forthe year ended December 31, 2006, total interest income, on a taxableequivalent basis, increased to $38.5 million compared to $34.3 millionfor the year ended December 31, 2005. The $4.2 million increase ininterest income was mainly the result of the $39.7 million increase in theaverage balances of loans receivable. In addition, beginning in June 2004,the Federal Open Market Committee raised the federal funds rate seventeen timesby a total of 425 basis points through year end 2006. During 2006, the federalfunds rate, and thus the prime rate, rose by 100 basis points while longer terminterest rates relevant to the Company’s loan origination activities, asmeasured by 5 year and 10 year U S Treasury securities, rose by approximately37 to 32 basis points, respectively. The higher prime rate had a positiveeffect on the Bank’s interest income because of the positive effect on the Bank’sadjustable rate and prime-based loans. At December 31, 2006 the Companyhad $74.3 million in floating rate, prime-based construction, home equity,and other loans. In addition, because longer term rates were higher, theCompany was able raise its prices on fixed rate loans.

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**TotalInterest Expense.  ****Total interest expense increased to$15.9 million from $11.5 million for the year ended December 31,2006 compared to 2005. During 2006 the Bank raised the interest rates paid onmany of its deposit products in order to retain existing deposit relationships,attract new deposit relationships, and generally respond to competitive pricingpressures throughout the Company’s deposit markets. As a result, the averageinterest rate paid on deposits rose by 70 basis points during 2006 comparedwith 2005, and produced a $3.3 million increase in interest expense. Interestpaid on advances from the FHLB increased by $1.0 million during 2006compared with 2005, largely because of the need to borrow from the FHLB inorder to fund the Company’s lending activities from sources other than depositgrowth.**

**Allowancefor Loan Losses.****  **Theallowance for loan losses was approximately $2.9 million at December 31,2006 and $2.6 million at December 31, 2005. The provision for loanlosses was $150,000 during 2006 compared with $540,000 during 2005. Netrecoveries of previously charged off loans were $74,000 during 2006 compared tonet charge-offs of $206,000 during 2005. While management maintains theallowance for losses at a level which it considers to be adequate to providefor probable losses, there can be no assurance that further additions will notbe made to the allowance and that such losses will not exceed the estimatedamounts.

**Non-InterestIncome.****  **Totalnon-interest income was $2.8 million during 2006 compared with$2.7 million during 2005. The increase is due to an increase in gain onsales of loans.

**Non-InterestExpense.****  **Totalnon-interest expense increased by $1.0 million during 2006 compared to2005. Employee compensation increased by $1.4 million during 2006 largely dueto $747,000 of stock-based compensation expense related to stock grants and therecognition of option expense associated with the new accounting standard SFAS123R, “Share-Based Payment”. In addition, compensation and other benefitexpenses were higher in 2006 due to hiring of staff at the new and renovatedbranches as well as annual salary increases. Office and occupancy costsincreased $189,000 between the years mainly as a result of costs associatedwith the relocation and renovations of the Feasterville branch as well as thenew branch opened in Philadelphia during 2005. Professional fees declined$75,000 during 2006 over 2005 as expenses associated with technology-relatedcompliance work which was completed in 2005. Marketing and advertising expensedecreased by $273,000 in 2006 in comparison to prior year of 2005 when the Bank’sefforts to increase market visibility included an expansion of the media usedto advertise image, products, and services.

**Income Tax Expense.****  **The Company’s effective tax rate was27.9% during 2006 compared to 27.2% during 2005. These effective tax rates arelower than the Company’s marginal tax rate of 34% largely due to the tax-exemptincome associated with the Company’s investments in tax-exempt municipal bondsand bank-owned life insurance.

**Comparison of YearsEnded December 31, 2005 and December 31, 2004**

**NetIncome.****  **Netincome was $6.2 million for the year ended December 31, 2005 comparedwith net income of $6.6 million for the year ended December 31, 2004.The decrease in net income of $0.4 million when comparing the year 2005with 2004 is largely attributable a $0.8 million increase in non-interestexpense, which was not entirely offset by a $0.1 million increase in netinterest income and a $0.1 million increase in non-interest income.

**TotalInterest Income.****  **Forthe year ended December 31, 2005, total interest income, on a taxequivalent basis, increased to $34.3 million compared to $31.5 millionfor the year ended December 31, 2004. The $2.8 million increase ininterest income was mainly the result of the $38.9 million increase in theaverage balances of loans receivable.

9

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In addition, beginning in June 2004, the FederalOpen Market Committee raised the federal funds rate thirteen times by a totalof 325 basis points through year end 2005. During 2005, the federal funds rate,and thus the prime rate, rose by 200 basis points while longer term interestrates relevant to the Company’s loan origination activities, as measured by 5year and 10 year U S Treasury securities, rose by approximately 65 to 15 basispoints, respectively. The higher prime rate had a positive effect on the Bank’sinterest income because of the positive effect on the Bank’s adjustable rateand prime-based loans. At December 31, 2005, the Company had $65.2 millionin floating rate, prime-based construction, home equity, and other loans. Inaddition, while longer term rates were higher, permitting the Company to raiseits prices on fixed rate loans, these rates were still relatively lowhistorically, and thus new loan production at the Company exceededexpectations.

**TotalInterest Expense.****  **Totalinterest expense increased to $11.5 million from $8.9 million for theyear ended December 31, 2005 compared to 2004. During 2005, the Bankraised the interest rates paid on many of its deposit products in order toretain existing deposit relationships, attract new deposit relationships, andgenerally respond to the extreme competitive pricing pressures throughout theCompany’s deposit markets. As a result, the average interest rate paid on depositsrose by 36 basis points during 2005 compared with 2004, and produced a $1.7million increase in interest expense.

Interest paid on advances from the FHLB increased by$1.0 million during 2005 compared with 2004, largely because of the need toborrow from the FHLB in order to fund the Company’s lending activities fromsources other than deposit growth.

**Allowancefor Loan Losses.**   The allowance for loan losseswas approximately $2.6 million at December 31, 2005 and $2.3 million at December 31,2004. The provision for loan losses was $540,000 during 2005 compared with$600,000 during 2004. Net charged-off loans were $206,000 during 2005 comparedto net charge-offs of $404,000 during 2004. While management maintains theallowance for losses at a level which it considers to be adequate to providefor probable losses, there can be no assurance that further additions will notbe made to the allowance and that such losses will not exceed the estimatedamounts.

**Non-InterestIncome.****  **Totalnon-interest income was $2.7 million during 2005 compared with$2.6 million during 2004. The increase is due to an increase in gain onsales of loans.

**Non-InterestExpense.  **Total non-interest expense increased by$0.8 million during 2005 compared to 2004. Employee compensation and benefitsincreased by $480,000 during 2005 compared to 2004. Most of this increase wasdue to normal salary increases and increased staff, and higher incentiverelated compensation; $124,000 of the increase was due to an increase inpension plan expense. Advertising expense increased by $118,000 due to anincrease in the Bank’s marketing efforts, and an expansion of the media used,to advertise its image, products, and services. Professional fees increased by$199,000 largely due to costs related to the Company’s concerted efforts togreatly enhance and improve the technology infrastructure and related security.

**Income Tax Expense.  **TheCompany’s effective tax rate was 27.2% during 2005 compared to 27.3% during2004. These effective tax rates are lower than the Company’s marginal tax rateof 34% largely due to the tax-exempt income associated with the Company’sinvestments in tax-exempt municipal bonds and bank-owned life insurance.

**Liquidity andCapital Resources**

**Liquidity.****  **The Company’s liquidity is a measureof its ability to fund loans, pay withdrawals of deposits and other cashoutflows, and pay dividends in an efficient, cost-effective manner. The Company’sprimary sources of funds are cash on hand and dividends from its wholly-ownedBank. The Bank’s primary 

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sources of funds aredeposits, borrowings, and scheduled amortization and prepayment of loan andmortgage-backed security principal.

The Bank endeavors to fund its operations internallybut has, when deemed prudent, borrowed funds from the Federal Home Loan Bank.As of December 31, 2006, such borrowed funds totaled $101.7 million.The amount of these borrowings that will mature during the twelve months endingDecember 31, 2007 is $25.1 million. At December 31, 2006 the Bankhad a $30 million line of credit, $30.0 million of which was unused,and up to approximately $300 million of additional collateral-basedborrowing capacity at the Federal Home Loan Bank.

The amount of certificate accounts that are scheduledto mature during the twelve months ending December 31, 2006, isapproximately $170.9 million. To the extent that these deposits do notremain at the Bank upon maturity, the Bank believes that it can replace thesefunds with deposits, excess liquidity, and advances from the FHLB or otherborrowings. It has been the Bank’s experience that substantial portions of suchmaturing deposits remain at the Bank.

At December 31, 2006, the Bank had outstandingcommitments to originate loans or fund unused lines of credit of $87.4 million.The loan commitments will be funded during the twelve months ending December 31,2007. The unused lines of credit can be funded at any time. Funds required tofill these commitments will be derived primarily from current excess liquidity,deposit inflows or loan and security repayments. At December 31, 2006, theBank had $2.9 million outstanding commitments to sell loans.

The Company also has obligations under leaseagreements. Payments required under such lease agreements will be approximately$432,000 during the year ending December 31, 2007.

The following tablecombines the Company’s contractual obligations and commitments to make futurepayments as of December 31, 2006.

| ** **                     | ** ** | **Payments due by period** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3  years** | ** ** | **4-5  years** | ** ** | **After  5 years** | ** ** |
| ** **                     | ** ** | **(in thousands)**                   | ** ** |
| Contractual obligations:       |       |                                      |       |   |   |   |   |   |   |   |   |
| FHLB advances                  |       | $                                         | 101,701    |   | $ | 25,122 |   | $ | 57,710 |   | $ | 15,850 |   | $ | 3,019 |   |
| Time deposits                  |       | 195,551                                   |       | 170,926 |   | 19,940 |   | 4,259 |   | 426 |   |
| Operating leases               |       | 1,476                                     |       | 432 |   | 487 |   | 182 |   | 375 |   |
| Total contractual  obligations |       | $                                         | 298,728    |   | $ | 196,480 |   | $ | 78,137 |   | $ | 20,291 |   | $ | 3,820 |   |

 

| ** **                         | ** ** | **Amount of commitment expirations by period** | ** ** |
|------------------------------------|------------|-------------------------------------------------------------------------|------------|
| Commitments:                       |       |                                                                    |       |   |   |   |   |   |   |   |   |
| Extensions of  credit              |       | $                                                                       | 85,199     |   | $ | 44,780 |   | $ | 7,141 |   | $ | 359 |   | $ | 32,919 |   |
| Letters of credit                  |       | 2,151                                                                   |       | 1,345 |   | 806 |   | — |   | — |   |
| Loans sold with  recourse due 2019 |       | 71                                                                      |       | — |   | — |   | — |   | 71 |   |
| Total commitments                  |       | $                                                                       | 87,421     |   | $ | 46,125 |   | $ | 7,947 |   | $ | 359 |   | $ | 32,990 |   |

** **

**CapitalResources.****  **Undercurrent regulations, the Bank must have core capital equal to 4% of adjustedtotal assets and risk-based capital equal to 8% of risk-weighted assets, ofwhich 1.5% must be tangible capital, excluding goodwill and certain otherintangible assets. On December 31, 2006, the Bank met its three regulatorycapital requirements.

Management believes thatunder current regulations, the Bank will continue to meet its minimum capitalrequirements in the foreseeable future. However, events beyond the control of theBank, such as increased interest rates or a downturn in the economy in areas inwhich the Bank operates, could adversely 

11

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affectfuture earnings and as a result, the ability of the Bank to meet its futureminimum capital requirements.

**Impact of Inflationand Changing Prices**

The consolidated financialstatements and related data have been prepared in accordance with accountingprinciples generally accepted in the United States of America which require themeasurement of financial position and operating results in terms of historicaldollars, without consideration for changes in the relative purchasing power ofmoney over time caused by inflation. Unlike industrial companies, nearly all ofthe assets and liabilities of a financial institution are monetary in nature.As a result, interest rates have a more significant impact on a financialinstitution’s performance than general levels of inflation. Interest rates donot necessarily move in the same direction or in the same magnitude as theprice of goods and services, since such goods and services are affected byinflation. In the current interest rate environment, liquidity and the maturitystructure of the Bank’s assets and liabilities are critical to the maintenanceof acceptable performance levels.

**Quantitative andQualitative Disclosures About Market Risk**

**Interest Rate RiskManagement**

The Bank has established an Asset/Liability ManagementCommittee (ALCO) for the purpose of monitoring and managing market risk, whichis defined as the risk of loss of net interest income or economic value arisingfrom changes in market interest rates and prices.

The type of market risk which most affects the Company’sfinancial instruments is interest rate risk, which is best quantified bysimulating the hypothetical change in net interest income that would occurunder specific changes in interest rates. Substantially all of the Bank’sinterest-bearing assets and liabilities are exposed to interest rate risk. Lossof economic value is measured using reports generated by the Office of ThriftSupervision (“OTS”), using input from the Bank, wherein the current netportfolio value of the Bank’s interest-sensitive assets and liabilities ismeasured at different hypothetical interest rate levels centered on the currentterm structure of interest rates. Gap reports prepared by the Bank are used tomeasure the net amount of assets and liabilities repricing, repaying andmaturing during future periods. ALCO evaluates the simulation results, the OTSmodel results and the “gap” reports and will make adjustments to the Bank’splanned activities if in its view there is a need to do so.

The Bank’s exposure to interest rate risk resultsfrom, among other things, the difference in maturities in interest-earningassets and interest-bearing liabilities. Since the Bank’s assets currently havea longer maturity than its liabilities, the Bank’s earnings could be negativelyimpacted during a period of rising interest rates. Alternatively, in periods offalling interest rates the Bank’s mortgage loans will repay at an increasingrate and cause the Bank to reinvest these cash flows in periods of low interestrates, also negatively affecting the Bank’s earnings. The relationship betweenthe interest rate sensitivity of the Bank’s assets and liabilities iscontinually monitored by management and ALCO.

Fundamentally, the Bank prices and originates loans,and prices and originates its deposits including CD’s at market interest rates.Volumes of such loans and deposits at various maturity and repricing horizonswill vary according to customer preferences as influenced by the term structureof market interest rates. The Bank utilizes its investment and mortgage-backedsecurity portfolios available for sale to generate additional interest income,to manage its liquidity, and to manage its interest rate risk. These securitiesare readily marketable and provide the Bank with a cash flow stream to fundasset growth or liability maturities. In addition, if management determinesthat it is advisable to do so, the Bank can lengthen or shorten the averagematurity of all interest-bearing assets through the selection of fixed rate orvariable rate securities, respectively.

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The Bank utilizes advancesfrom the FHLB in managing its interest rate risk and as a tool to augmentdeposits in funding asset growth. The Bank may utilize these funding sources tobetter match its fixed rate interest-bearing assets with longer maturities orrepricing characteristics.

The nature of the Bank’scurrent operations is such that it is not subject to foreign currency exchangeor commodity price risk. Additionally, neither the Company nor the Bank ownsany trading assets. At December 31, 2006, the Bank did not have anyhedging transactions in place such as interest rate swaps, caps, or floors,although these derivatives are often used by banks to manage interest raterisk.

The Company’s banksubsidiary is a savings bank regulated by the OTS and has policies orprocedures in place for measuring interest rate risk. These policies and proceduresstipulate acceptable levels of interest rate risk. As part of its interest raterisk management, the Bank uses the Interest Rate Risk Exposure Report, which isgenerated quarterly by the OTS. This report forecasts the interest ratesensitivity of net portfolio value (“NPV”) under alternative interest rateenvironments. The NPV is defined as the net present value of the Bank’sexisting assets, liabilities and off-balance sheet instruments. The calculatedestimates of change in NPV at December 31, 2006 are as follows:

| **Change in Interest Rates** | ** ** | ** **              | ** ** | **NPV  Amount** | ** ** | **% Change** | ** ** | **Policy Limitation** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|---------------------------|------------|-------------------|------------|----------------------------|------------|
| ** **                                  | ** ** | **(In Thousands)** | ** ** |
| +300 Basis Points                           |       |                    | $          | 53,984                    |       |              |       | -37                        | %          |   |   | +/- 5 | 0% |   |
| +200 Basis Points                           |       |                    | $          | 65,194                    |       |              |       | -24                        | %          |   |   | +/- 3 | 5% |   |
| +100 Basis Points                           |       |                    | $          | 75,934                    |       |              |       | -11                        | %          |   |   | +/- 2 | 5% |   |
| Flat Rates                                  |       |                    | $          | 85,278                    |       |              |       | 0                          | %          |   |   | 0 | % |   |
| -100 Basis  Points                          |       |                    | $          | 92,257                    |       |              |       | +8                         | %          |   |   | +/- 2 | 0% |   |
| -200 Basis Points                           |       |                    | $          | 95,935                    |       |              |       | +12                        | %          |   |   | +/- 3 | 0% |   |

 

Management believes thatthe assumptions utilized by OTS in evaluating the vulnerability of the Company’snet portfolio value to changes in interest rates are reasonable; however, theinterest rate sensitivity of the Bank’s assets and liabilities as well as theestimated effect of changes in interest rates on NPV could vary substantiallyif different assumptions are used or actual experience differs from theexperience on which the assumptions were based. In the event the Bank shouldmeasure an excessive decline in its NPV as the result of an immediate andsustained change in interest rate, it has a number of options which it couldutilize to remedy that situation. The Bank could restructure its investmentportfolio through sale or purchase of securities with more favorable repricingattributes. It could also emphasize loan products with appropriate maturitiesor repricing attributes, or it could attract deposits or obtain borrowings withdesired maturities.

