**Exhibit 13.0**

 

**CONTENTS**

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

 

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**CORPORATEPROFILE AND RELATED INFORMATION**

 

TFFinancial Corporation (the “Company”) is the parent company of Third FederalBank and its subsidiaries Third Delaware Corporation and Teragon FinancialCorporation (collectively, “Third Federal” or the “Bank”), TF InvestmentsCorporation, and Penns Trail Development Corporation. At December 31,2005, total assets were approximately $660.8 million. The Company wasformed as a Delaware corporation in March 1994 at the direction of theBank to acquire all of the capital stock that Third Federal issued upon itsconversion from the mutual to stock form of ownership (the “Conversion”) andconcurrent $52.9 million initial public offering effective July 13,1994. At December 31, 2005, total stockholders’ equity was approximately$62.6 million. The Company is a unitary savings and loan holding companywhich, under existing laws, generally is not restricted in the types ofbusiness activities in which it may engage, provided that Third Federal retainsa specified amount of its assets in housing-related investments. Third Federalis a federally chartered stock savings bank headquartered in Newtown,Pennsylvania, which was originally chartered in 1921 under the name “PolishAmerican Savings Building and Loan Association.” Deposits of Third Federal havebeen federally insured since 1935 and are currently insured up to the maximumamount allowable by the Federal Deposit Insurance Corporation (the “FDIC”).Third Federal is a community-oriented institution offering a variety of financialservices to meet the needs of the communities that it serves. As of December 31,2005 Third Federal operated branch offices in Bucks and Philadelphia counties,Pennsylvania and Mercer County, New Jersey. Third Federal attracts deposits(approximately $470.5 million at December 31, 2005) from the generalpublic and uses such deposits, together with borrowings mainly from the FederalHome Loan Bank of Pittsburgh (approximately $121.3 million at December 31,2005) 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.

 

**StockMarket Information**

 

Sinceits issuance in July 1994, the Company’s common stock has been traded onthe Nasdaq National Market. The daily stock quotation for the Company is listedin the Nasdaq National Market published in The Wall Street Journal, ThePhiladelphia Inquirer, and other leading newspapers under the trading symbol of“THRD.” The number of shareholders of record of common stock as of March 7,2006, was approximately 500. This does not reflect the number of persons orentities who held stock in nominee or “street” name through various brokeragefirms.

 

**DividendPolicy**

 

TheCompany’s ability to pay dividends to stockholders is dependent in part uponthe dividends it receives from Third Federal. Among other limitations, ThirdFederal may not declare or pay a cash dividend on any of its stock if theeffect thereof would cause Third Federal’s regulatory capital to be reducedbelow (1) the amount required for the liquidation account established inconnection with Third 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 prudentto do so. The Board of Directors will consider the payment of a dividend on aquarterly basis, after giving consideration to the level of profits for theprevious quarter and other relevant information.

 

**StockPrice and Dividend History**

 
| ** **               | ** ** | **Quoted market price** | ** ** | **Dividend paid** | ** ** |
|--------------------------|------------|-----------------------------------|------------|------------------------|------------|
| **Quarter ended**   | ** ** | **High**                          | ** ** | **Low**                | ** ** | **per share** | ** ** |
| 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 |   |
| December 31,  2004  |       | $                                 | 33.00      |                   | $          | 28.10 |   | $ | 0.17 |   |
| September 30,  2004 |       | $                                 | 29.61      |                   | $          | 26.52 |   | $ | 0.17 |   |
| June 30,  2004      |       | $                                 | 32.47      |                   | $          | 28.00 |   | $ | 0.17 |   |
| March 31,  2004     |       | $                                 | 34.22      |                   | $          | 31.00 |   | $ | 0.15 |   |

 

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

 
| **Financial Position**                                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|-----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Total assets                                               |       | $        | 660,839    |     | $          | 628,966  |       | $        | 606,752    |     | $          | 721,032 |   | $ | 711,204 |   |
| Loans receivable, net                                           |       | 490,959  |       | 442,195  |       | 404,649  |       | 370,092  |       | 377,635  |       |
| Mortgage-backed securities available for  sale, at fair value   |       | 83,511   |       | 103,610  |       | 106,774  |       | 115,243  |       | 99,763   |       |
| Mortgage-backed securities held to  maturity, at amortized cost |       | 10,177   |       | 14,900   |       | 23,630   |       | 54,592   |       | 93,367   |       |
| Investment securities available for sale,  at fair value        |       | 30,401   |       | 17,625   |       | 14,443   |       | 27,243   |       | 22,671   |       |
| Investment securities held to maturity, at amortized  cost      |       | 4,690    |       | 7,027    |       | 10,389   |       | 14,563   |       | 9,866    |       |
| Cash and cash equivalents(1)                                    |       | 3,821    |       | 7,900    |       | 8,241    |       | 100,580  |       | 69,139   |       |
| Deposits                                                        |       | 470,521  |       | 459,903  |       | 459,343  |       | 442,558  |       | 422,052  |       |
| Advances from the Federal Home Loan Bank  and other borrowings  |       | 121,260  |       | 102,747  |       | 86,853   |       | 207,359  |       | 222,359  |       |
| Retained earnings                                               |       | 61,610   |       | 57,428   |       | 52,626   |       | 59,978   |       | 56,370   |       |
| Total stockholders’ equity                                 |       | 62,648   |       | 61,155   |       | 55,480   |       | 62,840   |       | 57,975   |       |
| Book value per common share                                     |       | $        | 23.08      |     | $          | 22.30    |       | $        | 21.37      |     | $          | 25.31 |   | $ | 23.51 |   |
| Tangible book value per common share                            |       | $        | 21.46      |     | $          | 20.57    |       | $        | 19.56      |     | $          | 23.34 |   | $ | 21.44 |   |

 

**Ator for the year ended December 31,**

 
| **Summary of Operations**            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Interest  income                               |       | $        | 33,965     |     | $          | 31,221   |       | $        | 32,377     |     | $          | 40,455 |   | $ | 46,747 |   |
| Interest  expense                              |       | 11,532   |       | 8,866    |       | 15,252   |       | 22,660   |       | 26,908   |       |
| Net interest  income                           |       | 22,433   |       | 22,355   |       | 17,125   |       | 17,795   |       | 19,839   |       |
| Provision  for loan losses                     |       | 540      |       | 600      |       | 330      |       | 988      |       | 500      |       |
| Non-interest  income                           |       | 2,728    |       | 2,608    |       | 2,690    |       | 3,304    |       | 3,172    |       |
| Non-interest  expense                          |       | 16,168   |       | 15,329   |       | 28,703   |       | 13,414   |       | 14,708   |       |
| Net income  (loss)                             |       | $        | 6,153      |     | $          | 6,567    |       | $        | (5,834     | )        | $          | 5,092 |   | $ | 5,733 |   |
| Earnings  (loss) per common share—basic   |       | $        | 2.25       |     | $          | 2.44     |       | $        | (2.30      | )        | $          | 2.06 |   | $ | 2.32 |   |
| Earnings  (loss) per common share—diluted |       | $        | 2.20       |     | $          | 2.33     |       | $        | (2.30      | )        | $          | 1.91 |   | $ | 2.19 |   |

 