In order to measureinterest rate risk internally, the Company uses computer programs which enableit to simulate the changes that will occur to the Bank’s net interest income (“NII”)over a number of interest rate scenarios which are developed by “shocking”market interest rates (i.e. moving them immediately and permanently) up anddown in 100 basis point increments from their current levels. In addition, loanproduction is adjusted downward in the rates up scenarios.

In addition to the levelof interest rates, the most critical assumption regarding the estimated amountof the Bank’s NII is the expected prepayment speed of the Bank’s 1-4family residential loans, and related mortgage-backed securities, the bookvalue of which comprises approximately 61% of the Company’s total assets. Forthis prepayment speed assumption, the Company uses its own experience andcompares it with median expected prepayment speeds obtained from third partysources. The Company also incorporates into its simulations the effects of theinterest rate caps and interest rate floors that are part of the majority ofthe Bank’s variable rate loans. Finally, the Company makes certain assumptionsregarding the timing and magnitude of interest rate changes on its non-CDdeposits.

TheCompany uses its business planning forecast as the basis for its NIIsimulations. Therefore, planned business activities are incorporated into themeasurement horizon. Such activities include assumptions about substantial newloan and deposit volumes, the pricing of loan and deposit products, and 

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other assumptions about future activities that may ormay not be realized. In order to quantify the Company’s NII exposure, theCompany focused on the simulation of net interest income over 24 months intwo scenarios: shocked up 200 basis points and shocked down 100 basis points.The results of these simulations are as follows:

| **At December 31, 2006** | ** ** | **Net interest income volatility versus  level interest rates** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| **Year ending**                    | ** ** | **Shocked UP 200 bp**                                                          | ** ** | **Shocked DOWN 100 bp** | ** ** |
| 2007                                    |       |                                                                                          | -4.4%      |   |   |   | -3.0% |   |   |
| 2008                                    |       |                                                                                          | -4.7%      |   |   |   | -4.7% |   |   |

 

| **At December 31, 2005** | ** ** | **Net interest income volatility versus  level interest rates** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| **Year ending**                    | ** ** | **Shocked UP 200 bp**                                                          | ** ** | **Shocked DOWN 100 bp** | ** ** |
| 2006                                    |       |                                                                                          | -5.2%      |   |   |   | -3.6% |   |   |
| 2007                                    |       |                                                                                          | -3.4%      |   |   |   | -7.7% |   |   |

 

Inaddition, the Company prepared “gap” reports in order to show potentialmis-matches of repricing or cash flows from the Company’s current interestrate-sensitive assets and liabilities. Negative amounts indicate that there isan excess of rate sensitive liabilities repricing during the period and,generally, the Company’s net interest income would be adversely affected byrising market interest rates. The results of these “gap” measurements are asfollows: (in thousands)

| ** **                                  | ** ** | **GAP: Net rate sensitive assets (liabilities)** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| **At**** **December 31, 2006 | ** ** | ** **                                                                | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010 and beyond** | ** ** |
| Current rates                               |       | $                                                                         | (61,844    | ) | $ | 26,416 |   | $ | 2,704 |   |   | $ | 71,624 |   |   |
| Shocked down 100  bp                        |       | $                                                                         | 9,053      |   | $ | 61,771 |   | $ | 16,525 |   |   | $ | (48,449 | ) |   |
| Shocked up 200 bp                           |       | $                                                                         | (90,961    | ) | $ | 8,607 |   | $ | (6,992 | ) |   | $ | 128,245 |   |   |
|                                             |            |                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                              | ** ** | **GAP: Net rate sensitive assets (liabilities)** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------------------|------------|
| **At December 31, 2005** | ** ** | ** **                                                                | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009 and beyond** | ** ** |
| Current rates                           |       | $                                                                         | 30,815     |   | $ | 26,844 |   | $ | 22,041 |   |   | $ | (41,782 | ) |   |
| Shocked down 100  bp                    |       | $                                                                         | 111,647    |   | $ | 62,072 |   | $ | 33,276 |   |   | $ | (169,077 | ) |   |
| Shocked up 200 bp                       |       | $                                                                         | (21,353    | ) | $ | (599 | ) | $ | 10,491 |   |   | $ | 49,379 |   |   |
|                                         |            |                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The results of the NPV, NII, and gap measurementscollectively reflect the fact that the Company is highly sensitive to thesustained movement of long-term interest rates because of the resulting effecton the prepayment speeds of the Company’s mortgage-related earning assets. Inthe interest rates up scenarios, prepayment speeds slow, new loan volume is reduced,and deposits and other borrowings reprice at higher rates. In the rates downscenarios, higher rate earning assets repay at an increasing rate, floatingrate earning assets reprice downward, and deposits are more difficult toreprice downward. Each of these simulated scenarios was calculated using severechanges in prepayment speeds and other assumptions in order to stress-test theCompany’s current position.

During 2006, the Companyexperienced the adverse effects of a “flattening” of the yield curve whichoccurred because short-term market interest rates increased more than long terminterest rates. As a result, the interest rates on floating rates loansadjusted upward, but borrowers refinanced these loans into fixed rate loans atlower interest rates. Depositors were in search of higher interest rates ontheir deposits and moved many of their deposits into higher rate CD’s orfloating rate money market accounts. Thus, the Bank has experienced margincompression, and expects this situation to continue given the level of interestrates that existed at December 31, 2006. However, these assumptions andmeasurements are highly subjective in nature and are not intended to be aforecast of net interest income under any rate scenario for the years 2007, 2008or for any other period.

**Recent AccountingPronouncements**

See Note B in the Consolidated Financial Statementsfor a discussion on this topic.

14

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**FINANCIALSTATEMENTS AND REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**TF FINANCIALCORPORATION AND SUBSIDIARIES**

**December 31,2006 and 2005**

15

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

Board of Directors andShareholders of TF Financial Corporation

We have audited the accompanying consolidated balancesheets of TF Financial Corporation and subsidiaries (the Company) as of December 31,2006 and 2005, and the related consolidated statements of income, changes instockholders’ equity and comprehensive income and cash flows for each of thethree years in the period ended December 31, 2006. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform an audit of its internal control over financial reporting. Our auditsincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of TF FinancialCorporation and subsidiaries as of December 31, 2006 and 2005, and theconsolidated results of their operations and their consolidated cash flows foreach of the three years in the period ended December 31, 2006, inconformity with accounting principles generally accepted in the United Statesof America.

Asdiscussed in Note A to the consolidated financial statements, the Companyhas adopted Financial Accounting Standards Board Statement No. 123(R),Share-Based Payments in 2006. Also, as discussed in Note A to theconsolidated financial statements, the Company adopted Financial AccountingStandards Board Statement No. 158, Employer’s Accounting for DefinedBenefit Pension and Other Postretirement Plans, an amendment of FASB StatementsNo. 87, 88, 106 and 132(R) in 2006.
|                             |   |
|-----------------------------|--------|
| Philadelphia,  Pennsylvania |   |
| March 28, 2007         |   |

 

16

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**TF Financial Corporation and SubsidiariesCONSOLIDATED STATEMENTS OF FINANCIAL POSITION**

| ** **                                                                                                                                                                                                                                             | ** ** | **December 31**    | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                                                                                             | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                                                                                                             | ** ** | **(in thousands)** | ** ** |
| ASSETS                                                                                                                                                                                                                                                 |       |                    |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                             |       | $                       | 12,364     |   | $ | 3,821 |   |
| Certificates of  deposit in other financial institutions                                                                                                                                                                                               |       | 40                      |       | 40 |   |
| Investment  securities available for sale—at fair value                                                                                                                                                                                           |       | 34,524                  |       | 30,401 |   |
| Investment  securities held to maturity (fair value of $681 and $4,707 as of  December 31, 2006 and 2005, respectively)                                                                                                                           |       | 677                     |       | 4,690 |   |
| Mortgage-backed  securities available for sale—at fair value                                                                                                                                                                                      |       | 74,338                  |       | 83,511 |   |
| Mortgage-backed  securities held to maturity (fair value of $7,788 and $10,385 as of  December 31, 2006 and 2005, respectively)                                                                                                                   |       | 7,697                   |       | 10,177 |   |
| Loans receivable,  net held for investment                                                                                                                                                                                                             |       | 483,570                 |       | 490,891 |   |
| Loans receivable,  held for sale                                                                                                                                                                                                                       |       | 969                     |       | 68 |   |
| Federal Home Loan  Bank stock—at cost                                                                                                                                                                                                             |       | 7,130                   |       | 7,432 |   |
| Accrued interest  receivable                                                                                                                                                                                                                           |       | 3,030                   |       | 3,048 |   |
| Premises and  equipment, net                                                                                                                                                                                                                           |       | 6,544                   |       | 6,289 |   |
| Core deposit  intangible asset, net of accumulated amortization of $2,824 and $2,741 as of  December 31, 2006 and 2005, respectively                                                                                                              |       | —                  |       | 83 |   |
| Goodwill                                                                                                                                                                                                                                               |       | 4,324                   |       | 4,324 |   |
| Bank owned life  insurance                                                                                                                                                                                                                             |       | 15,274                  |       | 12,771 |   |
| Other assets                                                                                                                                                                                                                                           |       | 2,122                   |       | 3,293 |   |
| TOTAL ASSETS                                                                                                                                                                                                                                           |       | $                       | 652,603    |   | $ | 660,839 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                              |       |                    |       |   |   |
| Liabilities                                                                                                                                                                                                                                            |       |                    |       |   |   |
| Deposits                                                                                                                                                                                                                                               |       | $                       | 478,087    |   | $ | 470,521 |   |
| Advances from the Federal Home Loan Bank                                                                                                                                                                                                               |       | 101,701                 |       | 121,260 |   |
| Advances from borrowers for taxes and insurance                                                                                                                                                                                                        |       | 1,866                   |       | 1,915 |   |
| Accrued interest payable                                                                                                                                                                                                                               |       | 2,942                   |       | 2,052 |   |
| Other liabilities                                                                                                                                                                                                                                      |       | 2,368                   |       | 2,443 |   |
| Total liabilities                                                                                                                                                                                                                                      |       | 586,964                 |       | 598,191 |   |
| Stockholders’ equity                                                                                                                                                                                                                              |       |                    |       |   |   |
| Preferred stock, no par value; 2,000,000 shares  authorized at December 31, 2006 and 2005, none issued                                                                                                                                            |       | —                  |       | — |   |
| Common stock, $0.10 par value; 10,000,000 shares  authorized, 5,290,000 shares issued, 2,702,845 and 2,714,173 shares  outstanding at December 31, 2006 and 2005, respectively, net shares in  treasury: 2006—2,415,766; 2005—2,390,943 |       | 529                     |       | 529 |   |
| Retained earnings                                                                                                                                                                                                                                      |       | 65,075                  |       | 61,610 |   |
| Additional paid-in capital                                                                                                                                                                                                                             |       | 52,700                  |       | 53,048 |   |
| Unearned restricted stock                                                                                                                                                                                                                              |       | —                  |       | (1,080 | ) |
| Unearned ESOP shares                                                                                                                                                                                                                                   |       | (1,703                  | )          | (1,849 | ) |
| Treasury stock—at cost                                                                                                                                                                                                                            |       | (48,980                 | )          | (47,920 | ) |
| Accumulated other comprehensive income (loss)                                                                                                                                                                                                          |       | (1,982                  | )          | (1,690 | ) |
| Total stockholders’ equity                                                                                                                                                                                                                        |       | 65,639                  |       | 62,648 |   |
| TOTAL LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                       |       | $                       | 652,603    |   | $ | 660,839 |   |

 

The accompanying notes are an integral part of these statements.

17

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**TF Financial Corporation and SubsidiariesCONSOLIDATED STATEMENTS OF INCOME**

| ** **                                           | ** ** | **Year ended December 31,**                     | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(in thousands,  except per share data)** | ** ** |
| Interest income                                      |       |                                                           |       |   |   |   |   |
| Loans, including fees                                |       | $                                                              | 32,342     |   | $ | 27,570 |   | $ | 24,359 |   |
| Mortgage-backed securities                           |       | 3,722                                                          |       | 4,875 |   | 5,696 |   |
| Investment securities                                |       | 1,861                                                          |       | 1,461 |   | 1,152 |   |
| Interest-bearing deposits and other                  |       | 94                                                             |       | 59 |   | 14 |   |
| TOTAL INTEREST INCOME                                |       | 38,019                                                         |       | 33,965 |   | 31,221 |   |
| Interest expense                                     |       |                                                           |       |   |   |   |   |
| Deposits                                             |       | 10,923                                                         |       | 7,599 |   | 5,925 |   |
| Borrowings                                           |       | 4,938                                                          |       | 3,933 |   | 2,941 |   |
| TOTAL INTEREST EXPENSE                               |       | 15,861                                                         |       | 11,532 |   | 8,866 |   |
| NET INTEREST INCOME                                  |       | 22,158                                                         |       | 22,433 |   | 22,355 |   |
| Provision for loan  losses                           |       | 150                                                            |       | 540 |   | 600 |   |
| NET INTEREST INCOME AFTER PROVISION FOR LOAN  LOSSES |       | 22,008                                                         |       | 21,893 |   | 21,755 |   |
| Non-interest  income                                 |       |                                                           |       |   |   |   |   |
| Service fees, charges and other operating income     |       | 2,091                                                          |       | 2,069 |   | 2,075 |   |
| Bank owned life insurance                            |       | 503                                                            |       | 501 |   | 525 |   |
| Gain on sale of real estate                          |       | 29                                                             |       | — |   | — |   |
| Loss on sale of mortgage-backed securities           |       | (51                                                            | )          | — |   | — |   |
| Gain on sale of loans                                |       | 238                                                            |       | 158 |   | 8 |   |
| TOTAL NON-INTEREST INCOME                            |       | 2,810                                                          |       | 2,728 |   | 2,608 |   |
| Non-interest  expense                                |       |                                                           |       |   |   |   |   |
| Employee compensation and benefits                   |       | 10,636                                                         |       | 9,249 |   | 8,769 |   |
| Occupancy and equipment                              |       | 2,834                                                          |       | 2,645 |   | 2,518 |   |
| Federal deposit insurance premium                    |       | 60                                                             |       | 64 |   | 70 |   |
| Professional fees                                    |       | 739                                                            |       | 814 |   | 615 |   |
| Marketing and advertising                            |       | 500                                                            |       | 773 |   | 655 |   |
| Other operating                                      |       | 2,316                                                          |       | 2,493 |   | 2,547 |   |
| Amortization of core deposit intangible asset        |       | 83                                                             |       | 130 |   | 155 |   |
| TOTAL NON-INTEREST EXPENSE                           |       | 17,168                                                         |       | 16,168 |   | 15,329 |   |
| INCOME BEFORE INCOME TAXES                           |       | 7,650                                                          |       | 8,453 |   | 9,034 |   |
| Income tax expense                                   |       | 2,136                                                          |       | 2,300 |   | 2,467 |   |
| NET INCOME                                           |       | $                                                              | 5,514      |   | $ | 6,153 |   | $ | 6,567 |   |
| Earnings per  share—basic                       |       | $                                                              | 2.04       |   | $ | 2.25 |   | $ | 2.44 |   |
| Earnings per  share—diluted                     |       | $                                                              | 2.03       |   | $ | 2.20 |   | $ | 2.33 |   |

 

The accompanying notes are an integral part of these statements.