2

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| **Performance Ratios and Other Selected Data** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Return on  average assets                                               |       | 0.96     | %          | 1.06     | %          | n.m.     |       | 0.71     | %          | 0.82     | %          |
| Return on  average equity                                               |       | 10.16    | %          | 11.58    | %          | n.m.     |       | 8.47     | %          | 10.42    | %          |
| Average  equity to average assets                                       |       | 9.40     | %          | 9.16     | %          | 9.01     | %          | 8.34     | %          | 7.83     | %          |
| Average  interest rate spread                                           |       | 3.62     | %          | 3.79     | %          | 2.57     | %          | 2.44     | %          | 2.74     | %          |
| Non-performing  loans to total assets                                   |       | 0.24     | %          | 0.15     | %          | 0.38     | %          | 0.53     | %          | 0.53     | %          |
| Non-performing  loans to total loans                                    |       | 0.32     | %          | 0.22     | %          | 0.56     | %          | 1.03     | %          | 0.99     | %          |
| Allowance  for loan losses to non-performing loans                      |       | 166.31   | %          | 240.31   | %          | 92.51    | %          | 53.86    | %          | 52.22    | %          |
| Allowance  for loan losses to total loans                               |       | 0.54     | %          | 0.52     | %          | 0.52     | %          | 0.54     | %          | 0.52     | %          |
| Bank  regulatory capital                                                |       |     |       |     |       |     |       |     |       |     |       |
| Core                                                                    |       | 8.37     | %          | 8.13     | %          | 7.29     | %          | 6.85     | %          | 6.95     | %          |
| Tangible                                                                |       | 8.37     | %          | 8.13     | %          | 7.29     | %          | 6.85     | %          | 6.95     | %          |
| Risk based                                                              |       | 15.04    | %          | 15.67    | %          | 14.47    | %          | 15.25    | %          | 14.95    | %          |
| Dividend  payout ratio(2)                                               |       | 32.73    | %          | 28.33    | %          | n.m.     |       | 31.41    | %          | 26.48    | %          |

 

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n.m. = notmeaningful

 

(1)             Consists ofcash, cash due from banks, interest-bearing deposits with original maturitiesof less than three months, and federal funds sold.

 

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

 

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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.

 

TheCompany may from time to time make written or oral “forward-lookingstatements”, including statements contained in the Company’s filings with theSecurities and Exchange Commission, in its reports to stockholders and in othercommunications by the Company, which are made in good faith by the Companypursuant to the “Safe Harbor” Provisions of the Private Securities LitigationReform Act of 1995.

 

Theseforward-looking statements involve risks and uncertainties, such as statementsof the Company’s plans, objectives, expectations, estimates and intentions thatare subject to change based on various important factors (some of which arebeyond the Company’s control). The following factors, among others, could causethe Company’s financial performance to differ materially from the plans, objectives,expectations, estimates and intentions expressed in such forward-lookingstatements: the strength of the United States economy in general and thestrength of the local economies in which the Company conducts operations; theeffects of, and changes in, trade, monetary and fiscal policies and laws,including interest rate policies of the Board of Governors of the FederalReserve System, inflation, interest rate, market and monetary fluctuations; thetimely development of and acceptance of new products and services of theCompany and the perceived overall value of these products and services byusers, including the features, pricing and quality compared to competitors’products and services; the willingness of users to substitute competitors’products and services for the Company’s products and services; the success ofthe Company in gaining regulatory approval of its products and services, whenrequired; the impact of changes in financial services’ laws and regulations(including laws concerning taxes, banking, securities and insurance);technological changes, acquisitions; changes in consumer spending and savinghabits; and the success of the Company at managing the risks involved in theforegoing.

 

TheCompany cautions that the foregoing list of important factors is not exclusive.The Company does not undertake to update any forward-looking statement, whetherwritten or oral, that may be made from time to time by or on behalf of theCompany.

 

TheCompany’s income on a consolidated basis is derived substantially from itsinvestment in its subsidiary, Third Federal. The earnings of Third Federaldepend primarily on its net interest income. Net interest income is affected bythe interest income that Third Federal receives from its loans and investmentsand by the interest expense that Third Federal incurs on its deposits,borrowings and other sources of funds. In addition, the mix of Third Federal’sinterest-bearing assets and liabilities can have a significant effect on ThirdFederal’s net interest income; loans generally have higher yields thansecurities; retail deposits generally have lower interest rates than otherborrowings.

 

ThirdFederal also receives income from service charges and other fees andoccasionally from sales of investment securities and real estate owned. ThirdFederal incurs expenses in addition to interest expense in the form of salariesand benefits, deposit insurance premiums, property operations and maintenance,advertising and other related business expenses.

 

**CriticalAccounting Policies**

 

Certaincritical accounting policies of the Company require the use of significantjudgment and accounting estimates in the preparation of the consolidatedfinancial statements and related data of the Company. These accountingestimates require management to make assumptions about matters that are highlyuncertain at the time the accounting estimate is made.

 

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Managementbelieves that the most critical accounting policy requiring the use of asignificant amount of accounting estimates and judgment is the determination ofthe allowance for loan losses. Allowances are established based on pools ofsimilar loans, delinquencies, loss experience, economic conditions generallyand as they may affect individual borrowers, and other factors. Individualloans are evaluated based on cash flows or value of the underlying collateral,or both. All of these evaluation factors are subject to a high degree ofuncertainty. If the financial condition and collateral values of a significantamount of debtors should deteriorate more than the Company has estimated,present allowances for loan losses may be insufficient and additionalprovisions for loan losses may be required. In addition, a single loan loss ofa substantial amount may significantly reduce the allowance. The allowance forloan losses was $2,641,000 at December 31, 2005.

 

**FinancialCondition and Changes in Financial Condition**

 

**Assets. **The Company’stotal assets at December 31, 2005 were $660.8 million, an increase of$31.9 million during the year. This increase in total assets isessentially due to a $48.8 million increase in loans receivable, funded inpart by a $14.4 million reduction in investment and mortgage-backedsecurities, in part by an $18.5 million increase in advances from theFederal Home Loan Bank (“FHLB”), and in part by a $10.6 million increasein deposits.

 

TheCompany’s loans receivable at December 31, 2005 were $491.0 million,a $48.8 million or 11.0% increase since December 31, 2004. During 2005there were $96.6 million of principal payments of existing loans in theloans receivable portfolio; however, offsetting this reduction was theorigination of $147.6 million in predominately commercial real estateloans and single-family residential first and second mortgage loans.

 

Mortgage-backedsecurities available for sale decreased by $20.1 million during 2005 dueto $27.0 million in repayments throughout 2005 of the underlying mortgagescomprising such securities, partially offset by the purchases of$9.0 million of such securities. The remaining net change in the portfoliowas caused by $2.1 million amortization of purchase premiums and fairvalue adjustments. Mortgage-backed securities held to maturity decreased by$4.7 million during 2005 due to prepayment of the underlying mortgagescomprising the securities.

 

Investmentsecurities available for sale increased by $12.8 million during the year.The Company purchased $13.2 million of such securities, mainlybank-qualified municipal bonds, during 2005. The remaining net change in theportfolio was caused by $0.4 million amortization of purchase premiums andfair value adjustments.

 

TheCompany’s cash and cash equivalents were $3.8 million at December 31,2005. It is the Company’s current intent to keep cash and cash equivalents at aminimal level and use its line of credit at the FHLB to fund its day-to-daycash needs, if necessary.

 

**Liabilities. **The Company’stotal liabilities were $598.2 million at December 31, 2005, anincrease of $30.4 million during 2005. Total deposits increased by$10.6 million, and certificates of deposit were 31.8% of total deposits atyear end 2005. Advances from the FHLB increased by $18.5 million. It isthe current intent of the Company to fund a portion of its interest-bearingassets, not funded by deposits, with longer term advances from the FHLB, andfund its day-to-day cash needs and shorter term interest-bearing assets nototherwise funded with deposits using draws on its line of credit with the FHLB.Thus, during 2005 advances from the FHLB due in four years and beyond increasedslightly to $48.9 million even though $16.3 million of advances at December 31,2004 moved from a four year maturity horizon to a three year or less maturityhorizon at December 31, 2005. In addition, at December 31, 2005 theBank’s line of credit at the FHLB was $30 million of which$16.2 million was drawn.

 

5

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**Stockholders’equity.****  **Totalconsolidated stockholders’ equity increased by $1.5 million to$62.6 million at December 31, 2005. The increase is largely theresult of $6.2 million in net income less $2.0 million in cashdividends paid to the Company’s common stockholders and a $1.3 million othercomprehensive loss, mainly due to the fair value adjustment on available forsale securities. In addition there was a $0.8 million increase instockholders’ equity attributable to the exercise of stock options for 49,975shares. The Company also purchased 95,172 shares of common stock, held intreasury, reducing stockholders’ equity by $2.8 million. Finally, therewas a $0.5 million increase due to the allocation of 17,025 shares toparticipants in the Company’s employee stock ownership plan.

 

**Average Balance Sheet.****  **The following table sets forth information(dollars in thousands) relating to the Company’s average balance sheet andreflects the average yield on assets and average cost of liabilities for theperiods indicated. The yields and costs are computed by dividing income orexpense by the average balance of interest-earning assets or interest-bearingliabilities, respectively for the periods indicated.

 
| ** **                                                                         | ** ** | **2005**             | ** ** | **2004**     | ** ** | **2003**              | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------|------------|--------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **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)                                                               |       | $                    | 462,389    |         | $          | 27,570                |       | 5.96 | % | $ | 423,482 |   | $ | 24,359 |   | 5.75 | % | $ | 378,414 |   | $ | 23,372 |   | 6.18 | % |
| Mortgage-backed  securities                                                        |       | 108,029              |       | 4,875        |       | 4.51                  | %          | 128,759 |   | 5,696 |   | 4.42 | % | 154,721 |   | 6,725 |   | 4.35 | % |
| Investment  securities(2)                                                          |       | 37,357               |       | 1,774        |       | 4.75                  | %          | 30,969 |   | 1,377 |   | 4.45 | % | 62,747 |   | 1,966 |   | 3.13 | % |
| Other  interest-earning assets(3)                                                  |       | 1,910                |       | 59           |       | 3.09                  | %          | 1,127 |   | 14 |   | 1.24 | % | 45,590 |   | 474 |   | 1.04 | % |
| Total  interest-earning assets                                                     |       | 609,685              |       | 34,278       |       | 5.62                  | %          | 584,337 |   | 31,446 |   | 5.38 | % | 641,472 |   | 32,537 |   | 5.07 | % |
| Non  interest-earning assets                                                       |       | 34,215               |       |         |       |                  |       | 34,645 |   |   |   |   |   | 33,839 |   |   |   |   |   |
| Total assets                                                                       |       | $                    | 643,900    |         |       |                  |       |   | $ | 618,982 |   |   |   |   |   | $ | 675,311 |   |   |   |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                     |       |                 |       |         |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing  liabilities:**                                                 |       |                 |       |         |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                                           |       | 465,521              |       | 7,599        |       | 1.63                  | %          | 465,097 |   | 5,925 |   | 1.27 | % | 449,925 |   | 7,044 |   | 1.57 | % |
| Advances  from the FHLB and borrowings                                             |       | 111,628              |       | 3,933        |       | 3.52                  | %          | 91,660 |   | 2,941 |   | 3.21 | % | 160,325 |   | 8,208 |   | 5.12 | % |
| Total  interest-bearing liabilities                                                |       | 577,149              |       | 11,532       |       | 2.00                  | %          | 556,757 |   | 8,866 |   | 1.59 | % | 610,250 |   | 15,252 |   | 2.50 | % |
| Non  interest-bearing liabilities                                                  |       | 6,199                |       |         |       |                  |       | 5,536 |   |   |   |   |   | 4,195 |   |   |   |   |   |
| Total  liabilities                                                                 |       | 583,348              |       |         |       |                  |       | 562,293 |   |   |   |   |   | 614,445 |   |   |   |   |   |
| Stockholders’  equity                                                         |       | 60,552               |       |         |       |                  |       | 56,689 |   |   |   |   |   | 60,866 |   |   |   |   |   |
| Total  liabilities and stockholders’ equity                                   |       | $                    | 643,900    |         |       |                  |       |   | $ | 618,982 |   |   |   |   |   | $ | 675,311 |   |   |   |   |   |
| Net interest  income                                                               |       |                 |       | $            | 22,746     |                  |       |   |   |   | $ | 22,580 |   |   |   |   |   | $ | 17,285 |   |   |   |
| Interest  rate spread(4)                                                           |       |                 |       |         |       | 3.62                  | %          |   |   |   |   | 3.79 | % |   |   |   |   | 2.57 | % |
| Net yield on  interest-earning assets(5)                                           |       |                 |       |         |       | 3.73                  | %          |   |   |   |   | 3.86 | % |   |   |   |   | 2.69 | % |
| Ratio of  average interest-earning assets to average interest- bearing liabilities |       |                 |       |         |       | 106                   | %          |   |   |   |   | 105 | % |   |   |   |   | 105 | % |

 

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(1)             Nonaccrualloans have been included in the appropriate average loan balance category, butinterest on nonaccrual loans has not been included for purposes of determininginterest income.

 

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(2)             Taxequivalent adjustments to interest on investment securities were $313,000,$225,000 and $160,000 for the years ended December 31, 2005, 2004 and2003, respectively. Tax equivalent interest income is based upon a marginaleffective tax rate of 34%.

 

(3)             Includesinterest-bearing deposits in other banks.

 

(4)             Interestrate spread represents the difference between the average yield oninterest-earning assets and the average cost of interest-bearing liabilities.

 

(5)             Netyield on interest-earning assets represents net interest income as a percentageof average interest-earning assets.