18

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**TF Financial Corporation and SubsidiariesCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY ANDCOMPREHENSIVE INCOMEYears ended December 31, 2006, 2005 and 2004(in thousands, except share data)**

|            | ** ** | ** **       | ** ** | ** **     | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** | ** **   | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** **        | ** ** | ** ** | ** ** |
|------------|------------|------------------|------------|----------------|------------|--------------|------------|----------------|------------|------------|------------|--------------|------------|--------------|------------|-------------------|------------|-------------------|------------|------------|------------|
| ** ** | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | **Unearned** | ** ** | **Unearned**   | ** ** | ** ** | ** ** | ** **   | ** ** | **other**    | ** ** | ** **        | ** ** | **Comprehensive** | ** ** |
| ** ** | ** ** | ** **       | ** ** | **Par**        | ** ** | **paid-in**  | ** ** | **restricted** | ** ** | **ESOP**   | ** ** | **Treasury** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | ** **        | ** ** | **income** | ** ** |
| ** ** | ** ** | **Shares**       | ** ** | **value**      | ** ** | **capital**  | ** ** | **stock**      | ** ** | **shares** | ** ** | **stock**    | ** ** | **Earnings** | ** ** | **income (loss)** | ** ** | **Total**         | ** ** | **(loss)** | ** ** |

| Balance at December 31, 2003                                  |   |   | 2,596,037 |   |   |   | $      | 529    |   |   |   | $      | 51,982 |   |   |   | $      | — |   |   |   | $      | (2,196 | )      |   |   | $       | (47,043 | )      |   |   | $      | 52,626 |   |   |   | $      | (418   | )      |   | $      | 55,480 |   |   |   |   |   |
|--------------------------------------------------------------------|--------|--------|-----------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Allocation of ESOP shares                                          |   |   | 17,688    |   |   |   | — |   |   |   | 354    |   |   |   | — |   |   |   | 177    |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | 531    |   |   |   |   |   |
| Purchase of treasury stock                                         |   |   | (166,305  | )      |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (4,725 | )      |   |   | —  |    |   |   | — |   |   | (4,725 | )      |   |   |   |   |
| Cash dividends—common stock                                   |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (1,765  | )       |   |   | — |   |   | (1,765 | )      |   |   |   |   |
| Exercise of options                                                |   |   | 294,925   |   |   |   | — |   |   |   | (2,277 | )      |   |   | — |   |   |   | — |   |   |   | 5,687  |   |   |   | —  |    |   |   | — |   |   | 3,410  |   |   |   |   |   |
| Income tax benefit arising from stock  compensation                |   |   | —    |   |   |   | — |   |   |   | 1,616  |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | 1,616  |   |   |   |   |   |
| Other comprehensive loss, net of taxes                             |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | 41     |   |   | 41     |   |   | $      | 41     |   |   |
| Net income for the year ended December 31, 2004               |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 6,567   |    |   |   | — |   |   | 6,567  |   |   | 6,567  |   |   |
| Comprehensive income                                               |   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |    |   |   |   |   |   |   |   |   | $      | 6,608  |   |   |
| Balance at December 31, 2004                                  |   |   | 2,742,345 |   |   |   | $      | 529    |   |   |   | $      | 51,675 |   |   |   | — |   |   |   | $      | (2,019 | )      |   |   | $      | (46,081 | )       |   |   | $      | 57,428 |   |   |   | $      | (377   | )      |   | $      | 61,155 |   |   |   |   |   |
| Allocation of ESOP shares                                          |   |   | 17,025    |   |   |   | — |   |   |   | 324    |   |   |   | — |   |   |   | 170    |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | 494    |   |   |   |   |   |
| Purchase of treasury stock                                         |   |   | (95,172   | )      |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (2,830 | )      |   |   | —  |    |   |   | — |   |   | (2,830 | )      |   |   |   |   |
| Cash dividends—common stock                                   |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (1,971  | )       |   |   | — |   |   | (1,971 | )      |   |   |   |   |
| Restricted stock grant                                             |   |   | —    |   |   |   | — |   |   |   | 1,095  |   |   |   | (1,095 | )      |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | — |   |   |   |   |   |
| Compensation expense—  Restricted shares                      |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | 15     |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | 15     |   |   |   |   |   |
| Exercise of options                                                |   |   | 49,975    |   |   |   | — |   |   |   | (190   | )      |   |   | — |   |   |   | — |   |   |   | 991    |   |   |   | —  |    |   |   | — |   |   | 801    |   |   |   |   |   |
| Income tax benefit arising  from stock  compensation               |   |   | —    |   |   |   | — |   |   |   | 144    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | 144    |   |   |   |   |   |
| Other comprehensive loss, net of taxes                             |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | (1,313 | )      |   | (1,313 | )      |   | $      | (1,313 | )      |   |
| Net income for the year  ended December 31, 2005              |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 6,153   |    |   |   | — |   |   | 6,153  |   |   | 6,153  |   |   |
| Comprehensive income                                               |   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |    |   |   |   |   |   |   |   |   | $      | 4,840  |   |   |
| Balance at December 31,  2005                                 |   |   | 2,714,173 |   |   |   | $      | 529    |   |   |   | $      | 53,048 |   |   |   | (1,080 | )      |   |   | $      | (1,849 | )      |   |   | $      | (47,920 | )       |   |   | $      | 61,610 |   |   |   | $      | (1,690 | )      |   | $      | 62,648 |   |   |   |   |   |
| Allocation of ESOP shares                                          |   |   | 13,495    |   |   |   | — |   |   |   | 228    |   |   |   | — |   |   |   | 146    |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | 374    |   |   |   |   |   |
| Purchase of treasury stock                                         |   |   | (58,904   | )      |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (1,749 | )      |   |   | —  |    |   |   | — |   |   | (1,749 | )      |   |   |   |   |
| Cash dividends—common stock                                   |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (2,049  | )       |   |   | — |   |   | (2,049 | )      |   |   |   |   |
| Restricted stock grant                                             |   |   | —    |   |   |   | — |   |   |   | (1,080 | )      |   |   | 1,080  |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | — |   |   |   |   |   |
| Compensation expense—restricted shares                        |   |   | —    |   |   |   | — |   |   |   | 361    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | 361    |   |   |   |   |   |
| Exercise of options                                                |   |   | 21,415    |   |   |   | — |   |   |   | (108   | )      |   |   | — |   |   |   | — |   |   |   | 433    |   |   |   | —  |    |   |   | — |   |   | 325    |   |   |   |   |   |
| Income tax benefit arising from stock  compensation                |   |   | —    |   |   |   | — |   |   |   | 121    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | 121    |   |   |   |   |   |
| Stock option expense                                               |   |   | —    |   |   |   | — |   |   |   | 386    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | — |   |   | 386    |   |   |   |   |   |
| Vesting of stock grant                                             |   |   | 12,666    |   |   |   | — |   |   |   | (256   | )      |   |   | — |   |   |   | — |   |   |   | 256    |   |   |   | —  |    |   |   | — |   |   | — |   |   |   |   |   |
| Other comprehensive income,  net of taxes                          |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | 421    |   |   | 421    |   |   | $      | 421    |   |   |
| Adjustment to record funded status of pension (net of tax of $367) |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |    |   |   | (713   | )      |   | (713   | )      |   | (713   | )      |   |
| Net income for the year  ended December 31, 2006              |   |   | —    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 5,514   |    |   |   | — |   |   | 5,514  |   |   | 5,514  |   |   |
| Comprehensive income                                               |   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |    |   |   |   |   |   |   |   |   | $      | 5,222  |   |   |
|                                                                    |   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |    |   |   |   |   |   |   |   |   |   |   |   |
| Balance at December 31,  2006                                 |   |   | 2,702,845 |   |   |   | $      | 529    |   |   |   | $      | 52,700 |   |   |   | $      | — |   |   |   | $      | (1,703 | )      |   |   | $       | (48,980 | )      |   |   | $      | 65,075 |   |   |   | $      | (1,982 | )      |   | $      | 65,639 |   |   |   |   |   |
|                                                               |   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |    |   |   |   |   |   |   |   |   |   |   |   |

 

The accompanying notes are an integral part of this statement

19

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**TF FinancialCorporation and Subsidiaries**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

| ** **                                                                        | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                        | ** ** | **(in thousands)**                    | ** ** |
| OPERATING ACTIVITIES                                                              |       |                                       |       |   |   |   |   |
| Net income                                                                        |       | $                                          | 5,514      |   | $ | 6,153 |   | $ | 6,567 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities |       |                                       |       |   |   |   |   |
| Amortization of                                                                   |       |                                       |       |   |   |   |   |
| Mortgage loan servicing rights                                                    |       | 29                                         |       | 8 |   | — |   |
| Deferred loan origination fees                                                    |       | (303                                       | )          | (96 | ) | (50 | ) |
| Premiums and discounts on investment securities, net                              |       | 69                                         |       | 81 |   | 74 |   |
| Premiums and discounts on mortgage-backed  securities, net                        |       | 252                                        |       | 386 |   | 775 |   |
| Premiums and discounts on loans, net                                              |       | 167                                        |       | 123 |   | 127 |   |
| Core deposit intangibles                                                          |       | 83                                         |       | 130 |   | 155 |   |
| Discounts on wholesale deposits                                                   |       | 20                                         |       | — |   | — |   |
| Deferred income taxes                                                             |       | 327                                        |       | 403 |   | 343 |   |
| Provision for loan losses and provision for losses  on real estate                |       | 150                                        |       | 540 |   | 737 |   |
| Provision for decrease in fair value of mortgage  service rights                  |       | 13                                         |       | 1 |   | — |   |
| Depreciation of premises and equipment                                            |       | 954                                        |       | 961 |   | 973 |   |
| Increase in value of bank-owned life insurance                                    |       | (502                                       | )          | (501 | ) | (525 | ) |
| Stock grant expense                                                               |       | 361                                        |       | 15 |   | — |   |
| Stock option expense                                                              |       | 386                                        |       | — |   | — |   |
| ESOP expense                                                                      |       | 374                                        |       | 494 |   | 531 |   |
| Proceeds from sale of loans originated for sale                                   |       | 13,044                                     |       | 9,765 |   | 657 |   |
| Origination of loans held for sale                                                |       | (14,033                                    | )          | (8,995 | ) | (1,329 | ) |
| Tax benefit arising from stock compensation                                       |       | 121                                        |       | 144 |   | 1,616 |   |
| (Gain) loss on sale of                                                            |       |                                       |       |   |   |   |   |
| Investment and mortgage-backed securities                                         |       | 51                                         |       | — |   | — |   |
| Real estate acquired through foreclosure                                          |       | (29                                        | )          | — |   | (1 | ) |
| Mortgage loans available for sale                                                 |       | (104                                       | )          | (158 | ) | (8 | ) |
| Mortgage loans held to maturity                                                   |       | (134                                       | )          | — |   | — |   |
| (Income) expense from mortgage loan derivatives                                   |       | 7                                          |       | (8 | ) | — |   |
| (Income) expense associated with forward loan sales                               |       | (5                                         | )          | 7 |   | — |   |
| (Increase)  decrease in                                                           |       |                                       |       |   |   |   |   |
| Accrued interest receivable                                                       |       | 18                                         |       | (548 | ) | 171 |   |
| Other assets                                                                      |       | (639                                       | )          | (43 | ) | 3,026 |   |
| Increase (decrease) in                                                            |       |                                       |       |   |   |   |   |
| Accrued interest payable                                                          |       | 890                                        |       | 414 |   | (270 | ) |
| Other liabilities                                                                 |       | (75                                        | )          | 758 |   | (10 | ) |
| NET CASH PROVIDED BY OPERATING ACTIVITIES                                         |       | 7,006                                      |       | 10,034 |   | 13,559 |   |
|                                                                                   |            |                                            |            |  |  |  |  |  |  |  |

 

20

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| ** **                                                                                  | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                  | ** ** | **(in thousands)**                    | ** ** |
| INVESTING ACTIVITIES                                                                        |       |                                       |       |   |   |   |   |
| Loan originations                                                                           |       | $                                          | (125,660   | ) | $ | (147,629 | ) | $ | (151,517 | ) |
| Purchases of loans                                                                          |       | —                                     |       | — |   | (3,922 | ) |
| Loan principal payments                                                                     |       | 109,589                                    |       | 96,579 |   | 117,896 |   |
| Principal repayments on mortgage-backed securities  held to maturity                        |       | 2,472                                      |       | 4,709 |   | 8,730 |   |
| Principal repayments on mortgage-backed securities  available for sale                      |       | 14,263                                     |       | 26,959 |   | 30,099 |   |
| Proceeds from loan sales                                                                    |       | 23,512                                     |       | 1,108 |   | — |   |
| (Purchases) and maturities of certificates of  deposit in other financial institutions, net |       | —                                     |       | (2 | ) | 117 |   |
| Purchase of investment securities available for sale                                        |       | (3,795                                     | )          | (13,170 | ) | (3,040 | ) |
| Purchase of mortgage-backed securities available for  sale                                  |       | (10,120                                    | )          | (8,956 | ) | (27,701 | ) |
| Purchase of bank-owned life insurance                                                       |       | (2,000                                     | )          | — |   | — |   |
| Proceeds from maturities of investment securities  held to maturity                         |       | 4,018                                      |       | 2,280 |   | 3,295 |   |
| Proceeds from the sale of mortgage-backed securities  available for sale                    |       | 4,971                                      |       | — |   | — |   |
| (Purchase) redemption of Federal Home Loan Bank  stock                                      |       | 302                                        |       | 28 |   | (635 | ) |
| Proceeds from sale of real estate                                                           |       | 729                                        |       | — |   | 32 |   |
| Purchase of premises and equipment                                                          |       | (1,209                                     | )          | (1,287 | ) | (668 | ) |
| NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES                                         |       | 17,072                                     |       | (39,381 | ) | (27,314 | ) |
| FINANCING ACTIVITIES                                                                        |       |                                       |       |   |   |   |   |
| Net increase in deposits                                                                    |       | 7,546                                      |       | 10,618 |   | 560 |   |
| Net increase (decrease) in short-term Federal Home  Loan Bank advances                      |       | (16,190                                    | )          | 7,483 |   | (1,179 | ) |
| Proceeds of long-term Federal Home Loan Bank  advances                                      |       | 15,535                                     |       | 26,367 |   | 30,000 |   |
| Repayment of long-term Federal Home Loan Bank  advances                                     |       | (18,904                                    | )          | (15,337 | ) | (12,927 | ) |
| Net increase(decrease) in advances from borrowers  for taxes and insurance                  |       | (49                                        | )          | 137 |   | 40 |   |
| Treasury stock acquired                                                                     |       | (1,749                                     | )          | (2,830 | ) | (4,725 | ) |
| Exercise of stock options                                                                   |       | 325                                        |       | 801 |   | 3,410 |   |
| Common stock dividends paid                                                                 |       | (2,049                                     | )          | (1,971 | ) | (1,765 | ) |
| NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                                         |       | (15,535                                    | )          | 25,268 |   | 13,414 |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                        |       | 8,543                                      |       | (4,079 | ) | (341 | ) |
| Cash and cash  equivalents at beginning of year                                             |       | 3,821                                      |       | 7,900 |   | 8,241 |   |
| Cash and cash  equivalents at end of year                                                   |       | $                                          | 12,364     |   | $ | 3,821 |   | $ | 7,900 |   |
| Supplemental disclosure  of cash flow information                                           |       |                                       |       |   |   |   |   |
| Cash paid for                                                                               |       |                                       |       |   |   |   |   |
| Interest on deposits and advances from Federal Home  Loan Bank                              |       | $                                          | 14,971     |   | $ | 11,118 |   | $ | 9,136 |   |
| Income taxes                                                                                |       | $                                          | 1,645      |   | $ | 1,475 |   | $ | 1,330 |   |

 

The accompanyingnotes are an integral part of these statements.

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**TFFinancial Corporation and Subsidiaries**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**December 31,2006 and 2005**

**NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

TF Financial Corporation(the “Company”) is a unitary savings and loan holding company, organized underthe laws of the State of Delaware, which conducts its consumer bankingoperations primarily through its wholly owned subsidiary, Third Federal Bank(Third Federal or the Bank). Third Federal is a federally chartered-stocksavings bank insured by the Federal Deposit Insurance Corporation. ThirdFederal is a community-oriented savings institution that conducts operationsfrom its main office in Newtown, Pennsylvania, twelve full-service branchoffices located in Philadelphia and Bucks counties, Pennsylvania, and threefull-service branch offices located in Mercer County, New Jersey. The Bankcompetes with other banking and financial institutions in its primary marketcommunities, including financial institutions with resources substantiallygreater than its own. Commercial banks, savings banks, savings and loanassociations, credit unions and money market funds actively compete for savingsand time deposits and loans. Such institutions, as well as consumer finance andinsurance companies, may be considered competitors of the Bank with respect toone or more of the services it renders.

TheBank is subject to regulations of certain state and federal agencies and,accordingly, those regulatory authorities conduct periodic examinations. As aconsequence of the extensive regulation of commercial banking activities, theBank’s business is particularly susceptible to being affected by state andfederal legislation and regulations.

1.*   Principlesof Consolidation and Basis of Presentation*

The consolidated financialstatements include the accounts of the Company and its wholly ownedsubsidiaries: TF Investments, Penns Trail Development Corporation and ThirdFederal, and its wholly owned subsidiaries, Third Delaware Corporation andTeragon Financial Corporation, (collectively, the “Company”). All materialintercompany balances and transactions have been eliminated in consolidation.

Theaccounting policies of the Company conform to accounting principles generallyaccepted in the United States of America (US GAAP) and predominant practiceswithin the banking industry. The preparation of financial statements inconformity with US GAAP requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements, andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates. The more significantaccounting policies are summarized below.

2.*   Cashand Cash Equivalents*

TheCompany considers cash, due from banks, federal funds sold and interest-bearingdeposits in other financial institutions, with original terms to maturity ofless than three months, as cash equivalents for presentation purposes in theconsolidated statements of financial position and cash flows. The Company isrequired to maintain certain cash reserves relating to deposit liabilities.This requirement is ordinarily satisfied by cash on hand.

3.*   Investmentand Mortgage-Backed Securities*

The Company accounts forinvestment and mortgage-backed securities in accordance with Statement ofFinancial Accounting Standards (SFAS) No. 115, “Accounting for CertainInvestments in Debt and Equity Securities.” The Company classifies itsinvestment, mortgage-backed and marketable equity 

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securitiesin one of three categories: held to maturity, trading, or available for sale.The Company does not presently engage in security trading activities.

Investment,mortgage-backed and marketable equity securities available for sale are statedat fair value, with net unrealized gains and losses excluded from income andreported in other comprehensive income. Decreases in fair value deemed to beother than temporary are reported as a component of income. Realized gains andlosses on the sale of securities are recognized using the specificidentification method.

Investmentand mortgage-backed securities held to maturity are carried at cost, net ofunamortized premiums and discounts, which are recognized in interest incomeusing the interest method. Decreases in fair value deemed to be other thantemporary are reported as a component of income. The Company has the abilityand it is management’s intention to hold such assets to maturity.

4.*   LoansReceivable Held- for-Investment*

Loans receivable thatmanagement has the intent and ability to hold for the foreseeable future, oruntil maturity or payoff are stated at unpaid principal balances less theallowance for loan losses, and net of deferred loan origination fees, directorigination costs and unamortized premiums and discounts associated withpurchased loans, and unearned income. Loan origination fees and costs as wellas unamortized premiums and discounts on mortgage loans are amortized to incomeusing the interest method over the remaining period to contractual maturity,adjusted for actual prepayments.

Management’s periodicevaluation of the adequacy of the loan loss allowance is based on the Bank’shistorical loss experience, known and inherent risks in the portfolio, adversesituations that may affect the borrower’s ability to repay, the estimated valueof any underlying collateral and current economic conditions. Actual losses maybe higher or lower than historical trends, which vary. The allowance for loanlosses is increased by charges to income and decreased by charge-offs (net ofrecoveries).