 

**Rate/Volume Analysis.****  **The following table presents, for theperiods 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.

 
| ** **                             | ** ** | **2005 vs 2004  Increase (decrease) due to** | ** ** | **2004 vs 2003  Increase (decrease) due to** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                             | ** ** | **Volume**                                                            | ** ** | **Rate**                                                              | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| **Interest  income:**                  |       |                                                                  |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Loans  receivable, net                 |       | $                                                                     | 2,297      |                                                                  | $          | 914 |   | $ | 3,211 |   | $ | 2,662 |   | $ | (1,675 | ) | $ | 987 |   |
| Mortgage-backed  securities            |       | (933                                                                  | )          | 112                                                                   |       | (821 | ) | (1,147 | ) | 118 |   | (1,029 | ) |
| Investment  securities                 |       | 299                                                                   |       | 98                                                                    |       | 397 |   | (1,224 | ) | 635 |   | (589 | ) |
| Other  interest-earning assets         |       | 14                                                                    |       | 31                                                                    |       | 45 |   | (537 | ) | 77 |   | (460 | ) |
| Total  interest-earning assets         |       | 1,677                                                                 |       | 1,155                                                                 |       | 2,832 |   | (246 | ) | (845 | ) | (1,091 | ) |
| **Interest  expense:**                 |       |                                                                  |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Deposits                               |       | 5                                                                     |       | 1,669                                                                 |       | 1,674 |   | 231 |   | (1,350 | ) | (1,119 | ) |
| Advances  from the FHLB and borrowings |       | 684                                                                   |       | 308                                                                   |       | 992 |   | (2,814 | ) | (2,453 | ) | (5,267 | ) |
| Total  interest-bearing liabilities    |       | 689                                                                   |       | 1,977                                                                 |       | 2,666 |   | (2,583 | ) | (3,803 | ) | (6,386 | ) |
| Net change  in net interest income     |       | $                                                                     | 988        |                                                                  | $          | (822 | ) | $ | 166 |   | $ | 2,337 |   | $ | 2,958 |   | $ | 5,295 |   |

 

**Comparisonof Years Ended December 31, 2005 and December 31, 2004**

 

**Net Income.****  **Net income was $6.2 million for theyear ended December 31, 2005 compared with net income of $6.6 millionfor the year ended December 31, 2004. The decrease in net income of$0.4 million when comparing the year 2005 with 2004 is largelyattributable a $0.8 million increase in non-interest expense, which was notentirely offset by a $0.1 million increase in net interest income and a $0.1million increase in non-interest income.

 

**Total Interest Income.****  **For the year ended December 31,2005, total interest income increased to $34.0 million compared to$31.2 million for the year ended December 31, 2004. The$2.8 million increase in interest income was mainly the result of the$38.9 increase in the average balances of loans receivable.

 

Inaddition, beginning in June 2004, the Federal Open Market Committee raisedthe federal funds rate thirteen times by a total of 325 basis points throughyear end 2005. During 2005, the federal funds rate, and thus the prime rate,rose by 200 basis points while longer term interest rates relevant to theCompany’s loan origination activities, as measured by 5 year and 10 year U STreasury securities, rose by approximately 65 to 15 basis points, respectively.The higher prime rate had a positive effect on the Bank’s interest income becauseof the positive effect on the Bank’s adjustable rate and prime-based loans. At December 31,2005 the Company had $65.2 million in floating rate, prime-based construction,home equity, and other loans. In addition, while longer term rates were higher,permitting the Company to raise

 

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its prices on fixed rate loans, these rates were still relatively lowhistorically, and thus new loan production at the Company exceededexpectations.

 

**Total Interest Expense.****  **Total interest expense increased to$11.5 million from $8.9 million for the year ended December 31,2005 compared to 2004. During 2005 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 the extremecompetitive pricing pressures throughout the Company’s deposit markets. As aresult, the average interest rate paid on deposits rose by 36 basis pointsduring 2005 compared with 2004, and produced a $1.7 million increase ininterest expense.

 

Interestpaid on advances from the FHLB increased by $1.0 million during 2005compared with 2004, largely because of the need to borrow from the FHLB inorder to fund the Company’s lending activities from sources other than depositgrowth.

 

**Allowance for LoanLosses.****  **Theallowance for loan losses was approximately $2.6 million at December 31,2005 and $2.3 million at December 31, 2004. The provision for loanlosses was $540,000 during 2005 compared with $600,000 during 2004. Netrecoveries of previously 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-Interest Income.****  **Total non-interest income was$2.7 million during 2005 compared with $2.6 million during 2004. Theincrease is due to an increase in gain on sales of loans.

 

**Non-Interest Expense.****  **Total non-interest expense increased by$0.8 million during 2005 compared to 2004. Employee compensation andbenefits increased by $480,000 during 2005 compared to 2004. Most of thisincrease was due to normal salary increases and increased staff, and higherincentive related compensation; $124,000 of the increase was due to an increasein pension 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.****  **The Company’s effective tax rate was27.2% during 2005 compared to 27.3% during 2004. 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.

 

**Comparisonof Years Ended December 31, 2004 and December 31, 2003**

 

**Net Income.****  **Net income was $6.6 million for theyear ended December 31, 2004. Net loss was $5.8 million for the yearended December 31, 2003. The increase in net income of $12.4 millionwhen comparing the year 2004 with 2003 is largely attributable to the debtrefinancing transaction described in the next paragraph, which produced a netloss for 2003 of $9.3 million after considering the income tax benefitassociated with the transaction.

 

Duringthe third quarter of 2003, the Company completed a series of transactions (the“debt refinancing”) that resulted in the repayment and refinancing of$187.4 million of Federal Home Loan Bank borrowings which carried aweighted average interest rate of 5.46%. $80 million of these borrowingswere refinanced at 3.23%; the remaining $107.4 million was repaid. Aprepayment fee of $13.8 million was assessed by the Federal Home LoanBank. A portion of the funds used to repay these borrowings came from the saleof $70.2 million of investment securities available for sale and$9.5 million of mortgage-backed securities available for sale, which hadbeen yielding a combined 1.93%. The loss on the sale of

 

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these securities was $0.4 million. Management believed that it wasin the best interest of the Company’s shareholders and the Bank’s employees andcustomers to replace these high-cost borrowings in order to improve the Company’sfuture net interest income and thus its overall financial performance.

 

Pre-taxincome was $9.0 million for 2004. After adjusting for the$14.2 million pre-tax cost of the debt refinancing, pre-tax income was$5.0 million for 2003. This $4.0 million increase in adjusted pre-taxincome for 2003 compared to pre-tax income for 2004 is mainly attributable to a$5.2 million increase in net interest income, less a $0.3 millionincrease in provisions for loan losses and a $0.4 million increase inoperating expenses, as described more fully below.

 

**Total Interest Income.****  **For the year ended December 31,2004, total interest income decreased to $31.2 million compared to$32.4 million for the year ended December 31, 2003. The$1.2 million decrease in interest income was mainly the result of thedecrease in the average balances of mortgage-backed securities and otherinterest-earning assets during 2004 compared with 2003, largely due to theeffect of the debt refinancing, and also due to the high rate ofmortgage-backed security repayments that occurred in 2003 because ofnear-record low mortgage interest rates that existed throughout much of 2003.Offsetting these net decreases in interest income was the positive effect of a$45.1 million increase in the average balance of loans receivable during2004 when compared to 2003, although the continued high level of loan prepaymentsand refinancing caused the average rate on loans receivable to decrease by 43basis points during 2004 when compared to 2003.

 

**Total Interest Expense.****  **Total interest expense decreased to$8.9 million from $15.3 million for the year ended December 31,2004 compared to 2003. $1.4 million of this decrease is primarily theresult of low market interest rates during 2003 and, consequently, the Companyhad lowered the interest rates paid on most of its deposit products in order tokeep them in line with short-term market interest rates. However, by the end of2004 the Company had begun to raise the interest rates on its deposit productsto maintain competitive pricing.

 

Interestpaid on advances from the FHLB decreased by $5.3 million during 2004compared with 2003, largely because of the debt refinancing transaction.

 

**Allowance for LoanLosses.****  **Theallowance for loan losses was approximately $2.3 million at December 31,2004 and $2.1 million at December 31, 2003. The provision for loanlosses was $600,000 during 2004 compared with $330,000 during 2003. Charge-offswere $404,000 during 2004 compared to $266,000 during 2003. While managementmaintains Third Federal’s allowance for losses at a level which it considers tobe adequate to provide for probable losses, there can be no assurance thatfurther additions will not be made to the allowance and that such losses willnot exceed the estimated amounts.