The Bank provides anallowance for accrued but uncollected interest when a loan becomes more thanninety days past due or is identified as impaired. The allowance is establishedby a charge to interest income equal to all interest previously accrued, andincome is subsequently recognized only to the extent that cash payments arereceived until, in management’s judgment, the borrower’s ability to makeperiodic interest and principal payments is no longer impaired, in which casethe loan is returned to accrual status.

The Company accounts forimpaired loans in accordance with SFAS No. 114, “Accounting by Creditorsfor Impairment of a Loan,” as amended by SFAS No. 118, “Accounting byCreditors for Impairment of a Loan—Income Recognition and Disclosures*.*” SFAS No. 114 requires a creditor to measureimpairment based on the present value of expected future cash flows discountedat the loan’s effective interest rate, except that as a practical expedient, acreditor may measure impairment based on a loan’s observable market price, orthe fair value of the collateral if the loan is collateral dependent.Regardless of the measurement method, a creditor must measure impairment basedon the fair value of the collateral when the creditor determines thatforeclosure is probable.

The Company accounts forloans acquired in a transfer in accordance with the American Institute ofCertified Public Accountants’ Statement of Position No. 03-3, “Accountingfor Certain Loans or Debt Securities Acquired in a Transfer” (SOP 03-3).SOP 03-3 requires that acquired impaired loans for which it is probablethat the investor will be unable to collect all contractually required paymentsreceivable be recorded at the present value of amounts expected to be receivedand prohibits carrying over or creation of valuation allowances in the initialaccounting for these loans.

23

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5.*   LoansReceivable Held-for-Sale*

Mortgages loans originatedand intended for sale in the secondary market are carried at the lower ofaggregate cost or estimated fair value. Any resulting unrealized losses areincluded in other income. The fair value of the Bank’s loans held as availablefor sale was valued in excess of cost at December 31, 2006 and 2005.

6.*   Transfersof Financial Assets*

TheCompany accounts for the transfer of financial assets in accordance with SFAS No. 140“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities.” The standard is based on consistent application of afinancial-components approach that recognizes the financial and servicingassets it controls and the liabilities it has incurred, derecognizes financialassets when control has been surrendered and derecognizes liabilities whenextinguished. The standard provides consistent guidelines for distinguishingtransfers of financial assets from transfers that are secured borrowings.

7.*   Premisesand Equipment*

Landis carried at cost. Buildings and furniture, fixtures and equipment are carriedat cost less accumulated depreciation. Depreciation is provided by thestraight-line method over the estimated useful lives of the assets. The Companyaccounts for the impairment of long-lived assets in accordance with SFAS No. 144“Accounting for the Impairment orDisposal of Long-Lived Assets”. The standard requires recognition andmeasurement for the impairment of long-lived assets to be held and used or tobe disposed of by sale. The Company had no impaired long-lived assets at December 31,2006 and 2005.

8.*   Goodwilland Other Intangible Assets*

Goodwill does not requireamortization but is subject to annual impairment testing. The Company hastested the goodwill for impairment prior to its fiscal year ending December 31,2006. No impairment has been recognized.

Coredeposit intangible asset is the result of the Company’s 1996 acquisition ofcertain branches and deposits of Cenlar Federal Savings Bank. The core depositintangible acquired is being amortized over 10 years and was fullyamortized at September 30, 2006.

9.*   BankOwned Life Insurance*

TheCompany purchased $10.5 million in life insurance policies on the lives of itsexecutives and officers prior to 2004 and an additional $2.0 million in November 2006.The Company is the owner and beneficiary of the policies. The cash surrendervalues of the policies are approximately $15.3 million and $12.8 million at December 31,2006 and 2005, respectively.

10.*   BenefitPlans*

The Company hasestablished an Employee Stock Ownership Plan (ESOP) covering eligible employeeswith six months of service, as defined by the ESOP. The Company accounts forthe ESOP in accordance with the American Institute of Certified PublicAccountants’ Statement of Position (SOP) 93-6, “Employers’ Accounting forEmployee Stock Ownership Plans.” SOP 93-6 addresses the accounting forshares of stock issued to employees by an ESOP. SOP 93-6 requires thatthe employer record compensation expense in the amount equal to the fair valueof shares committed to be released from the ESOP to employees less dividendsreceived on the allocated shares.

24

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The Company has a definedbenefit pension plan covering substantially all full-time employees meetingcertain requirements. The Company accounts for the defined benefit plan inaccordance with SFAS No. 87, “Employers’ Accounting for Pensions”  which provides guidance for the variouscomponents of pension expense recognized in the income statement and anyrelated employer pension assets or liabilities. Additionally, the Companyincludes reporting disclosures required by SFAS No. 132R, “Employers’Disclosures about Pensions and Other Postretirement Benefits”. The Company adopted (SFAS 158), “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans—anamendment of FASB Statements No. 87, 88, 106, and 132(R)”. SFAS 158requires an employer to recognize the overfunded or underfunded status of adefined benefit postretirement plan (other than a multiemployer plan) as anasset or liability in its statement of financial position and to recognizechanges in that funded status including the gains and or losses and priorservice costs or credits that were not recognized as components of net periodicbenefit cost pursuant to FASB No. 87 in the year in which the changesoccur through comprehensive income. This Statement also improves financialreporting by requiring an employer to measure the funded status of a plan as ofthe date of its year-end statement of financial position, with limitedexceptions. The Company was required toinitially recognize the funded status of a defined benefit postretirement planand to provide the required disclosures as of the end of the fiscal year endingafter December 15, 2006.

Thefollowing table illustrates the effect of applying the provisions of thisstatement:

**IncrementalEffect of Applying Statement No. 158 on Individual Line Items in the Statement of Financial Position**

| ** **                            | ** ** | **December 31, 2006**                                 | ** ** |
|---------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                            | ** ** | **Before   Application  of Statement  158** | ** ** | **Adjustments** | ** ** | **After   Application  of Statement  158** | ** ** |
| ** **                            | ** ** | **(in thousands)**                               | ** ** |
| Assets:                               |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Prepaid pension  cost                 |       |                                                  | $          | 1,380 |   |   |   | $ | (1,080 | ) |   |   | $ | 300 |   |   |
| Deferred income  tax asset            |       |                                                  | —     |   |   |   | 137 |   |   |   | 137 |   |   |
| Liabilities:                          |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Deferred income  tax liability        |       |                                                  | 230        |   |   |   | (230 | ) |   |   | — |   |   |
| Equity:                               |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Accumulated other  comprehensive loss |       |                                                  | $          | 421 |   |   |   | $ | (713 | ) |   |   | $ | (292 | ) |   |

 

11.*   Stock-BasedCompensation*

The Company has stockbenefit plans that allow the Company to grant options and stock to employeesand directors. The options, which have a term of up to 10 years whenissued, vest over a three to five year period. The exercise price of eachoption equals the market price of the Company’s stock on the date of the grant.

On January 1, 2006,the Company adopted the provisions of Statement of Financial AccountingStandards (“SFAS”) 123R, “Share-Based Payment,” using the modified prospectivetransition method. Under this transition method, compensation cost to berecognized beginning in the first quarter of 2006 includes: (a) compensationcost for all share-based payments granted prior to, but not yet vested as of January 1,2006, based on the grant date fair value estimated in accordance with theoriginal provisions of SFAS 123, and (b) compensation cost for allshare-based payments granted subsequent to January 1, 2006, based on thegrant-date fair value estimated in accordance with the provisions of SFAS 123R

25

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Prior to 2006, the Companydisclosed pro forma compensation expense quarterly and annually by calculatingthe stock option grant’s fair value using the intrinsic value method under APBOpinion No. 25, “Accounting for Stock Issued to Employees”, as permittedby SFAS No. 123 “Accounting for Stock-Based Compensation,” that contains afair value-based method for valuing stock-based compensation that entities mayuse, measures compensation cost at the grant date based on the fair value ofthe award. Compensation is then recognized over the service period, which isusually the vesting period. No stock-based compensation expense related tostock options was reflected in net income in 2005 and 2004, as all optionsgranted under the plans had an exercise price equal to the market value of theunderlying common stock on the date of the grant.

Hadcompensation cost for the plans been determined based on the fair value ofoptions at the grant dates consistent with the method of SFAS No. 123, “Accountingfor Stock-Based Compensation,” the Company’s net income and earnings per sharewould have been reduced to the pro forma amounts indicated below (in thousandsexcept per share data).

| ** **                                                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income                                                                                                   |       |     |       |     |       |
| As reported                                                                                                  |       | $        | 6,153      |     | $          | 6,567 |   |
| Deduct: stock-based compensation expense determined  using the fair value method, net of related tax effects |       | 68       |       | 88       |       |
| Pro forma                                                                                                    |       | $        | 6,085      |     | $          | 6,479 |   |
| Basic earnings  per share                                                                                    |       |     |       |     |       |
| As reported                                                                                                  |       | $        | 2.25       |     | $          | 2.44 |   |
| Deduct: stock-based compensation expense determined  using the fair value method, net of related tax effects |       | 0.03     |       | 0.03     |       |
| Pro forma                                                                                                    |       | $        | 2.22       |     | $          | 2.41 |   |
| Diluted earnings  per share                                                                                  |       |     |       |     |       |
| As reported                                                                                                  |       | $        | 2.20       |     | $          | 2.33 |   |
| Deduct: stock-based compensation expense determined  using the fair value method, net of related tax effects |       | 0.01     |       | 0.02     |       |
| Pro forma                                                                                                    |       | $        | 2.19       |     | $          | 2.31 |   |

 

Thefair value of each option grant during 2006 and 2005 was estimated on the dateof grant using the Black-Scholes option-pricing model with the followingweighted average assumptions: There were no options granted in 2004.

| ** **                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| Weighted average assumptions        |       |     |       |     |       |
| Dividend yield                                |       | 2.59     | %          | 2.41     | %          |
| Expected volatility                           |       | 25.48    | %          | 22.77    | %          |
| Risk-free interest rate                       |       | 5.00     | %          | 4.34     | %          |
| Fair value of options granted during the year |       | $        | 7.27       |     | $          | 6.15 |   |
| Expected lives in  years                      |       | 6.64     |       | 5.14     |       |
|                                               |            |          |            |          |            |  |  |

 

12.*   Income Taxes*

The Company accounts for income taxes under theliability method specified in SFAS No. 109, “Accounting for Income Taxes”whereby deferred income taxes are recognized for the tax consequences of “temporarydifferences” by applying enacted statutory tax rates applicable to future yearsto differences 

26

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between the financialstatement carrying amounts and the tax bases of existing assets andliabilities. The effect on deferred taxes of a change in tax rates isrecognized in income in the period that includes the enactment date.

13.*   Advertising Costs*

The Company expenses marketing and advertising costsas incurred.

14.*   Earnings Per Share*

The Company followsthe provisions of SFAS No. 128, “Earnings Per Share.” Basic earnings pershare excludes dilution and is computed by dividing income available to commonshareholders by the weighted average common shares outstanding during theperiod. Diluted earnings per share takes into account the potential dilutionthat could occur if securities or other contracts to issue common stock were exercisedand converted into common stock.

15.*   ComprehensiveIncome*

TheCompany follows SFAS No. 130, “Reporting Comprehensive Income.” SFAS No. 130establishes standards to provide prominent disclosure of comprehensive incomeitems. Comprehensive income is the change in equity of a business enterpriseduring a period from transactions and other events and circumstances fromnon-owner sources. The components of other comprehensive income (loss) are asfollows:

| ** **                                       | ** ** | **December 31, 2006** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Before tax  amount**     | ** ** | **Tax  (expense)  benefit** | ** ** | **Net of tax  amount** | ** ** |
| ** **                                       | ** ** | **(in thousands)**         | ** ** |
| Unrealized gains on  securities                  |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding gains arising during period   |       |                            | $          | 586 |   |   |   | $ | (198 | ) |   |   | $ | 388 |   |   |
| Reclassification  adjustment for losses realized |       |                            | 51         |   |   |   | (18 | ) |   |   | 33 |   |   |
| Other comprehensive income,  net                 |       |                            | $          | 637 |   |   |   | $ | (216 | ) |   |   | $ | 421 |   |   |

 

| ** **                                      | ** ** | **December 31, 2005** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **Before tax  amount**     | ** ** | **Tax  (expense)  benefit** | ** ** | **Net of tax  amount** | ** ** |
| ** **                                      | ** ** | **(in thousands)**         | ** ** |
| Unrealized losses on  securities                |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding losses arising during period |       |                            | $          | (2,094 | ) |   |   | $ | 711 |   |   |   | $ | (1,383 | ) |   |
| Minimum pension  liability adjustment           |       |                            | 107        |   |   |   | (37 | ) |   |   | 70 |   |   |
| Other comprehensive  loss, net                  |       |                            | $          | (1,987 | ) |   |   | $ | 674 |   |   |   | $ | (1,313 | ) |   |

 

| ** **                                     | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **Before tax  amount**     | ** ** | **Tax  (expense)  benefit** | ** ** | **Net of tax  amount** | ** ** |
| ** **                                     | ** ** | **(in thousands)**         | ** ** |
| Unrealized gains on  securities                |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding gains arising during period |       |                            | $          | 168 |   |   |   | $ | (57 | ) |   |   | $ | 111 |   |   |
| Minimum pension  liability adjustment          |       |                            | (107       | ) |   |   | 37 |   |   |   | (70 | ) |   |
| Other  comprehensive income, net               |       |                            | $          | 61 |   |   |   | $ | (20 | ) |   |   | $ | 41 |   |   |

 

27

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16.*   SegmentReporting*

TheCompany follows SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information.” The Company has one reportable segment, “CommunityBanking.” All of the Company’s activities are interrelated, and each activityis dependent and assessed based on how each of the activities of the Companysupports the others. For example, commercial lending is dependent upon theability of the Bank to fund itself with retail deposits and other borrowingsand to manage interest rate and credit risk. This situation is also similar forconsumer and residential mortgage lending. Accordingly, all significantoperating decisions are based upon analysis of the Company as one operatingsegment or unit.

17.*   Reclassifications*

Certain prior year amountshave been reclassified to conform to the current period presentation.

**NOTE B—RECENT ACCOUNTING PRONOUNCEMENTS**

In March 2006, theFinancial Accounting Standards Board (FASB) issued Statement No. 156 (SFAS156), “Accounting for Servicing of Financial Assets”. SFAS 156 amends SFAS No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities.” SFAS 156 permits, but does not require, an entity to chooseeither the amortization method or the fair value measurement method formeasuring each class of separately recognized servicing assets and servicingliabilities. SFAS 156 is effective for fiscal years beginning after September 15,2006 and is not expected to have a material impact on the Company’sconsolidated financial statements.

In July 2006, FASBissued FASB Interpretation (FIN) 48, “Accountingfor Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109, “Accounting for Income Taxes”. FIN48 clarifies the accounting for uncertainty in income taxes recognized in anentity’s financial statements in accordance with Statement of SFAS No. 109.FIN 48 prescribes a recognition threshold and measurement attribute for thefinancial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15,2006 and is currently under evaluation by the Company to determine theimpact on the Company’s consolidated financial statements.

In September 2006,FASB Issued Statement No. 157 (SFAS 157), “Fair Value Measurements” whichis effective for fiscal years beginning after November 15, 2007 and forinterim periods within those years. This statement defines fair value,establishes a framework for measuring fair value and expands the relateddisclosure requirements. The Company is currently evaluating the impact theadoption of SFAS No. 157 will have on its consolidated financialstatements.

In September 2006, FASBIssued Statement No. 158 (SFAS 158), “Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans—an amendment of FASBStatements No. 87, 88, 106, and 132(R)”. SFAS 158 requires an employer torecognize the overfunded or underfunded status of a defined benefitpostretirement plan (other than a multiemployer plan) as an asset or liabilityin its statement of financial position and to recognize changes in that fundedstatus in the year in which the changes occur through comprehensive income.This Statement also improves financial reporting by requiring an employer tomeasure the funded status of a plan as of the date of its year-end statement offinancial position, with limited exceptions. An employer with publicly traded equity securities is required toinitially recognize the funded status of a defined benefit postretirement planand to provide the required disclosures as of the end of the fiscal year endingafter December 15, 2006. TheCompany adopted the recognition and disclosure provisions of SFAS 158. Theeffects of the adoption of SFAS 158 on the Company’s financial condition atDecember 31, 2006 has been reflected in the consolidated financialstatements and resulted in the recognition $713,000 of accumulated othercomprehensive loss, net of income tax of $367,000.

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In September 2006, the SEC staff issued StaffAccounting Bulletin No.108 “Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements”. SAB 108was issued to provide consistency among registrants in the quantification offinancial statement misstatements. SAB 108 established an approach thatrequires quantification of financial statement misstatements based on theeffects of the misstatement on each of the company’s financial statements andthe related disclosures. SAB 108 allows registrants to initially apply theapproach either by (1) retroactively adjusting prior financial statementsas if the approach had always been used or (2) recording the cumulativeeffect of initially applying the approach as adjustments to the carrying valuesof assets and liabilities as of January 1, 2006 with the related offsetrecorded to the opening balance of retained earnings. Use of the “cumulativeeffect” transition requires full disclosure as to the nature and amount of eachindividual error being corrected. As the Company is not aware of any materialmisstatement, the adoption of SAB 108 did not have a material effect on thefinancial statements.