 

**Non-Interest Income.****  **Total non-interest income was$2.6 million during 2004 compared with $2.7 million during 2003.Service fees and other operating income increased by $0.2 million largelydue to the introduction of new deposit account services. Gains on sales of realestate and securities were $0 during 2004 compared to $0.3 million during2003.

 

**Non-Interest Expense.****  **Total non-interest expense, excluding the$13.8 million debt prepayment fee paid during 2003, increased by$0.4 million during 2004 compared to 2003. Employee compensation andbenefits increased by $583,000 during 2004 compared to 2003. Approximately$252,000 of this increase was due to normal salary increases and increasedstaff, and $271,000 of the increase was due to an increase in incentivecompensation expenses. Advertising expense increased by $104,000 due to anincrease in the Bank’s marketing efforts, and an expansion of the media used,to advertise its image, products, and services. During 2004 the Companyincurred approximately $40,000 of expense due to the commencement ofimplementation of compliance with the Sarbanes-Oxley Act of 2002.

 

**Income Tax Expense.****  **The Company’s effective tax rate was27.3% (tax expense) during 2004 compared to 36.7% (tax benefit) during 2003.The high effective tax (benefit) rate during 2003 is due to the

 

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pre-tax loss for the year produced by the debt refinancing, whichpre-tax loss produces a tax benefit at a 34% rate, further increased by theelimination of net non-taxable income from the pre-tax loss.

 

**Liquidityand Capital Resources**

 

**Liquidity.****  **The Company’s liquidity is a measure ofits ability to fund loans, pay withdrawals of deposits and other cash outflows,and pay dividends in an efficient, cost-effective manner. The Company’s primarysources of funds are cash on hand and dividends from its wholly-owned Bank. TheBank’s primary sources of funds are deposits, borrowings, and scheduledamortization and prepayment of loan and mortgage-backed security principal.

 

TheBank endeavors to fund its operations internally but has, when deemed prudent,borrowed funds from the Federal Home Loan Bank. As of December 31, 2005,such borrowed funds totaled $121.3 million. The amount of these borrowingsthat will mature during the twelve months ending December 31, 2006 is$32.7 million. At December 31, 2005 the Bank had a $30 millionline of credit, $13.8 million of which was unused, and up to approximately$300 million of additional collateral-based borrowing capacity at theFederal Home Loan Bank.

 

Theamount of certificate accounts that are scheduled to mature during the twelvemonths ending December 31, 2006, is approximately $92.4 million. Tothe extent that these deposits do not remain at the Bank upon maturity, theBank believes that it can replace these funds with deposits, excess liquidity,advances from the FHLB or other borrowings. It has been the Bank’s experiencethat substantial portions of such maturing deposits remain at the Bank.

 

AtDecember 31, 2005, the Bank had outstanding commitments to originate loansor fund unused lines of credit of $72.1 million. The loan commitments willbe funded during the twelve months ending December 31, 2006. The unusedlines of credit can be funded at any time. Funds required to fill thesecommitments will be derived primarily from current excess liquidity, depositinflows or loan and security repayments. At December 31, 2005, the Bankhad $1.1 million outstanding commitments to sell loans.

 

TheCompany also has obligations under lease agreements. Payments required undersuch lease agreements will be approximately $401,000 during the year ending December 31,2006.

 

Thefollowing table combines the Company’s contractual obligations and commitmentsto make future payments as of December 31, 2005.

 
| ** **                     | ** ** | **Payments due by period** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3  years** | ** ** | **4-5  years** | ** ** | **After  5 years** | ** ** |
| ** **                     | ** ** | **(in thousands)**                   | ** ** |
| Contractual  obligations:      |       |                                      |       |   |   |   |   |   |   |   |   |
| FHLB  advances                 |       | $                                         | 121,260    |   | $ | 32,672 |   | $ | 39,688 |   | $ | 43,105 |   | $ | 5,795 |   |
| Time  deposits                 |       | 149,673                                   |       | 92,402 |   | 41,248 |   | 15,409 |   | 614 |   |
| Operating  leases              |       | 1,724                                     |       | 401 |   | 599 |   | 279 |   | 445 |   |
| Total  contractual obligations |       | $                                         | 272,657    |   | $ | 125,475 |   | $ | 81,535 |   | $ | 58,793 |   | $ | 6,854 |   |

 
| ** **                | ** ** | **Amount of commitment expirations by period** | ** ** |
|---------------------------|------------|-------------------------------------------------------------------------|------------|
| Commitments:              |       |                                                                    |       |   |   |   |   |   |   |   |   |
| Extensions  of credit     |       | $                                                                       | 69,822     |   | $ | 22,272 |   | $ | 8,338 |   | $ | 499 |   | $ | 38,713 |   |
| Letters of  credit        |       | 2,220                                                                   |       | 2,220 |   | — |   | — |   | — |   |
| Loans sold  with recourse |       | 74                                                                      |       | — |   | — |   | — |   | 74 |   |
| Total  commitments        |       | $                                                                       | 72,116     |   | $ | 24,492 |   | $ | 8,338 |   | $ | 499 |   | $ | 38,787 |   |

 

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**Capital Resources.****  **Under current regulations, the Bank musthave core capital equal to 4% of adjusted total assets and risk-based capitalequal to 8% of risk-weighted assets, of which 1.5% must be tangible capital,excluding goodwill and certain other intangible assets. On December 31,2005, the Bank met its three regulatory capital requirements.

 

Managementbelieves that under current regulations, the Bank will continue to meet itsminimum capital requirements in the foreseeable future. However, events beyondthe control of the Bank, such as increased interest rates or a downturn in theeconomy in areas in which the Bank operates, could adversely affect futureearnings and as a result, the ability of the Bank to meet its future minimumcapital requirements.

 

**Impactof Inflation and Changing Prices**

 

Theconsolidated financial statements and related data have been prepared inaccordance with accounting principles generally accepted in the United Statesof America which require the measurement of financial position and operatingresults in terms of historical dollars, without consideration for changes inthe relative purchasing power of money over time caused by inflation. Unlikeindustrial companies, nearly all of the assets and liabilities of a financialinstitution are monetary in nature. As a result, interest rates have a moresignificant impact on a financial institution’s performance than general levelsof inflation. Interest rates do not necessarily move in the same direction orin the same magnitude as the price of goods and services, since such goods andservices are affected by inflation. In the current interest rate environment,liquidity and the maturity structure of the Bank’s assets and liabilities arecritical to the maintenance of acceptable performance levels.

 

**Quantitativeand Qualitative Disclosures About Market Risk**

 

**InterestRate Risk Management**

 

TheBank has established an Asset/Liability Management Committee (ALCO) for thepurpose of monitoring and managing market risk, which is defined as the risk ofloss of net interest income or economic value arising from changes in marketinterest rates and prices.

 

Thetype of market risk which most affects the Company’s financial instruments isinterest rate risk, which is best quantified by simulating the hypotheticalchange in net interest income that would occur under specific changes ininterest rates. Substantially all of the Bank’s interest-bearing assets andliabilities are exposed to interest rate risk. Loss of economic value ismeasured using reports generated by the Office of Thrift Supervision (“OTS”),using input from the Bank, wherein the current net portfolio value of the Bank’sinterest-sensitive assets and liabilities is measured at different hypotheticalinterest rate levels centered on the current term structure of interest rates. Gapreports prepared by the Bank are used to measure the net amount of assets andliabilities repricing, pre-paying and maturing during future periods. ALCOevaluates the simulation results, the OTS model results and the “gap” reportsand will make adjustments to the Bank’s planned activities if in its view thereis a need to do so.

 

TheBank’s exposure to interest rate risk results from, among other things, thedifference in maturities in interest-earning assets and interest-bearingliabilities. Since the Bank’s assets currently have a longer maturity than itsliabilities, the Bank’s earnings could be negatively impacted during a periodof rising interest rates. Alternatively, in periods of falling interest ratesthe Bank’s mortgage loans will prepay at an increasing rate and caused the Bankto reinvest these cash flows in periods of low interest rates, also negativelyaffecting the Bank’s earnings. The relationship between the interest ratesensitivity of the Bank’s assets and liabilities is continually monitored bymanagement.

 

Fundamentally,the Bank prices and originates loans, and prices and originates its depositsincluding CD’s at market interest rates. Volumes of such loans and deposits atvarious maturity and repricing

 

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horizons will vary according to customer preferences as influenced bythe term structure of market interest rates. The Bank utilizes its investmentand mortgage-backed security portfolios available for sale to generateadditional interest income, to managing its liquidity, and to manage itsinterest rate risk. These securities are readily marketable and provide theBank with a cash flow stream to fund asset growth or liability maturities. Inaddition, if management determines that it is advisable to do so, the Bank canlengthen or shorten the average maturity of all interest-bearing assets throughthe selection of fixed rate or variable rate securities, respectively.

 

TheBank utilizes advances from the FHLB in managing its interest rate risk and asa tool to augment deposits in funding asset growth. The Bank may utilize thesefunding sources to better match its fixed rate interest-bearing assets withlonger maturities or repricing characteristics.

 

Thenature of the Bank’s current operations is such that it is not subject toforeign currency exchange or commodity price risk. Additionally, neither theCompany nor the Bank owns any trading assets. At December 31, 2005, theBank did not have any hedging transactions in place such as interest rateswaps, caps, or floors, although these derivatives are often used by banks tomanage interest rate risk.

 

TheCompany’s bank subsidiary is a savings bank regulated by the OTS and haspolicies or procedures in place for measuring interest rate risk. Thesepolicies and procedures stipulate acceptable levels of interest rate risk. Aspart of its interest rate risk management, the Bank uses the Interest Rate RiskExposure Report, which is generated quarterly by the OTS. This report forecaststhe interest rate sensitivity of net portfolio value (“NPV”) under alternativeinterest rate environments. The NPV is defined as the net present value of theBank’s existing assets, liabilities and off-balance sheet instruments. Thecalculated estimates of change in NPV at December 31, 2005 are as follows:

 
| **Change in Interest Rates** | ** ** | **NPV Amount**     | ** ** | **% Change** | ** ** | **Policy Limitation** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-------------------|------------|----------------------------|------------|
| ** **                                  | ** ** | **(In Thousands)** | ** ** | ** **        | ** ** | ** **                 | ** ** |
| +300 Basis  Points                          |       | $                       | 52,947     |              | -37        | %                          | +/- 50     | % |
| +200 Basis  Points                          |       | $                       | 63,731     |              | -24        | %                          | +/- 35     | % |
| +100 Basis  Points                          |       | $                       | 73,974     |              | -12        | %                          | +/- 25     | % |
| Flat Rates                                  |       | $                       | 84,194     |              | 0          | %                          | 0          | % |
| -100 Basis  Points                          |       | $                       | 91,406     |              | +9         | %                          | +/- 20     | % |
| -200 Basis  Points                          |       | $                       | 91,564     |              | +9         | %                          | +/- 30     | % |

 

Managementbelieves that the assumptions utilized by OTS in evaluating the vulnerabilityof the Company’s net portfolio value to changes in interest rates arereasonable; however, the interest rate sensitivity of the Bank’s assets andliabilities as well as the estimated effect of changes in interest rates on NPVcould vary substantially if different assumptions are used or actual experiencediffers from the experience on which the assumptions were based. In the eventthe Bank should measure an excessive decline in its NPV as the result of animmediate and sustained change in interest rate, it has a number of optionswhich it could utilize to remedy that situation. The Bank could restructure itsinvestment portfolio through sale or purchase of securities with more favorablerepricing attributes. It could also emphasize loan products with appropriatematurities or repricing attributes, or it could attract deposits or obtainborrowings with desired maturities.

 

Inorder to measure interest rate risk internally, the Company uses computerprograms which enable it to simulate the changes that will occur to the Bank’snet interest income (“NII”) over several interest rate scenarios which aredeveloped by “shocking” market interest rates (i.e. moving them immediately andpermanently) up and down in 100 basis point increments from their currentlevels, and by “ramping” interest rates, i.e. spreading evenly the change overthe horizon period. In addition, loan production is adjusted downward in therates up scenarios.

 

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Inaddition to the level of interest rates, the most critical assumption regardingthe estimated amount of the Bank’s NII is the expected prepayment speed of theBank’s 1-4 family residential loans, and related mortgage-backed securities,the book value of which comprises approximately 64% of the Company’s totalassets. For this prepayment speed assumption the Company uses its ownexperience and median expected prepayment speeds which are obtained from areliable third party source. The Company also incorporates into its simulationsthe effects of the interest rate caps and interest rate floors that are part ofthe majority of the Bank’s variable rate loans. Finally, the Company makescertain assumptions regarding the timing and magnitude of interest rate changeson its non-CD deposits.

 

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 otherassumptions about future activities that may or may not be realized. In orderto quantify the Company’s NII exposure, the Company focused on the simulationof net interest income over 24 months in three scenarios: ramped up 200basis points, shocked up 200 basis points, and shocked down 100 basis points.The results of these simulations are as follows:

 
| **At December 31, 2005** | ** ** | **Net interest income volatility versus level interest rates** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| **Year ending**                    | ** ** | **Ramp UP 200 bp**                                                                 | ** ** | **Shocked UP 200 bp** | ** ** | **Shocked DOWN 100 bp** | ** ** |
| 2006                                    |       | -0.39                                                                                             | %          | -5.24 | % | -3.64 | % |
| 2007                                    |       | -3.55                                                                                             | %          | -3.42 | % | -7.69 | % |

 
| **At December 31, 2004** | ** ** | **Net interest income volatility versus level interest rates** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| **Year ending**                    | ** ** | **Ramp UP 200 bp**                                                                 | ** ** | **Shocked UP 200 bp** | ** ** | **Shocked DOWN 100 bp** | ** ** |
| 2005                                    |       | +0.39                                                                                             | %          | -4.20 | % | -6.38 | % |
| 2006                                    |       | -3.61                                                                                             | %          | -3.89 | % | -12.87 | % |

 