In September 2006, theFASB EITF finalized Issue No. 06-5, “Accounting for Purchases ofLife Insurance—Determining the Amount That Could Be Realized in Accordance withFASB Technical Bulletin No. 85-4 (Accounting for Purchases of LifeInsurance)”.**This issue requires that a policyholderconsider contractual terms of a life insurance policy in determining the amountthat could be realized under the insurance contract. It also requires that ifthe contract provides for a greater surrender value if all individual policiesin a group are surrendered at the same time, that the surrender value bedetermined based on the assumption that policies will be surrendered on anindividual basis. Lastly, the issue discusses whether the cash surrender valueshould be discounted when the policyholder is contractually limited in itsability to surrender a policy. This issue is effective for fiscal yearsbeginning after December 15, 2006. The Company does not believe theapplication of this EITF conclusion will have a material impact on itsfinancial statements.

On February 15, 2007,the FASB issued FASB Statement No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities-Including an Amendment of FASBStatement No. 115.” This standard permits an entity to choose to measuremany financial instruments and certain other items at fair value. Most of theprovisions in Statement 159 are elective; however, the amendment to FASBStatement No. 115, “Accounting for Certain Investments in Debt and EquitySecurities”, applies to all entities with available-for-sale and tradingsecurities. The fair value option established by Statement 159 permits allentities to choose to measure eligible items at fair value at specifiedelection dates. A business entity will report unrealized gains and losses onitems for which the fair value option has been elected in earnings at eachsubsequent reporting date. The fair value option: (a) may be appliedinstrument by instrument, with a few exceptions, such as investments otherwiseaccounted for by the equity method; (b) is irrevocable (unless a newelection date occurs); and (c) is applied only to entire instruments andnot to portions of instruments. Statement 159 is effective as of the beginningof an entity’s first fiscal year that begins after November 15, 2007.Early adoption is permitted as of the beginning of the previous fiscal yearprovided that the entity makes that choice in the first 120 days of that fiscalyear and also elects to apply the provisions of FASB Statement No 157, “FairValue Measurements.” The Company is currently evaluating the impact of thispronouncement.

**NOTE C—CASH ANDCASH EQUIVALENTS**

Cashand cash equivalents consist of the following:

| ** **                                                 | ** ** | **December 31,**   | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                 | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                                 | ** ** | **(in thousands)** | ** ** |
| Cash and due from  banks                                   |       | $                       | 5,544      |   | $ | 3,684 |   |
| Interest-bearing  deposits in other financial institutions |       | 6,820                   |       | 137 |   |
|                                                       |       | $                       | 12,364     |   | $ | 3,821 |   |

** **

29

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**NOTE D—INVESTMENTAND MORTGAGE-BACKED SECURITIES**

Theamortized cost, gross unrealized gains and losses, and fair value of theCompany’s investment securities at December 31, 2006 and 2005, aresummarized as follows:

| ** **                                     | ** ** | **December 31, 2006** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **Amortized  cost**             | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Fair  value** | ** ** |
| ** **                                     | ** ** | **(in thousands)**         | ** ** |
| Investment securities  held to maturity        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| State and political subdivisions               |       |                            | $          | 677 |   |   |   | $ | 4 |   |   |   | $ | — |   |   | $ | 681 |   |
| Corporate debt securities                      |       |                            | —     |   |   |   | — |   |   |   | — |   |   | — |   |
|                                           |       |                            | $          | 677 |   |   |   | 4 |   |   |   | — |   |   | $ | 681 |   |
| Investment securities  available for sale      |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and federal agencies           |       |                            | $          | 5,990 |   |   |   | $ | — |   |   |   | $ | (79 | ) |   | $ | 5,911 |   |
| Corporate debt securities                      |       |                            | 4,003      |   |   |   | — |   |   |   | (21 | ) |   | 3,982 |   |
| State and political subdivisions               |       |                            | 24,406     |   |   |   | 177 |   |   |   | (154 | ) |   | 24,429 |   |
| Equities                                       |       |                            | 150        |   |   |   | 52 |   |   |   | — |   |   | 202 |   |
|                                           |       |                            | $          | 34,549 |   |   |   | $ | 229 |   |   |   | $ | (254 | ) |   | $ | 34,524 |   |
| Mortgage-backed  securities held to maturity   |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| FHLMC certificates                             |       |                            | $          | 2,297 |   |   |   | $ | 79 |   |   |   | $ | — |   |   | $ | 2,376 |   |
| FNMA certificates                              |       |                            | 3,084      |   |   |   | 34 |   |   |   | (69 | ) |   | 3,049 |   |
| GNMA certificates                              |       |                            | 2,316      |   |   |   | 47 |   |   |   | — |   |   | 2,363 |   |
| Real estate mortgage investment conduit        |       |                            | —     |   |   |   | — |   |   |   | — |   |   | — |   |
|                                           |       |                            | $          | 7,697 |   |   |   | $ | 160 |   |   |   | $ | (69 | ) |   | $ | 7,788 |   |
| Mortgage-backed  securities available for sale |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| FHLMC certificates                             |       |                            | $          | 8,106 |   |   |   | $ | 1 |   |   |   | $ | (219 | ) |   | $ | 7,888 |   |
| FNMA certificates                              |       |                            | 10,765     |   |   |   | — |   |   |   | (435 | ) |   | 10,330 |   |
| Real estate mortgage investment conduit        |       |                            | 57,365     |   |   |   | 8 |   |   |   | (1,253 | ) |   | 56,120 |   |
|                                           |       |                            | $          | 76,236 |   |   |   | $ | 9 |   |   |   | $ | (1,907 | ) |   | $ | 74,338 |   |

 

30

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| ** **                                     | ** ** | **December 31, 2005** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **Amortized  cost**             | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Fair  value** | ** ** |
| ** **                                     | ** ** | **(in thousands)**         | ** ** |
| Investment securities  held to maturity        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| State and political subdivisions               |       |                            | $          | 1,015 |   |   |   | $ | 21 |   |   |   | $ | — |   |   | $ | 1,036 |   |
| Corporate debt securities                      |       |                            | 3,675      |   |   |   | — |   |   |   | (4 | ) |   | 3,671 |   |
|                                           |       |                            | $          | 4,690 |   |   |   | $ | 21 |   |   |   | $ | (4 | ) |   | $ | 4,707 |   |
| Investment securities  available for sale      |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and federal agencies           |       |                            | $          | 5,982 |   |   |   | $ | — |   |   |   | $ | (102 | ) |   | $ | 5,880 |   |
| Corporate debt securities                      |       |                            | 4,002      |   |   |   | — |   |   |   | (44 | ) |   | 3,958 |   |
| State and political subdivisions               |       |                            | 20,844     |   |   |   | 64 |   |   |   | (345 | ) |   | 20,563 |   |
|                                           |       |                            | $          | 30,828 |   |   |   | $ | 64 |   |   |   | $ | (491 | ) |   | $ | 30,401 |   |
| Mortgage-backed  securities held to maturity   |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| FHLMC certificates                             |       |                            | $          | 3,161 |   |   |   | $ | 124 |   |   |   | — |   |   | 3,285 |   |
| FNMA certificates                              |       |                            | 3,969      |   |   |   | 55 |   |   |   | (76 | ) |   | 3,948 |   |
| GNMA certificates                              |       |                            | 3,040      |   |   |   | 105 |   |   |   | — |   |   | 3,145 |   |
| Real estate mortgage investment conduit        |       |                            | 7          |   |   |   | — |   |   |   | — |   |   | 7 |   |
|                                           |       |                            | $          | 10,177 |   |   |   | $ | 284 |   |   |   | $ | (76 | ) |   | $ | 10,385 |   |
| Mortgage-backed  securities available for sale |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| FHLMC certificates                             |       |                            | $          | 9,986 |   |   |   | $ | 3 |   |   |   | $ | (303 | ) |   | $ | 9,686 |   |
| FNMA certificates                              |       |                            | 12,594     |   |   |   | 1 |   |   |   | (422 | ) |   | 12,173 |   |
| Real estate mortgage investment conduit        |       |                            | 63,064     |   |   |   | — |   |   |   | (1,412 | ) |   | 61,652 |   |
|                                           |       |                            | $          | 85,644 |   |   |   | $ | 4 |   |   |   | $ | (2,137 | ) |   | $ | 83,511 |   |

 

Gross realized loses were $51,000 for the year ended December 31,2006. These losses resulted from the sale of mortgage-backed securities of$5.0 million during the year ended December 31, 2006.

There were no sales of investments and mortgage-backedsecurities during the years ended December 31, 2005 and 2004.

Theamortized cost and fair value of investment and mortgage-backed securities, bycontractual maturity, are shown below.

| ** **                            | ** ** | **December 31, 2006**  | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **Available for sale** | ** ** | **Held to maturity** | ** ** |
| ** **                            | ** ** | **Amortized  cost**              | ** ** | **Fair  value** | ** ** | **Amortized  cost** | ** ** | **Fair  value** | ** ** |
| ** **                            | ** ** | **(in thousands)**          | ** ** |
| Investment securities                 |       |                             |       |   |   |   |   |   |   |   |   |
| Due in one year or less               |       | $                                | 6,153      |   | $ | 6,187 |   |   | $ | — |   |   | $ | — |   |
| Due after one year through five years |       | 5,451                            |       | 5,348 |   |   | 462 |   |   | 466 |   |
| Due after five years through 10 years |       | 11,793                           |       | 11,763 |   |   | 215 |   |   | 215 |   |
| Due after 10 years                    |       | 11,152                           |       | 11,226 |   |   | — |   |   | — |   |
|                                  |       | 34,549                           |       | 34,524 |   |   | 677 |   |   | 681 |   |
| Mortgage-backed  securities           |       | 76,236                           |       | 74,338 |   |   | 7,697 |   |   | 7,788 |   |
|                                  |       | $                                | 110,785    |   | $ | 108,862 |   |   | $ | 8,374 |   |   | $ | 8,469 |   |

 

Investment securities having an aggregate amortizedcost of approximately $3.0 million were pledged to secure public depositsat December 31, 2006 and 2005.

There were no securities held other than U.S.Government and agencies from a single issuer that represented more than 10% ofstockholders’ equity at year end.

31

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The table below indicates the length of timeindividual securities, both held-to-maturity and available-for-sale, have beenin a continuous unrealized loss position at December 31, 2006:

| ** **                              | ** ** | **Number**              | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**            | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|----------------------|------------|
| **Description of Securities** | ** ** | ** **              | ** ** | **of  Securities**                     | ** ** | **Fair Value**                    | ** ** | **Unrealized  Loss** | ** ** | **Fair Value** | ** ** | **Unrealized  Loss** | ** ** | **Fair value** | ** ** | **Unrealized  Loss** | ** ** |
| ** **                              | ** ** | **(in thousands)** | ** ** |
| U.S. Government and federal agencies    |       |                    | 2          |                                   |       |                                   | $          | —               |       |   |   | $ | — |   |   |   | $ | 5,911 |   |   |   | $ | (79 | ) |   |   | $ | 5,911 |   |   |   | $ | (79 | ) |   |
| Corporate debt securities               |       |                    | 3          |                                   |       |                                   | —     |                 |       |   | — |   |   |   | 3,982 |   |   |   | (21 | ) |   |   | 3,982 |   |   |   | (21 | ) |   |
| State and political subdivisions        |       |                    | 19         |                                   |       |                                   | 976        |                 |       |   | (4 | ) |   |   | 13,375 |   |   |   | (150 | ) |   |   | 14,351 |   |   |   | (154 | ) |   |
| Mortgage-backed securities              |       |                    | 38         |                                   |       |                                   | 7,298      |                 |       |   | (53 | ) |   |   | 65,827 |   |   |   | (1,923 | ) |   |   | 73,125 |   |   |   | (1,976 | ) |   |
| Total temporarily  impaired securities  |       |                    | 62         |                                   |       |                                   | $          | 8,274                |       |   |   | $ | (57 | ) |   |   | $ | 89,095 |   |   |   | $ | (2,173 | ) |   |   | $ |  97,369 |   |   |   | $ | (2,230 | ) |   |
|                                         |            |                         |            |                                        |            |                                        |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The table below indicates the length of time individual securities,both held-to-maturity and available-for-sale, have been in a continuousunrealized loss position at December 31, 2005:

| ** **                             | ** ** | **Number**              | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**            | ** ** |
|----------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|----------------------|------------|
| **Descriptionof Securities**      | ** ** | ** **              | ** ** | **of  Securities**                     | ** ** | **Fair Value**                    | ** ** | **Unrealized  Loss** | ** ** | **Fair Value** | ** ** | **Unrealized  Loss** | ** ** | **Fair value** | ** ** | **Unrealized  Loss** | ** ** |
| ** **                             | ** ** | **(in thousands)** | ** ** |
| U.S. Government and federal agencies   |       |                    | 2          |                                   |       |                                   | $          | 2,984                |       |   |   | $ | (14 | ) |   |   | $ | 2,897 |   |   |   | $ | (88 | ) |   |   | $ | 5,881 |   |   |   | $ | (102 | ) |   |
| Corporate debt securities              |       |                    | 6          |                                   |       |                                   | 6,632      |                 |       |   | (44 | ) |   |   | 997 |   |   |   | (4 | ) |   |   | 7,629 |   |   |   | (48 | ) |   |
| State and political subdivisions       |       |                    | 20         |                                   |       |                                   | 11,061     |                 |       |   | (155 | ) |   |   | 5,042 |   |   |   | (190 | ) |   |   | 16,103 |   |   |   | (345 | ) |   |
| Mortgage-backed securities             |       |                    | 32         |                                   |       |                                   | 35,899     |                 |       |   | (657 | ) |   |   | 49,199 |   |   |   | (1,556 | ) |   |   | 85,098 |   |   |   | (2,213 | ) |   |
| Total temporarily  impaired securities |       |                    | 60         |                                   |       |                                   | $          | 56,576               |       |   |   | $ | (870 | ) |   |   | $ | 58,135 |   |   |   | $ | (1,838 | ) |   |   | $ | 114,711 |   |   |   | $ | (2,708 | ) |   |
|                                        |            |                         |            |                                        |            |                                        |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The unrealized losses on investments in securitiesissued by the U.S. Treasury and Government agencies, U.S. Government sponsoredagencies and agency mortgage-backed securities were caused by changes in marketinterest rates. The contractual terms and contractual cash flows of thesesecurities do not permit the issuer to settle at a price less than theamortized cost of the investment. The Company has the ability and intent tohold these investments until a market price recovery or maturity. Accordingly,the Company  has evaluated relevantfactors and has determined that the unrealized losses at December 31, 2006and 2005, respectively are not considered other-than-temporary.

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**NOTE E—LOANSRECEIVABLE**

Loansreceivable are summarized as follows:

| ** **                                                    | ** ** | **December 31,**   | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                    | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                                    | ** ** | **(in thousands)** | ** ** |
| Held for investment:                                          |       |                    |       |   |   |
| First mortgage  loans (principally conventional)              |       |                    |       |   |   |
| Secured by one-to-four family residences                      |       | $                       | 266,789    |   | $ | 289,678 |   |
| Secured by other non-residential properties                   |       | 93,607                  |       | 89,489 |   |
| Construction loans                                            |       | 34,944                  |       | 24,888 |   |
|                                                          |       | 395,340                 |       | 404,055 |   |
| Net deferred loan origination costs and unamortized  premiums |       | 531                     |       | 504 |   |
| Total first mortgage loans                                    |       | 395,871                 |       | 404,559 |   |
| Other loans                                                   |       |                    |       |   |   |
| Commercial non-real estate                                    |       | 40,458                  |       | 48,471 |   |
| Home equity and second mortgage                               |       | 46,864                  |       | 37,479 |   |
| Commercial leases                                             |       | 36                      |       | 186 |   |
| Other                                                         |       | 3,206                   |       | 2,836 |   |
|                                                          |       | 90,564                  |       | 88,972 |   |
| Unamortized premiums                                          |       | 0                       |       | 1 |   |
| Total other loans                                             |       | 90,564                  |       | 88,973 |   |
| Less allowance for loan losses                                |       | (2,865                  | )          | (2,641 | ) |
| Total loans receivable                                        |       | $                       | 483,570    |   | $ | 490,891 |   |
| Held  for sale:                                               |       |                    |       |   |   |
| First mortgage loans  (principally conventional)              |       |                    |       |   |   |
| Secured by one-to four family residences                      |       | $                       | 969        |   | $ | 68 |   |

 

Activityin the allowance for loan losses is summarized as follows:

| ** **                        | ** ** | **December 31,**   | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **(in thousands)** | ** ** |
| Balance at  beginning of year     |       | $                       | 2,641      |   | $ | 2,307 |   | $ | 2,111 |   |
| Provision charged  to income      |       | 150                     |       | 540 |   | 600 |   |
| (Charge-offs),  net of recoveries |       | 74                      |       | (206 | ) | (404 | ) |
| Balance at end of year            |       | $                       | 2,865      |   | $ | 2,641 |   | $ | 2,307 |   |

 

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Non-performingloans, which include non-accrual loans for which the accrual of interest hasbeen discontinued and loan balances past due over 90 days that are not ona non-accrual status but that management expects will eventually be paid infull are summarized as follows:

| ** **                                                                      | ** ** | **December 31,**   | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                      | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                                                      | ** ** | **(in thousands)** | ** ** |
| Impaired loans  with a related allowance                                        |       | $                       | —     |   | $ | — |   |
| Impaired loans  without a related allowance                                     |       | $                       | —     |   | $ | — |   |
| Total impaired  loans                                                           |       | $                       | —     |   | $ | — |   |
| Allowance for  impaired loans                                                   |       | $                       | —     |   | $ | — |   |
| Total non-accrual  loans                                                        |       | $                       | 2,110      |   | $ | 1,589 |   |
| Total loans past due 90  days as to interest or principal and accruing interest |       | $                       | —     |   | $ | — |   |

 

Interest income that would have been recorded underthe original terms of such loans totaled approximately $130,000, $60,000, and$30,000 for the years ended December 31, 2006, 2005, and 2004. No interestincome has been recognized on non-accrual loans for any of the periods presented.The Company has reviewed these loans and has determined there was no impairmentat December 31, 2006 and 2005.