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, 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 |   |
| Ramped up  200 bp                       |       | $                                                                         | 2,161      |   | $ | 11,894 |   | $ | 15,675 |   | $ | 8,188 |   |

 
| ** **                              | ** ** | **GAP: Net rate sensitive assets (liabilities)** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------------------|------------|
| **At December 31, 2004** | ** ** | **2005**                                                                  | ** ** | **2006** | ** ** | **2007** | ** ** | **2008 and beyond** | ** ** |
| Current  rates                          |       | $                                                                         | 21,639     |   | $ | 43,790 |   | $ | 12,699 |   | $ | (46,715 | ) |
| Shocked down  100 bp                    |       | $                                                                         | 86,949     |   | $ | 71,242 |   | $ | 22,219 |   | $ | (148,997 | ) |
| Shocked up  200 bp                      |       | $                                                                         | (40,576    | ) | $ | 8,270 |   | $ | (6,145 | ) | $ | 69,864 |   |
| Ramped up  200 bp                       |       | $                                                                         | (4,246     | ) | $ | 29,243 |   | $ | 4,927 |   | $ | 1,489 |   |

 

Essentially,the Company’s net interest income is highly sensitive to the sustained movementof long-term interest rates because of the resulting effect on the prepaymentspeeds of the Company’s mortgage-related earning assets. In the interest ratesup scenarios, prepayment speeds slow and the Company becomes more sensitive torising interest rates. In addition, the flattening of the yield curve, whichhas occurred over the past two years has required the Bank to reprice upward alarge amount of its savings and money market accounts in order to prevent theoutflows of these funds. Thus, the Bank has experienced

 

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margin compression, and expects this situation to continue given thelevel of interest rates that existed at December 31, 2005. However, theseassumptions and measurements are highly subjective in nature and are notintended to be a forecast of net interest income under any rate scenario forthe years 2006, 2007 or for any other period.

 

**RecentAccounting Pronouncements**

 

OnDecember 16, 2004, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards No. 123(R) (SFAS 123 R),“Share-Based Payment.” This statement establishes standards for the accountingfor transactions in which the entity exchanges its equity instruments inexchange for goods and services and addresses transactions in which an entityincurs liabilities in exchange for goods and services that are based on thefair value of the entity’s equity instruments or that may be settled by the issuanceof those equity instruments. SFAS123(R) focuses primarily on accountingfor transactions in which an entity obtains employee services in share-basedpayment transactions. Under SFAS123(R), all forms of share-based payments toemployees, including employee stock options, will be treated the same as otherforms of compensation by recognizing the related cost in the income statement.The expense of the award will generally be measured at fair value at the grantdate. The grant-date fair value of employee share options and similarinstruments will be estimated using option pricing models. Current accountingguidance requires that the expense relating to so-called fixed plan employeestock options only be disclosed in the footnotes to the financial statements.The Company plans on implementing SFAS 123(R) on January 1, 2006using the modified prospective method whereby the cost of share-based awardsnot vested as of the adoption date will be recorded in results of operationsover the remaining vesting period; the Company intends to use a straight-linemethodology. At the present time the Company estimates that the adoption ofSFAS123(R) will reduce net income by approximately $274,000 during the yearending December 31, 2006.

 

InMarch 2005, the FASB issued Interpretation No. 47, “Accounting forConditional Asset Retirement Obligations” (FIN 47). FIN 47 requires an entityto recognize a liability for the fair value of a legal obligation to performasset-retirement activities that are conditional on a future event if theamount can be reasonably estimated. The Interpretation provides guidance toevaluate whether fair value is reasonably estimable. FIN 47 is effective nolater than the end of fiscal years ending after December 15, 2005. FIN 47is not expected to have a material impact on the Company’s financial positionor results of operations.

 

InMay 2005, the FASB issued Statement No. 154, “Accounting Changes andError Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3”(SFAS 154.) SFAS 154 changes the accounting for and reporting of avoluntary change in an accounting principle and replaces ABP Opinion No. 20,“Accounting Changes” and FASB Statement No. 3, “Reporting AccountingChanges in Interim Financial Statements.” Under Opinion No. 20, mostchanges in an accounting principle were reported in the income statement of theperiod of change as a cumulative adjustment. However, under SFAS 154, avoluntary change in an accounting principle must be shown retrospectively inthe financial statements, if practicable, for all periods presented. In caseswhere retrospective application is impracticable, an adjustment to the assets,liabilities and a corresponding adjustment to retained earnings can be made asof the beginning of the earliest period for which retrospective application ispracticable rather than being reported in the income statement. SFAS 154is effective for accounting changes and corrections of errors made in fiscalyears ending after December 15, 2005. The adoption of SFAS 154 did nothave a material impact on the Company’s financial position or results ofoperations.

 

InNovember, 2005, the FASB issued staff position FSP FAS 115-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments”.The staff position replaced the guidance in paragraphs 10-18 of EITF Issue 03-1with references to already established other-than-temporary impairment guidanceas is set forth in FASB Statement 115, “Accounting for Certain

 

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Investments in Debt and Equity Securities”, Staff Accounting Bulletin59, “Accounting for Non-current Marketable Equity Securities” and APB Opinion18, “The Equity Method of Accounting for Investments in Common Stock.” FSP FAS115-1 clarified that an investor should recognize an impairment loss no laterthan when the impairment is considered other than temporary, even if a decisionto sell has not been made. FSP FAS 115-1 was effective for other-than-temporaryimpairment analysis conducted in periods after September 15, 2005. Theadoption of FSP FAS 115-1 did not have a material impact on the Company’sfinancial position or results of operations.

 

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

 

**TF FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**December 31, 2005 and 2004**

 

16

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

Board of Directors andShareholders of TF Financial Corporation

 

We have audited theaccompanying consolidated statements of financial position of TF FinancialCorporation and Subsidiaries as of December 31, 2005 and 2004, and therelated consolidated statements of operations, changes in stockholders’ equityand comprehensive income and cash flows for each of the three years in theperiod ended December 31, 2005. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. The Company is not required to have, nor were weengaged to perform an audit of its internal control over financial reporting.Our audits included consideration of internal control over financial reportingas a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting.Accordingly, we express no such opinion. An audit also includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the consolidated financial position of TF Financial Corporation andSubsidiaries as of December 31, 2005 and 2004, and the consolidatedresults of their operations and their consolidated cash flows for each of thethree years in the period ended December 31, 2005, in conformity withaccounting principles generally accepted in the United States of America.

 

 
| /s/ Grant Thornton LLP     |   |
|----------------------------|--------|
| Philadelphia, Pennsylvania |
| March 15, 2006        |

 

17

----

 

**TFFinancial Corporation and Subsidiaries**

 