The Bank has noconcentration of loans to borrowers engaged in similar activities that exceeded10% of loans at December 31, 2006 and 2005. In the ordinary course ofbusiness, the Bank has granted loans to certain executive officers, directorsand their related interests. Related party loans are made on substantially thesame terms as those prevailing at the time for comparable transactions withunrelated persons and do not involve more than the normal risk ofcollectibility. The aggregate dollar amount of these loans was approximately$252,000 and $70,000 at December 31, 2006 and 2005, respectively. Newloans to related parties of $230,000 were made during the year. For the yearended December 31, 2006, principal repayments of approximately $48,000were received.

**NOTE F—LOANSERVICING**

Mortgageloans serviced for others are not included in the accompanying consolidatedstatements of financial position. The unpaid principal balances of these loansare summarized as follows:

| ** **                          | ** ** | **December 31,**   | ** ** |
|-------------------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                          | ** ** | **(in thousands)** | ** ** |
| Mortgage loan servicing  portfolios |       |                    |       |   |   |
| FHLMC                               |       | $                       | 903        |   | $ | 1,182 |   |
| FNMA                                |       | 21,918                  |       | 9,696 |   |
| Other investors                     |       | 10,841                  |       | 6,173 |   |
|                                |       | $                       | 33,662     |   | $ | 17,051 |   |

 

Custodial balancesmaintained in connection with the foregoing loan servicing totaledapproximately $238,000 and $168,000 at December 31, 2006 and 2005,respectively. Net servicing revenue on mortgage loans serviced for other was $19,000,$18,000 and $11,000 for the years ended December 31, 2006, 2005, and 2004,respectively. Mortgage servicing rights of $279,000 and $137,000 are reportedas a component of other assets at December 31, 2006 and 2005.

34

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**NOTE G—PREMISES ANDEQUIPMENT**

Premises and equipment are summarized as follows:

| ** **                         | ** ** | **Estimated**         | ** ** | **December 31,**   | ** ** |
|------------------------------------|------------|-----------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **useful lives** | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                         | ** ** | ** **            | ** ** | **(in thousands)** | ** ** |
| Buildings                          |       | 30 years              |       | $6,207                  |       | $6,125 |   |
| Leasehold  improvements            |       | 5 years               |       | 1,932                   |       | 1,623 |   |
| Furniture,  fixtures and equipment |       | 3-7 years             |       | 10,257                  |       | 10,331 |   |
|                               |       |                  |       | 18,396                  |       | 18,079 |   |
| Less accumulated  depreciation     |       |                  |       | 13,544                  |       | 13,482 |   |
|                               |       |                  |       | 4,852                   |       | 4,597 |   |
| Land                               |       |                  |       | 1,692                   |       | 1,692 |   |
|                               |       |                  |       | $6,544                  |       | $6,289 |   |

 

**NOTE H—DEPOSITS**

Depositsare summarized as follows:

| ** **                                       | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| **Deposit type**                            | ** ** | ** **              | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| Demand                                           |       | $36,991                 |       | $37,138 |   |
| NOW                                              |       | 51,272                  |       | 52,319 |   |
| Money market                                     |       | 62,914                  |       | 79,666 |   |
| Passbook savings                                 |       | 131,359                 |       | 151,725 |   |
| Total demand,  transaction and passbook deposits |       | 282,536                 |       | 320,848 |   |
| Certificates of  deposit                         |       | 195,551                 |       | 149,673 |   |
|                                             |       | $478,087                |       | $470,521 |   |
|                                                  |            |                         |            |  |  |  |  |

 

The aggregate amount of certificates of deposit with aminimum denomination of $100,000 was approximately $42.4 million and$31.3 million at December 31, 2006 and 2005, respectively. The Bankhad broker-originated certificates of deposit of $11.7 million and $0 at December 31,2006 and 2005, respectively.

At December 31,2006, scheduled maturities of certificates of deposit are as follows:

| **Year ending December 31,** |
|---------------------------------------------|
| **2007**                                    | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** | **Total** |
| **(in thousands)**                     |
| $170,926                                    |   | $12,745 |   | $7,195 |   | $3,493 |   | $766 |   | $426 |   | $195,551 |

 

Related party deposits are on substantially the same terms as forcomparable transactions with unrelated persons. The aggregate dollar amount ofthese deposits was approximately $2.5 million and $2.0 million at December 31,2006 and 2005, respectively.

35

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**NOTE I—ADVANCESFROM THE FEDERAL HOME LOAN BANK AND OTHER BORROWINGS**

Advances from the Federal Home Loan Bank consist of the following:

| ** **                                       | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **2006**                | ** ** | **2005** | ** ** |
| **Principal payments due during** | ** ** | ** **              | ** ** | **Amount** | ** ** | **Weighted  average rate** | ** ** | **Amount** | ** ** | **Weighted  average rate** | ** ** |
| ** **                                       | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| 2006                                             |       |                    | $          | — |   |   |   | — | % |   |   | 32,672 |   |   |   | 3.81 | % |   |
| 2007                                             |       |                    | 25,122     |   |   |   | 3.92 |   |   |   | 22,050 |   |   |   | 3.73 |   |   |
| 2008                                             |       |                    | 23,144     |   |   |   | 3.76 |   |   |   | 17,638 |   |   |   | 3.40 |   |   |
| 2009                                             |       |                    | 34,566     |   |   |   | 3.84 |   |   |   | 34,566 |   |   |   | 3.84 |   |   |
| 2010                                             |       |                    | 13,074     |   |   |   | 4.41 |   |   |   | 8,539 |   |   |   | 4.25 |   |   |
| 2011                                             |       |                    | 2,776      |   |   |   | 4.17 |   |   |   | 2,776 |   |   |   | 4.17 |   |   |
| Thereafter                                       |       |                    | 3,019      |   |   |   | 4.23 |   |   |   | 3,019 |   |   |   | 4.23 |   |   |
|                                             |       |                    | $          | 101,701 |   |   |   | 3.93 | % |   |   | $ | 121,260 |   |   |   | 3.79 | % |   |
|                                                  |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The advances arecollateralized by Federal Home Loan Bank stock and certain first mortgage loansand mortgage-backed securities. Total unused lines of credit at the FederalHome Loan Bank were $30.0 million at December 31, 2006. The advancesfrom the Federal Home Loan Bank are fixed rate, fixed term.

**NOTE J—BENEFIT PLANS**

**1.*   DefinedContribution Plan***

The Bank maintains a 401(k) profit-sharing planfor eligible employees. Participants may contribute up to 15% of pretaxeligible compensation. The Bank makes matching discretionary contributionsequal to 75% of the initial $1,000 deferral. Contributions to the 401(k) plantotaled $65,000, $61,000, and $65,000 in 2006, 2005 and 2004, respectively.

2.*   DefinedBenefit Plan*

The Bank has a non-contributory defined benefit pension plan coveringsubstantially all full-time employees meeting certain eligibility requirements.The benefits are based on each employee’s years of service and an averageearnings formula. An employee becomes fully vested upon completion of fiveyears of qualifying service. It is the policy of the Bank to fund the maximumamount allowable under the individual aggregate cost method to the extentdeductible under existing federal income tax regulations.

36

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The following tables set forth the projected benefitobligation, funded status of the defined benefit pension plan and the amountsreflected in the consolidated statements of financial position, and fair valueof assets of the plan.

| ** **                                      | ** ** | **December 31,**   | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **(in thousands)** | ** ** |
| Reconciliation of  Projected Benefit Obligation |       |                    |       |   |   |
| Benefit obligation at beginning of year         |       | $                       | 3,621      |   | $ | 3,382 |   |
| Service cost                                    |       | 308                     |       | 314 |   |
| Interest cost                                   |       | 211                     |       | 211 |   |
| Plan amendments                                 |       | —                  |       | — |   |
| Actuarial loss                                  |       | (82                     | )          | 122 |   |
| Benefits paid                                   |       | (498                    | )          | (408 | ) |
| Benefits  obligation at end of year             |       | $                       | 3,560      |   | $ | 3,621 |   |
| Reconciliation of  Fair Value of Assets         |       |                    |       |   |   |
| Fair value of plan assets at beginning of year  |       | $                       | 3,174      |   | $ | 2,490 |   |
| Actual return on plan assets                    |       | 364                     |       | 77 |   |
| Employer contribution                           |       | 820                     |       | 1,015 |   |
| Benefits paid                                   |       | (498                    | )          | (408 | ) |
| Fair value of plan assets at end of year        |       | $                       | 3,860      |   | $ | 3,174 |   |
| Reconciliation of  Funded Status                |       |                    |       |   |   |
| Funded status                                   |       | $                       | 300        |   | $ | (447 | ) |
| Unrecognized net actuarial loss                 |       | —                  |       | 1,162 |   |
| Unrecognized prior service cost                 |       | —                  |       | 156 |   |
| Prepaid benefit  cost at end of year            |       | $                       | 300        |   | $ | 871 |   |

 

The amount recognized in accumulated other comprehensiveincome at December 31, 2006 was $1,080,000 which included a net actuarialloss of $987,000 and prior service cost of $93,000. The expected 2007amortization of accumulated other comprehensive income is $42,000 of loss and$63,000 of prior service cost.

The accumulated benefit obligation at December 31, 2006 and 2005was $3,036,000 and $3,079,000 respectively.

Employer contributions and benefits paid in the above table includeonly those amounts contributed directly to, or paid directly from, Plan assets.The expected employer contribution for 2007 is $1.1 million.

| ** **                                                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Weighted-average  assumptions used to determine benefit obligations, end of year |       |     |       |     |       |
| Discount rate                                                                    |       | 5.75     | %          | 5.75     | %          |
| Rate of compensation  increase                                                   |       | 4.00     |       | 4.00     |       |

 

37

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| ** **                                    | ** ** | **2006**           | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|----------|------------|----------|------------|
| ** **                                    | ** ** | **(in thousands)** | ** ** |
| Components of net  periodic benefit cost      |       |               |       |     |       |     |       |
| Service cost                                  |       | $                  | 308        |     | $          | 314      |       | $ | 230 |   |
| Interest cost                                 |       | 211                |       | 211      |       | 190      |       |
| Expected return on plan assets                |       | (324               | )          | (205     | )          | (210     | )          |
| Amortization of prior service cost            |       | 63                 |       | 63       |       | 63       |       |
| Amortization of transition obligation (asset) |       | —             |       | —   |       | 4        |       |
| Recognized net actuarial (gain) loss          |       | 51                 |       | 42       |       | 24       |       |
| Net periodic  benefit cost                    |       | $                  | 309        |     | $          | 425      |       | $ | 301 |   |

 

| ** **                                                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted-average  assumptions used to determine net benefit costs as of December 31 |       |     |       |     |       |     |       |
| Discount rate                                                                                 |       | 5.75     | %          | 6.00     | %          | 6.25     | %          |
| Expected return on plan assets                                                                |       | 9.00     |       | 8.00     |       | 8.00     |       |
| Rate of  compensation increase                                                                |       | 4.00     |       | 4.00     |       | 4.00     |       |

 

The expected rate of return was determined by applying the averagerates of return over the past ten years on the assets which the Plan iscurrently invested.

Estimatedfuture benefits payments are as follows:

| ** ** | ** ** | **(in thousands)** | ** ** |
|------------|------------|-------------------------|------------|
| 2007       |       |                    | $          | 296 |   |   |
| 2008       |       |                    | 49         |   |   |
| 2009       |       |                    | 78         |   |   |
| 2010       |       |                    | 78         |   |   |
| 2011       |       |                    | 79         |   |   |
| 2012-2016  |       |                    | 698        |   |   |

 

The Plan’s weighted-average asset allocations by asset category is asfollows:

| ** **        | ** ** | **Percentage of Plan Assets  at Year End** | ** ** |
|-------------------|------------|---------------------------------------------------------------------|------------|
| ** **        | ** ** | **2006**                                                            | ** ** | **2005** | ** ** |
| Asset Category    |       |                                                                |       |   |   |   |   |   |   |
| Equity securities |       |                                                                | 59         | % |   |   | 64 | % |   |
| Debt securities   |       |                                                                | 21         |   |   |   | 27 |   |   |
| Other             |       |                                                                | 20         |   |   |   | 9 |   |   |
| Total             |       |                                                                | 100        | % |   |   | 100 | % |   |

 

Trustees of the Plan are responsible for defining and implementing theinvestment objectives and policies for the Plan’s assets. Assets are investedin accordance with sound investment practices that emphasize long-terminvestment fundamentals that closely match the demographics of the plan’sparticipants. The Plan’s goal is to earn long-term returns that match or exceedthe benefit obligations of the Plan through a well-diversified portfoliostructure. The Plan’s return objectives and risk parameters are managed througha diversified mix of assets. The asset mix and investment strategy are reviewedon a quarterly basis and rebalanced when necessary. The asset allocation forthe Plan is targeted at 60% equity securities and 40% debt and othersecurities.

38

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3..*   Employee Stock Ownership Plan (ESOP)*

The Company has an internally leveraged ESOP for eligible employees whohave completed six months of service with the Company or its subsidiaries. TheESOP borrowed $4.2 million from the Company in 1996 to purchase 423,200newly issued shares of common stock. The Company makes discretionarycontributions to the ESOP in order to service the ESOP’s debt. Any dividendsreceived by the ESOP will be used to pay debt service. The ESOP shares arepledged as collateral for its debt. As the debt is repaid, shares are releasedfrom collateral based on the proportion of debt service paid in the year andallocated to qualifying employees. As shares are released from collateral, theCompany reports compensation expense equal to the current market price of theshares, and the allocated shares are included in outstanding shares forearnings per share computations. ESOP compensation expense was $332,000,$387,000 and $431,000 in 2006, 2005 and 2004, respectively.

| ** **                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Allocated shares                                |       | 169,000  |       | 165,000  |       |
| Unreleased shares                               |       | 171,000  |       | 184,000  |       |
| Total ESOP shares                               |       | 340,000  |       | 349,000  |       |
| Fair value of unreleased  shares (in thousands) |       | $        | 5,301      |     | $          | 5,235 |   |
|                                                 |            |          |            |          |            |  |  |

 

4.     *Stock-BasedCompensation Plans*

Asummary of the status of the Company’s stock option plans as ofDecember 31, 2006, and changes for each of the years in the three-yearperiod then ended is as follows:

| ** **                        | ** ** | **2006**               | ** ** | **2005**                                               | ** ** | **2004**               | ** ** |
|-----------------------------------|------------|------------------------|------------|--------------------------------------------------------|------------|------------------------|------------|
| ** **                        | ** ** | **Number  of  shares** | ** ** | **Weighted  average  exercise  price per  share** | ** ** | **Number  of  shares** | ** ** | **Weighted  average  exercise  price per  share** | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Exercise  price per  Share** | ** ** |
| Outstanding at  beginning of year |       | 384,848                |       |                                                   | $          | 23.18                  |       |   | 283,072 |   |   | $ | 19.09 |   |   | 585,714 |   |   | $ | 15.40 |   |   |
| Options granted                   |       | 11,000                 |       |                                                   | 27.20      |                   |       | 160,500 |   |   | 28.46 |   |   | — |   |   | — |   |   |
| Options exercised                 |       | (21,415                | )          |                                                   | 15.25      |                   |       | (49,975 | ) |   | 16.01 |   |   | (294,925 | ) |   | 11.56 |   |   |
| Options forfeited                 |       | (8,699                 | )          |                                                   | 29.72      |                   |       | (8,749 | ) |   | 28.40 |   |   | (7,717 | ) |   | 26.75 |   |   |
| Options expired                   |       | —                 |       |                                                   | —     |                   |       | — |   |   | — |   |   | — |   |   | — |   |   |
| Outstanding at end of  year       |       | 365,734                |       |                                                   | $          | 23.62                  |       |   | 384,848 |   |   | $ | 23.18 |   |   | 283,072 |   |   | $ | 19.09 |   |   |

 

 

39

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Thefollowing table summarizes information about stock options outstanding at December 31,2006:

| ** **                                  | ** ** | **Options outstanding** | ** ** | **Options exercisable**                             | ** ** |
|---------------------------------------------|------------|------------------------------|------------|----------------------------------------------------------|------------|
| **Range of exercise prices** | ** ** | ** **                   | ** ** | **Number  outstanding at  December 31,  2006** | ** ** | **Weighted  average  remaining  contractual  life (years)** | ** ** | **Weighted  average  exercise  price** | ** ** | **Number  exercisable at  December 31,  2006** | ** ** | **Weighted  average  exercise  price** | ** ** |
| $13.25-19.88                                |       |                         | 133,854    |                                                     |       |   | 0.73 |   |   |   | $ | 15.96 |   |   |   | 133,854 |   |   |   | $ | 15.96 |   |   |
| $19.89-29.84                                |       |                         | 211,242    |                                                     |       |   | 4.58 |   |   |   | 27.44 |   |   |   | 88,068 |   |   |   | 26.36 |   |   |
| $29.85-34.14                                |       |                         | 20,638     |                                                     |       |   | 6.97 |   |   |   | 34.14 |   |   |   | 12,383 |   |   |   | 34.14 |   |   |
|                                        |       |                         | 365,734    |                                                     |       |   | 3.31 |   |   |   | $ | 23.62 |   |   |   | 234,305 |   |   |   | $ | 20.83 |   |   |
|                                             |            |                              |            |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The aggregate intrinsic value represents the totalpre-tax intrinsic value (the difference between the Company’s closing stockprice on the last trading day of 2006 and the exercise price, multiplied by thenumber of in-the money options). At December 31, 2006 the aggregateintrinsic value of options outstanding totaled $2,699,000 and the aggregateintrinsic value of options exercisable was $2,383,000. The aggregate intrinsicvalue of options exercised during the years ended December 31, 2006 and2005 was $320,000 and $714,000, respectively. Exercise of stock options duringthe year ended December 31, 2006 and 2005 resulted in cash receipts of$325,000 and $801,000, respectively. The Company has a policy of issuing sharesfrom treasury to satisfy share option exercises.

Stock-based compensation expense included in netincome related to stock options was $386,000, resulting in a tax benefit of$116,000, for the year ended December 31, 2006. Results for prior periodshave not been restated. At  December 31,2006, there was $818,000 of total unrecognized compensation cost, net ofestimated forfeitures, related to non-vested options under the Plan. That costis expected to be recognized over a weighted average period of 26.8 months

Thetable below summarizes the changes in non-vested restricted stock during thepast year:

| ** **                                                   | ** ** | **December 31, 2006** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **Shares**                      | ** ** | **Weighted  Average grant  date fair value** | ** ** |
| Total non-vested  restricted stock at December 31, 2005 |       |                            | 39,000     |   |   |   | $ | 28.48 |   |   |
| Restricted stock  grant in 2006                              |       |                            | —     |   |   |   | — |   |   |
| Vested restricted  stock in 2006                             |       |                            | (12,666    | ) |   |   | $ | 28.48 |   |   |
| Forfeitures of  restricted stock in 2006                     |       |                            | (1,000     | ) |   |   | $ | 28.48 |   |   |
| Total non-vested restricted  stock at December 31, 2006 |       |                            | 25,334     |   |   |   | $ | 28.48 |   |   |

 

Stock-based compensationexpense included in net income related to stock grants was $361,000 and $15,000for the years ended December 31, 2006 and 2005, respectively. The expectedcompensation expense for 2007 and 2008 is $361,000 and $346,000, respectively.

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**NOTE K—INCOME TAXES**

Thecomponents of income tax expense (benefit) are summarized as follows:

| ** **                                                   | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                   | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**                    | ** ** |
| Federal                                                      |       |                                       |       |   |   |   |   |
| Current                                                      |       | $                                          | 1,687      |   | $ | 1,753 |   | $ | 508 |   |
| Charge in lieu of income tax relating to stock  compensation |       | 121                                        |       | 144 |   | 1,616 |   |
| Deferred                                                     |       | 327                                        |       | 403 |   | 343 |   |
|                                                         |       | 2,135                                      |       | 2,300 |   | 2,467 |   |
| State and local—current                                 |       | 1                                          |       | — |   | — |   |
| Income tax provision                                         |       | $                                          | 2,136      |   | $ | 2,300 |   | $ | 2,467 |   |

 

TheCompany’s effective income tax rate was different than the statutory federalincome tax rate as follows:

| ** **                              | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Statutory federal  income tax (benefit) |       | 34.0                                       | %          | 34.0 | % | (34.0 | )% |
| Increase  (decrease) resulting from     |       |                                       |       |   |   |   |   |
| Tax-exempt income                       |       | (6.4                                       | )          | (5.7 | ) | (3.7 | ) |
| State tax, net of federal benefit       |       | (0.0                                       | )          | (0.0 | ) | (0.0 | ) |
| Other                                   |       | 0.3                                        |       | (1.1 | ) | (3.0 | ) |
|                                    |       | 27.9                                       | %          | 27.2 | % | 27.3 | % |

 

Deferred taxes areincluded in the accompanying consolidated statements of financial position at December 31,2006 and 2005, for the estimated future tax effects of differences between thefinancial statement and federal income tax bases of assets and liabilitiesaccording to the provisions of currently enacted tax laws. No valuationallowance was recorded against deferred tax assets at December 31, 2006and 2005. The Company’s net deferred tax asset at December 31, 2006 and2005, was composed of the following:

| ** **                                        | ** ** | **December 31,**   | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                        | ** ** | **(in thousands)** | ** ** |
| Deferred tax assets                               |       |                    |       |   |   |
| Deferred compensation                             |       | $                       | 202        |   | $ | 208 |   |
| Allowance for loan  losses, net                   |       | 974                     |       | 885 |   |
| Unrealized loss on  securities available for sale |       | 653                     |       | 869 |   |
| Stock compensation                                |       | 121                     |       | — |   |
| Adjustment to record  funded status of pension    |       | 367                     |       | — |   |
| Other                                             |       | 41                      |       | 51 |   |
|                                              |       | 2,358                   |       | 2,013 |   |
| Deferred tax liabilities                          |       |                    |       |   |   |
| Accrued pension expense                           |       | 843                     |       | 504 |   |
| Prepaid expenses                                  |       | 44                      |       | 43 |   |
| Deferred loan costs                               |       | 492                     |       | 472 |   |
| Amortization of goodwill                          |       | 450                     |       | 263 |   |
| Other                                             |       | 393                     |       | 419 |   |
|                                              |       | 2,222                   |       | 1,701 |   |
| Net deferred tax asset                            |       | $                       | 136        |   | $ | 312 |   |

 

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Prior to 2004 the Company filed its income tax returnson the basis of a fiscal tax year ending June 30. Effective July 1,2004, the Company changed the tax year end to coincide with the fiscalreporting period end of December 31.

The Bank is not requiredto recapture approximately $5.7 million of its tax bad debt reserve,attributable to bad debt deductions taken by it prior to 1988, as long as theBank continues to operate as a bank under federal tax law and does not use thereserve for any other purpose. In accordance with SFAS No. 109, the Bankhas not recorded any deferred tax liability on this portion of its tax bad debtreserve. The tax that would be paid were the Bank ultimately required torecapture that portion of the reserve would amount to approximately$1.9 million.

**NOTE L—REGULATORYMATTERS**

The Bank is subject to minimum regulatory capitalstandards promulgated by the Office of Thrift Supervision (OTS). Failure tomeet minimum capital requirements can initiate certain mandatory—and possibleadditional discretionary—actions by regulators that, if undertaken, could havea direct material effect on the Company’s consolidated financial statements.Under capital adequacy guidelines and the regulatory framework for promptcorrective action, the Bank must meet specific capital guidelines that involvequantitative measures of the Bank’s assets, liabilities, and certainoff-balance sheet items as calculated under regulatory accounting practices.The Company’s capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings, andother factors. Such minimum capital standards generally require the maintenanceof regulatory capital sufficient to meet each of three tests, hereinafterdescribed as the tangible capital requirement, the core capital requirement andthe risk-based capital requirement. The tangible capital requirement providesfor minimum tangible capital (defined as stockholders’ equity less allintangible assets) equal to 1.5% of adjusted total assets. The core capitalrequirement provides for minimum core capital (tangible capital plus certainforms of supervisory goodwill and other qualifying intangible assets) equal to4% of adjusted total assets at December 31, 2006. The risk-based capitalrequirement provides for minimum core capital (tangible capital plus certainforms of supervisory goodwill and other qualifying intangible assets) adjustedfor the general valuation allowances equal to 8% of total assets classified inone of four risk-weighted categories at December 31, 2006.

As of December 31,2006, management believes that the Bank met all capital adequacy requirementsto which it was subject.

| ** **                                                | ** ** | **Regulatory capital  December 31, 2006** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                | ** ** | **Tangible**                                             | ** ** | **Core** | ** ** | **Risk-based** | ** ** |
| ** **                                                | ** ** | **Capital**                                              | ** ** | **Percent** | ** ** | **Capital** | ** ** | **Percent** | ** ** | **Capital** | ** ** | **Percent** | ** ** |
| ** **                                                | ** ** | **(in thousands)**                                  | ** ** |
| Capital under generally accepted accounting  principles   |       | $                                                        | 61,306     |   |   | 9.41 | % |   | $ | 61,306 |   |   | 9.41 | % |   | $ | 61,306 |   |   | 16.33 | % |   |
| Unrealized loss on certain available-for-sale  securities |       | 1,304                                                    |       |   | 0.20 |   |   | 1,304 |   |   | 0.20 |   |   | 1,304 |   |   | 0.35 |   |   |
| Goodwill and other intangible assets                      |       | (4,324                                                   | )          |   | (0.66 | ) |   | (4,324 | ) |   | (0.66 | ) |   | (4,324 | ) |   | (1.15 | ) |   |
| Additional capital items                                  |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| General valuation allowances—limited                 |       | —                                                   |       |   | — |   |   | — |   |   | — |   |   | 2,865 |   |   | 0.76 |   |   |
| Regulatory capital computed                               |       | 58,286                                                   |       |   | 8.95 |   |   | 58,286 |   |   | 8.95 |   |   | 61,151 |   |   | 16.29 |   |   |
| Minimum capital requirement                               |       | 9,774                                                    |       |   | 1.50 |   |   | 26,063 |   |   | 4.00 |   |   | 30,035 |   |   | 8.00 |   |   |
| Regulatory  capital—excess                           |       | $                                                        | 48,512     |   |   | 7.45 | % |   | $ | 32,223 |   |   | 4.95 | % |   | $ | 31,116 |   |   | 8.29 | % |   |

 

42

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| ** **                                                | ** ** | **Regulatory capital  December 31, 2005** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                | ** ** | **Tangible**                                             | ** ** | **Core** | ** ** | **Risk-based** | ** ** |
| ** **                                                | ** ** | **Capital**                                              | ** ** | **Percent** | ** ** | **Capital** | ** ** | **Percent** | ** ** | **Capital** | ** ** | **Percent** | ** ** |
| ** **                                                | ** ** | **(in thousands)**                                  | ** ** |
| Capital under generally accepted accounting  principles   |       | $                                                        | 57,421     |   |   | 8.70 | % |   | $ | 57,421 |   |   | 8.70 | % |   | $ | 57,421 |   |   | 14.90 | % |   |
| Unrealized loss on certain available-for-sale  securities |       | 1,689                                                    |       |   | 0.26 |   |   | 1,689 |   |   | 0.26 |   |   | 1,689 |   |   | 0.44 |   |   |
| Goodwill and other intangible assets                      |       | (4,626                                                   | )          |   | (0.70 | ) |   | (4,626 | ) |   | (0.70 | ) |   | (4,626 | ) |   | (1.20 | ) |   |
| Additional capital items                                  |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| General valuation allowances—limited                 |       | —                                                   |       |   | — |   |   | — |   |   | — |   |   | 2,641 |   |   | 0.68 |   |   |
| Regulatory capital computed                               |       | 54,484                                                   |       |   | 8.26 |   |   | 54,484 |   |   | 8.26 |   |   | 57,125 |   |   | 14.82 |   |   |
| Minimum capital requirement                               |       | 9,900                                                    |       |   | 1.50 |   |   | 26,400 |   |   | 4.00 |   |   | 30,834 |   |   | 8.00 |   |   |
| Regulatory  capital—excess                           |       | $                                                        | 44,584     |   |   | 6.76 | % |   | $ | 28,084 |   |   | 4.26 | % |   | $ | 26,291 |   |   | 6.82 | % |   |

 

At December 31, 2006, the Bank met all regulatoryrequirements for classification as a “well-capitalized” institution. A“well-capitalized” institution must have risk-based capital of 10% and corecapital of 5%. The Bank’s capital exceeded the minimum required amounts forclassification as a “well-capitalized” institution. There are no conditions orevents that have occurred that management believes have changed the Bank’sclassification as a “well-capitalized” institution.

The Bank maintains a liquidation account for thebenefit of eligible savings account holders who maintained deposit accounts inthe Bank after the Bank converted to a stock form of ownership. The Bank maynot declare or pay a cash dividend on or repurchase any of its common shares ifthe effect thereof would cause the Bank’s stockholders’ equity to be reducedbelow either the amount required for the liquidation account or the regulatorycapital requirements for insured institutions.

**NOTE M—FINANCIALINSTRUMENTS WITH OFF-BALANCE-SHEET RISK**

The Company is a party to financial instruments withoff-balance-sheet risk in the normal course of business to meet the financingneeds of its customers. These financial instruments are primarily commitmentsto extend credit and standby letters of credit. Such financial instruments arerecorded in the consolidated financial statements when they become receivableor payable. Those instruments involve, to varying degrees, elements of creditand interest rate risk in excess of the amount recognized in the consolidatedstatements of financial position. The contract or notional amounts of thoseinstruments reflect the extent of the Bank’s involvement in particular classesof financial instruments.

The Company’s exposure to credit loss in the event ofnon-performance by the other party to the financial instrument for commitmentsto extend credit and standby letters of credit is represented by thecontractual amount of those instruments. The Company uses the same creditpolicies in making commitments and conditional obligations as it does foron-balance-sheet instruments.

Unless noted otherwise, the Company requirescollateral to support financial instruments with credit risk.

Financialinstruments, the contract amounts of which represent credit risk, are asfollows:

| ** **                    | ** ** | **December 31,**   | ** ** |
|-------------------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                    | ** ** | **(in thousands)** | ** ** |
| Commitments to  extend credit |       | $                       | 85,199     |   | $ | 69,822 |   |
| Standby letters  of credit    |       | 2,151                   |       | 2,220 |   |
| Loans sold with  recourse     |       | 71                      |       | 74 |   |
|                          |       | $                       | 87,421     |   | $ | 72,116 |   |

 

Commitments to extend credit are agreements to lend toa customer as long as there is no violation of any condition established in thecontract. Commitments generally have fixed expiration dates or other 

43

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termination clauses andmay require payment of a fee. The Company evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained, ifit is deemed necessary by the Company upon extension of credit, is based onmanagement’s credit evaluation of the borrower. Collateral held generallyincludes residential and or commercial real estate.

Standby letters of creditare conditional commitments issued by the Bank to guarantee the performance ofa customer to a third party. The credit risk involved in issuing letters ofcredit is essentially the same as that involved in extending loan facilities tocustomers.

**NOTE N—COMMITMENTSAND CONTINGENCIES**

The Bank had optional commitments of $2,910,000 and$1,085,000 to sell mortgage loans to investors at December 31, 2006 and 2005respectively.

The Bank leases branch facilities and office space forperiods ranging up to ten years. These leases are classified as operatingleases and contain options to renew for additional periods. Rental expense wasapproximately $481,000, $420,000, and $359,000, for the years ended December 31,2006, 2005 and 2004, respectively.

Theminimum annual rental commitments of the Bank under all non-cancelable leaseswith terms of one year or more are as follows:

| **Year ending December 31,** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** |
|---------------------------------------------|------------|------------|------------|-------------------------|------------|
| 2007                                        |       |       | $          | 432                     |       |   |
| 2008                                        |       |       | 302        |                    |       |
| 2009                                        |       |       | 185        |                    |       |
| 2010                                        |       |       | 100        |                    |       |
| 2011                                        |       |       | 82         |                    |       |
| Thereafter                                  |       |       | 375        |                    |       |
|                                        |       |       | $          | 1,476                   |       |   |

 

The Company has agreements with certain key executivesthat provide severance pay benefits if there is a change in control of theCompany. The agreements will continue in effect until terminated or not renewedby the Company or key executives. Upon a change in control, the Company shallmake a lump-sum payment or continue to pay the key executives’ salaries per theagreements, and reimburse the executive for certain benefits for one year. Thecontingent liability under the agreements at December 31, 2006 wasapproximately $1,973,000.

From time to time, theCompany and its subsidiaries are parties to routine litigation that arises inthe normal course of business. In the opinion of management, the resolution ofthese lawsuits would not have a material adverse effect on the Company’sconsolidated financial position or results of operations.

**NOTE O—SIGNIFICANTCONCENTRATIONS OF CREDIT RISK**

The Bank is principallyengaged in originating and investing in one-to-four family residential realestate and commercial real estate loans in eastern Pennsylvania and New Jersey.The Bank offers both fixed and adjustable rates of interest on these loans thathave amortization terms ranging to 30 years. The loans are generallyoriginated or purchased on the basis of an 80% loan-to-value ratio, which hashistorically provided the Bank with more than adequate collateral coverage inthe event of default. Nevertheless, the Bank, as with any lending institution,is subject to the risk that residential real estate values in the primarylending area will deteriorate, thereby potentially impairing underlyingcollateral values. However, management believes that residential and commercialreal estate values are presently 

44

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stablein its primary lending area and that loan loss allowances have been providedfor in amounts commensurate with its current perception of the foregoing risksin the portfolio.

**NOTE P—FAIR VALUEOF FINANCIAL INSTRUMENTS**

SFAS No. 107, “Disclosures about Fair Value ofFinancial Instruments,” requires all entities to disclose the estimated fairvalue of their assets and liabilities considered to be financial instruments.For the Bank, as for most financial institutions, the majority of its assetsand liabilities are considered financial instruments as defined in SFAS No. 107.However, many such instruments lack an available trading market ascharacterized by a willing buyer and willing seller engaging in an exchangetransaction. Also, it is the Company’s general practice and intent to hold itsfinancial instruments to maturity or available for sale and to not engage intrading or significant sales activities. Therefore, the Company and the Bankuse significant estimations and present value calculations to prepare thisdisclosure.

Changes in the assumptions or methodologies used toestimate fair values may materially affect the estimated amounts. In addition,there may not be reasonable comparability between institutions due to the widerange of permitted assumptions and methodologies in the absence of activemarkets. This lack of uniformity gives rise to a high degree of subjectivity inestimating financial instrument fair values.

Fair values have been estimated using data whichmanagement considered the best available, as generally provided by estimationmethodologies deemed suitable for the pertinent category of financialinstrument. The estimation methodologies, resulting fair values and recordedcarrying amounts are as follows:

Fair value of loans and deposits with floatinginterest rates is generally presumed to approximate the recorded carryingamounts.

Fairvalue of financial instruments actively traded in a secondary market has beenestimated using quoted market prices.

| ** **                  | ** ** | **December 31,**   | ** ** |
|-----------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                  | ** ** | **Fair  value**         | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** | **Carrying  value** | ** ** |
| ** **                  | ** ** | **(in thousands)** | ** ** |
| Cash and cash  equivalents  |       |                    | $          | 12,364 |   |   | $ | 12,364 |   | $ | 3,821 |   | $ | 3,821 |   |
| Investment  securities      |       |                    | 35,205     |   |   | 35,201 |   | 35,108 |   | 35,091 |   |
| Mortgage-backed  securities |       |                    | 82,126     |   |   | 82,035 |   | 93,896 |   | 93,688 |   |
|                             |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefair value of financial instruments with stated maturities has been estimatedusing the present value of cash flows, discounted at rates approximatingcurrent market rates for similar assets and liabilities.

| ** **                         | ** ** | **December 31,**   | ** ** |
|------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **Fair  value**         | ** ** | **Carrying  value** | ** ** | **Fair  Value** | ** ** | **Carrying  value** | ** ** |
| ** **                         | ** ** | **(in thousands)** | ** ** |
| Assets                             |       |                    |       |   |   |   |   |   |   |
| Certificates of deposit            |       | $                       | 40         |   | $ | 40 |   | $ | 40 |   | $ | 40 |   |
| Liabilities                        |       |                    |       |   |   |   |   |   |   |
| Deposits with stated maturities    |       | 194,441                 |       | 195,551 |   | 147,561 |   | 149,673 |   |
| Borrowings with  stated maturities |       | 99,179                  |       | 101,701 |   | 118,352 |   | 121,260 |   |
|                                    |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

45

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The fair value of financial instrument liabilities with no statedmaturities is generally presumed to approximate the carrying amount (the amountpayable on demand).

| ** **                          | ** ** | **December 31,**   | ** ** |
|-------------------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                          | ** ** | **Fair  value**         | ** ** | **Carrying  Value** | ** ** | **Fair  value** | ** ** | **Carrying  value** | ** ** |
| ** **                          | ** ** | **(in thousands)** | ** ** |
| Deposits with no  stated maturities |       | $                       | 282,536    |   | $ | 282,536 |   | $ | 320,848 |   | $ | 320,848 |   |
|                                     |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

The fair value of the net loan portfolio has been estimated using thepresent value of cash flows, discounted at the approximate current marketrates, and giving consideration to estimated prepayment risk and credit lossfactors.

| ** ** | ** ** | **December 31,**   | ** ** |
|------------|------------|-------------------------|------------|
| ** ** | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** ** | ** ** | **Fair  value**         | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** | **Carrying  value** | ** ** |
| ** ** | ** ** | **(in thousands)** | ** ** |
| Net loans  |       | $                       | 480,660    |   | $ | 484,539 |   | $ | 486,214 |   | $ | 490,959 |   |
|            |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

The fair value of commitments to extend credit isestimated based on the amount of unamortized deferred loan commitment fees. Thefair value of letters of credit is based on the amount of unearned fees plusthe estimated cost to terminate the letters of credit. Fair values ofunrecognized financial instruments including commitments to extend credit andthe fair value of letters of credit are immaterial.

The Bank’s remainingassets and liabilities are not considered financial instruments. No disclosureof the relationship value of the Bank’s deposits is required by SFAS No. 107.

**NOTE Q—SERVICE FEES, CHARGES AND OTHER OPERATINGINCOME AND OTHER OPERATING EXPENSE**

| ** **                                                                         | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**                    | ** ** |
| **Service fees, charges and other operating income** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loan servicing fees                                                                |       | $                                          | 245        |   | $ | 363 |   | $ | 331 |   |
| Late charge income                                                                 |       | 94                                         |       | 83 |   | 90 |   |
| Deposit service charges                                                            |       | 1,100                                      |       | 1,061 |   | 1,092 |   |
| Debt card income                                                                   |       | 266                                        |       | 219 |   | 169 |   |
| Other income                                                                       |       | 386                                        |       | 343 |   | 393 |   |
|                                                                               |       | $                                          | 2,091      |   | $ | 2,069 |   | $ | 2,075 |   |
| Other operating expense                                                            |       |                                       |       |   |   |   |   |
| Insurance and surety bond                                                          |       | $                                          | 194        |   | $ | 193 |   | $ | 190 |   |
| Office supplies                                                                    |       | 193                                        |       | 221 |   | 220 |   |
| Loan expense                                                                       |       | 252                                        |       | 337 |   | 444 |   |
| MAC expense                                                                        |       | 309                                        |       | 328 |   | 315 |   |
| Postage                                                                            |       | 285                                        |       | 272 |   | 237 |   |
| Telephone                                                                          |       | 298                                        |       | 306 |   | 273 |   |
| Supervisory examination fees                                                       |       | 146                                        |       | 138 |   | 130 |   |
| Other expenses                                                                     |       | 639                                        |       | 698 |   | 738 |   |
|                                                                               |       | $                                          | 2,316      |   | $ | 2,493 |   | $ | 2,547 |   |

 

46

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**NOTE R—EARNINGS PERSHARE**

Thefollowing tables set forth the reconciliation of the numerators anddenominators of the basic and diluted earnings per share computations (dollarsin thousands, except per share data):

| ** **                                                                  | ** ** | **Year ended December 31, 2006** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **Income  (numerator)**                              | ** ** | **Weighted  average  shares  (denominator)** | ** ** | **Per share  Amount** | ** ** |
| Basic earnings per share                                                    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income available to  common stockholders                                    |       |                                                 | $          | 5,514 |   |   |   | 2,697,460 |   |   |   | $ | 2.04 |   |   |
| Effect of dilutive  securities                                              |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Stock compensation plans                                                    |       |                                                 | —     |   |   |   | 22,782 |   |   |   | (0.01 | ) |   |
| Diluted earnings per share                                                  |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income available to common stockholders plus effect  of dilutive securities |       |                                                 | $          | 5,514 |   |   |   | 2,720,242 |   |   |   | $ | 2.03 |   |   |

 

Therewere options to purchase 20,638 shares of common stock at a price of $34.14 pershare which were outstanding during 2006 that were not included in the computationof diluted earnings per share because the options’ exercise prices were greaterthan the average market price of the common shares.

| ** **                                                                  | ** ** | **Year ended December 31, 2005** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **Income  (numerator)**                              | ** ** | **Weighted  average  shares  (denominator)** | ** ** | **Per share  Amount** | ** ** |
| Basic earnings per share                                                    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income available to  common stockholders                                    |       |                                                 | $          | 6,153 |   |   |   | 2,736,945 |   |   |   | $ | 2.25 |   |   |
| Effect of dilutive  securities                                              |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Stock compensation plans                                                    |       |                                                 | —     |   |   |   | 61,226 |   |   |   | (0.05 | ) |   |
| Diluted earnings per  share                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income available to common stockholders plus effect  of dilutive securities |       |                                                 | $          | 6,153 |   |   |   | 2,798,171 |   |   |   | $ | 2.20 |   |   |

 

There were options to purchase 170,321 shares of common stock at arange of $28.48 to $34.14 per share which were outstanding during 2005 thatwere not included in the computation of diluted earnings per share because theoptions’ exercise prices were greater than the average market price of thecommon shares.

| ** **                                                                  | ** ** | **Year ended December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **Income  (numerator)**                              | ** ** | **Weighted  average  shares  (denominator)** | ** ** | **Per share  amount** | ** ** |
| Basic earnings per share                                                    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income available to  common stockholders                                    |       |                                                 | $          | 6,567 |   |   |   | 2,686,732 |   |   |   | $ | 2.44 |   |   |
| Effect of dilutive  securities                                              |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Stock compensation plans                                                    |       |                                                 | —     |   |   |   | 126,173 |   |   |   | (0.11 | ) |   |
| Diluted earnings per  share                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income available to common stockholders plus effect  of dilutive securities |       |                                                 | $          | 6,567 |   |   |   | 2,812,905 |   |   |   | $ | 2.33 |   |   |

 

There were options topurchase 30,029 shares of common stock at a price of $34.14 per share whichwere outstanding during 2004 that were not included in the computation ofdiluted earnings per share because the options’ exercise prices were greaterthan the average market price of the common shares.

47

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**NOTE S—SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATE(UNAUDITED)**

| ** **                                 | ** ** | **Three months ended**                                   | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Dec. 31,  2006**                                            | ** ** | **Sept. 30,  2006** | ** ** | **June 30,  2006** | ** ** | **March 31,  2006** | ** ** |
| ** **                                 | ** ** | **(in thousands, except per share data)** | ** ** |
| Total interest  income                     |       | $                                                                  | 9,678      |   |   | $ | 9,611 |   |   |   | $ | 9,627 |   |   |   | $ | 9,103 |   |   |
| Total interest  expense                    |       | 4,224                                                              |       |   | 4,093 |   |   |   | 3,948 |   |   |   | 3,596 |   |   |
| Net interest income                        |       | 5,454                                                              |       |   | 5,518 |   |   |   | 5,679 |   |   |   | 5,507 |   |   |
| Provision for  possible loan losses        |       | —                                                             |       |   | — |   |   |   | 60 |   |   |   | 90 |   |   |
| Net interest  income after provision       |       | 5,454                                                              |       |   | 5,518 |   |   |   | 5,619 |   |   |   | 5,417 |   |   |
| Other income                               |       | 691                                                                |       |   | 813 |   |   |   | 625 |   |   |   | 681 |   |   |
| Other expenses                             |       | 4,127                                                              |       |   | 4,370 |   |   |   | 4,301 |   |   |   | 4,370 |   |   |
| Income before income taxes                 |       | 2,018                                                              |       |   | 1,961 |   |   |   | 1,943 |   |   |   | 1,728 |   |   |
| Income taxes                               |       | 563                                                                |       |   | 549 |   |   |   | 551 |   |   |   | 473 |   |   |
| Net income                                 |       | $                                                                  | 1,455      |   |   | $ | 1,412 |   |   |   | $ | 1,392 |   |   |   | $ | 1,255 |   |   |
| Earnings per  share—basic             |       | $                                                                  | 0.54       |   |   | $ | 0.52 |   |   |   | $ | 0.52 |   |   |   | $ | 0.47 |   |   |
| Earnings per  share—assuming dilution |       | $                                                                  | 0.53       |   |   | $ | 0.52 |   |   |   | $ | 0.51 |   |   |   | $ | 0.46 |   |   |

 

| ** **                                 | ** ** | **Three months ended**                                   | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Dec. 31,  2005**                                            | ** ** | **Sept. 30,  2005** | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** |
| ** **                                 | ** ** | **(in thousands, except per share data)** | ** ** |
| Total interest  income                     |       | $                                                                  | 8,927      |   |   | $ | 8,570 |   |   |   | $ | 8,371 |   |   |   | $ | 8,097 |   |   |
| Total interest  expense                    |       | 3,281                                                              |       |   | 2,987 |   |   |   | 2,797 |   |   |   | 2,467 |   |   |
| Net interest income                        |       | 5,646                                                              |       |   | 5,583 |   |   |   | 5,574 |   |   |   | 5,630 |   |   |
| Provision for  possible loan losses        |       | 90                                                                 |       |   | 150 |   |   |   | 150 |   |   |   | 150 |   |   |
| Net interest income after provision        |       | 5,556                                                              |       |   | 5,433 |   |   |   | 5,424 |   |   |   | 5,480 |   |   |
| Other income                               |       | 647                                                                |       |   | 742 |   |   |   | 677 |   |   |   | 662 |   |   |
| Other expenses                             |       | 4,010                                                              |       |   | 4,084 |   |   |   | 3,943 |   |   |   | 4,131 |   |   |
| Income before income taxes                 |       | 2,193                                                              |       |   | 2,091 |   |   |   | 2,158 |   |   |   | 2,011 |   |   |
| Income tax expense                         |       | 666                                                                |       |   | 546 |   |   |   | 553 |   |   |   | 535 |   |   |
| Net income                                 |       | $                                                                  | 1,527      |   |   | $ | 1,545 |   |   |   | $ | 1,605 |   |   |   | $ | 1,476 |   |   |
| Earnings per  share—basic             |       | $                                                                  | 0.56       |   |   | $ | 0.57 |   |   |   | $ | 0.59 |   |   |   | $ | 0.54 |   |   |
| Earnings per  share—assuming dilution |       | $                                                                  | 0.55       |   |   | $ | 0.55 |   |   |   | $ | 0.57 |   |   |   | $ | 0.52 |   |   |

 

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**NOTE T—CONDENSEDFINANCIAL INFORMATION—PARENT COMPANY ONLY**

Condensedfinancial information for TF Financial Corporation (parent company only)follows:

**BALANCESHEET**

| ** **                                       | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| ASSETS                                           |       |                    |       |   |   |
| Cash                                             |       | $                       | 2,959      |   | $ | 3,452 |   |
| Certificates of  deposit—other institutions |       | 40                      |       | 40 |   |
| Investment in  Third Federal                     |       | 58,995                  |       | 55,611 |   |
| Investment in TF  Investments                    |       | 2,463                   |       | 2,392 |   |
| Investment in  Penns Trail Development           |       | 1,007                   |       | 991 |   |
| Investment  securities available for sale        |       | 203                     |       | — |   |
| Other assets                                     |       | 12                      |       | 240 |   |
| Total assets                                     |       | $                       | 65,679     |   | $ | 62,726 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY       |       |                    |       |   |   |
| Total liabilities                                |       | $                       | 40         |   | $ | 78 |   |
| Stockholders’  equity                       |       | 65,639                  |       | 62,648 |   |
| Total liabilities  and stockholders’ equity |       | $                       | 65,679     |   | $ | 62,726 |   |

 

**STATEMENTOF OPERATIONS**

| ** **                         | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                         | ** ** | **(in thousands)**                    | ** ** |
| INCOME                             |       |                                       |       |   |   |   |   |
| Equity in earnings of subsidiaries |       | $                                          | 6,448      |   | $ | 6,510 |   | $ | 6,906 |   |
| Interest and dividend income       |       | 54                                         |       | 72 |   | 74 |   |
| Total income                       |       | 6,502                                      |       | 6,582 |   | 6,980 |   |
| EXPENSES                           |       |                                       |       |   |   |   |   |
| Other                              |       | 988                                        |       | 429 |   | 413 |   |
| Total expenses                     |       | 988                                        |       | 429 |   | 413 |   |
| NET INCOME                         |       | $                                          | 5,514      |   | $ | 6,153 |   | $ | 6,567 |   |

 

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**STATEMENTOF CASH FLOWS**

| ** **                                                                                  | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                  | ** ** | **(in thousands)**                    | ** ** |
| Cash flows from  operating activities                                                       |       |                                       |       |   |   |   |   |
| Net income                                                                                  |       | $                                          | 5,514      |   | $ | 6,153 |   | $ | 6,567 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities |       |                                       |       |   |   |   |   |
| Stock compensation plans                                                                    |       | 747                                        |       | 15 |   | — |   |
| Equity in earnings of subsidiaries                                                          |       | (6,448                                     | )          | (6,510 | ) | (6,906 | ) |
| Net change in assets and liabilities                                                        |       | 199                                        |       | (89 | ) | 357 |   |
| Net cash provided by (used in) operating activities                                         |       | 12                                         |       | (431 | ) | 18 |   |
| Cash flows from  investing activities                                                       |       |                                       |       |   |   |   |   |
| Capital distribution from subsidiaries                                                      |       | 3,118                                      |       | 3,255 |   | 2,622 |   |
| (Purchase) and maturities of certificates of deposit  in other financial institutions, net  |       | (150                                       | )          | (2 | ) | 117 |   |
| Net cash provided by investing activities                                                   |       | 2,968                                      |       | 3,253 |   | 2,739 |   |
| Cash flows from  financing activities                                                       |       |                                       |       |   |   |   |   |
| Cash dividends paid to stockholders                                                         |       | (2,049                                     | )          | (1,971 | ) | (1,765 | ) |
| Treasury stock acquired                                                                     |       | (1,749                                     | )          | (2,830 | ) | (4,725 | ) |
| Exercise of stock options                                                                   |       | 325                                        |       | 801 |   | 3,410 |   |
| Net cash used in financing activities                                                       |       | (3,473                                     | )          | (4,000 | ) | (3,080 | ) |
| NET DECREASE IN CASH                                                                        |       | (493                                       | )          | (1,178 | ) | (323 | ) |
| Cash at beginning of year                                                                   |       | 3,452                                      |       | 4,630 |   | 4,953 |   |
| Cash at end of  year                                                                        |       | $                                          | 2,959      |   | $ | 3,452 |   | $ | 4,630 |   |
| Supplemental  disclosure of cash flow information                                           |       |                                       |       |   |   |   |   |
| Cash paid during  the year for income taxes                                                 |       | $                                          | —     |   | $ | — |   | $ | — |   |

 

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**BOARD OF DIRECTORSAND EXECUTIVE OFFICERS**

**TF FinancialCorporation**

**Board of Directors**

Robert N. DusekChairman of the Board

Carl F. Gregory

Dennis L. McCartney

George A. Olsen

John R. Stranford

Albert M. Tantala, Sr.

Kent C. Lufkin

**Executive Officers**

Kent C. LufkinPresident and Chief Executive Officer

Dennis R. StewartExecutive Vice President and Chief Financial Officer

Lorraine A. WolfCorporate Secretary

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