**CONSOLIDATEDSTATEMENTS OF FINANCIAL POSITION**

 
| ** **                                                                                                                                                                                                                                              | ** ** | **December 31**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                                                                                              | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                                                                                                              | ** ** | **(in thousands)** | ** ** |
| ASSETS                                                                                                                                                                                                                                                  |       |                    |       |   |   |
| Cash  and cash equivalents                                                                                                                                                                                                                              |       | $                       | 3,821      |   | $ | 7,900 |   |
| Certificates  of deposit in other financial institutions                                                                                                                                                                                                |       | 40                      |       | 38 |   |
| Investment  securities available for sale—at fair value                                                                                                                                                                                            |       | 30,401                  |       | 17,625 |   |
| Investment  securities held to maturity (fair value of $4,707 and $7,188 as of  December 31, 2005 and 2004, respectively)                                                                                                                          |       | 4,690                   |       | 7,027 |   |
| Mortgage-backed  securities available for sale—at fair value                                                                                                                                                                                       |       | 83,511                  |       | 103,610 |   |
| Mortgage-backed  securities held to maturity (fair value of $10,385 and $15,546 as of  December 31, 2005 and 2004, respectively)                                                                                                                   |       | 10,177                  |       | 14,900 |   |
| Loans  receivable, net (including loans held for sale of $68 and $680 as of  December 31, 2005 and 2004, respectively)                                                                                                                             |       | 490,959                 |       | 442,195 |   |
| Federal  Home Loan Bank stock—at cost                                                                                                                                                                                                              |       | 7,432                   |       | 7,460 |   |
| Accrued  interest receivable                                                                                                                                                                                                                            |       | 3,048                   |       | 2,500 |   |
| Premises  and equipment, net                                                                                                                                                                                                                            |       | 6,289                   |       | 5,963 |   |
| Core  deposit intangible asset, net of accumulated amortization of $2,741 and  $2,611 as of December 31, 2005 and 2004, respectively                                                                                                               |       | 83                      |       | 213 |   |
| Goodwill                                                                                                                                                                                                                                                |       | 4,324                   |       | 4,324 |   |
| Other  assets                                                                                                                                                                                                                                           |       | 16,064                  |       | 15,211 |   |
| TOTAL  ASSETS                                                                                                                                                                                                                                           |       | $                       | 660,839    |   | $ | 628,966 |   |
|                                                                                                                                                                                                                                                    |       |                    |       |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                               |       |                    |       |   |   |
| Liabilities                                                                                                                                                                                                                                             |       |                    |       |   |   |
| Deposits                                                                                                                                                                                                                                                |       | $                       | 470,521    |   | $ | 459,903 |   |
| Advances  from the Federal Home Loan Bank                                                                                                                                                                                                               |       | 121,260                 |       | 102,747 |   |
| Advances  from borrowers for taxes and insurance                                                                                                                                                                                                        |       | 1,915                   |       | 1,778 |   |
| Accrued  interest payable                                                                                                                                                                                                                               |       | 2,052                   |       | 1,638 |   |
| Other  liabilities                                                                                                                                                                                                                                      |       | 2,443                   |       | 1,745 |   |
| Total  liabilities                                                                                                                                                                                                                                      |       | 598,191                 |       | 567,811 |   |
| Stockholders’  equity                                                                                                                                                                                                                              |       |                    |       |   |   |
| Preferred  stock, no par value; 2,000,000 shares authorized at December 31, 2005  and 2004, none issued                                                                                                                                            |       | —                  |       | — |   |
| Common  stock, $0.10 par value; 10,000,000 shares authorized, 5,290,000 shares  issued, 2,714,173 and 2,742,345 shares outstanding at December 31, 2005  and 2004, respectively, net shares in treasury: 2005—2,390,943;  2004—2,345,746 |       | 529                     |       | 529 |   |
| Retained  earnings                                                                                                                                                                                                                                      |       | 61,610                  |       | 57,428 |   |
| Additional  paid-in capital                                                                                                                                                                                                                             |       | 53,048                  |       | 51,675 |   |
| Unearned  restricted stock                                                                                                                                                                                                                              |       | (1,080                  | )          | — |   |
| Unearned  ESOP shares                                                                                                                                                                                                                                   |       | (1,849                  | )          | (2,019 | ) |
| Treasury  stock—at cost                                                                                                                                                                                                                            |       | (47,920                 | )          | (46,081 | ) |
| Accumulated  other comprehensive income (loss)                                                                                                                                                                                                          |       | (1,690                  | )          | (377 | ) |
| Total  stockholders’ equity                                                                                                                                                                                                                        |       | 62,648                  |       | 61,155 |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                        |       | $                       | 660,839    |   | $ | 628,966 |   |

 

The accompanyingnotes are an integral part of these statements.

 

18

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**TFFinancial Corporation and Subsidiaries**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
| ** **                                                 | ** ** | **Year ended December 31,**                         | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                 | ** ** | **(in thousands, except per share data)** | ** ** |
| Interest  income                                           |       |                                                               |       |   |   |   |   |
| Loans,  including fees                                     |       | $                                                                  | 27,570     |   | $ | 24,359 |   | $ | 23,372 |   |
| Mortgage-backed  securities                                |       | 4,875                                                              |       | 5,696 |   | 6,725 |   |
| Investment  securities                                     |       | 1,461                                                              |       | 1,152 |   | 1,806 |   |
| Interest-bearing  deposits and other                       |       | 59                                                                 |       | 14 |   | 474 |   |
|                                                       |       |                                                               |       |   |   |   |   |
| TOTAL  INTEREST INCOME                                     |       | 33,965                                                             |       | 31,221 |   | 32,377 |   |
|                                                       |       |                                                               |       |   |   |   |   |
| Interest  expense                                          |       |                                                               |       |   |   |   |   |
| Deposits                                                   |       | 7,599                                                              |       | 5,925 |   | 7,044 |   |
| Borrowings                                                 |       | 3,933                                                              |       | 2,941 |   | 8,208 |   |
|                                                       |       |                                                               |       |   |   |   |   |
| TOTAL  INTEREST EXPENSE                                    |       | 11,532                                                             |       | 8,866 |   | 15,252 |   |
|                                                       |       |                                                               |       |   |   |   |   |
| NET  INTEREST INCOME                                       |       | 22,433                                                             |       | 22,355 |   | 17,125 |   |
| Provision  for loan losses                                 |       | 540                                                                |       | 600 |   | 330 |   |
|                                                       |       |                                                               |       |   |   |   |   |
| NET  INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES       |       | 21,893                                                             |       | 21,755 |   | 16,795 |   |
|                                                       |       |                                                               |       |   |   |   |   |
| Non-interest  income                                       |       |                                                               |       |   |   |   |   |
| Service  fees, charges and other operating income          |       | 2,570                                                              |       | 2,600 |   | 2,372 |   |
| Gain  on sale of real estate                               |       | —                                                             |       | — |   | 110 |   |
| Gain  on sale of investment and mortgage-backed securities |       | —                                                             |       | — |   | 208 |   |
| Gain  on sale of loans                                     |       | 158                                                                |       | 8 |   | — |   |
|                                                       |       |                                                               |       |   |   |   |   |
| TOTAL  NON-INTEREST INCOME                                 |       | 2,728                                                              |       | 2,608 |   | 2,690 |   |
|                                                       |       |                                                               |       |   |   |   |   |
| Non-interest  expense                                      |       |                                                               |       |   |   |   |   |
| Employee  compensation and benefits                        |       | 9,249                                                              |       | 8,769 |   | 8,186 |   |
| Occupancy  and equipment                                   |       | 2,645                                                              |       | 2,518 |   | 2,488 |   |
| Federal  deposit insurance premium                         |       | 64                                                                 |       | 70 |   | 72 |   |
| Professional  fees                                         |       | 814                                                                |       | 615 |   | 609 |   |
| Marketing  and advertising                                 |       | 773                                                                |       | 655 |   | 551 |   |
| Other  operating                                           |       | 2,493                                                              |       | 2,547 |   | 2,847 |   |
| Amortization  of core deposit intangible asset             |       | 130                                                                |       | 155 |   | 185 |   |
| Debt  prepayment fee                                       |       | —                                                             |       | — |   | 13,765 |   |
|                                                       |       |                                                               |       |   |   |   |   |
| TOTAL  NON-INTEREST EXPENSE                                |       | 16,168                                                             |       | 15,329 |   | 28,703 |   |
|                                                       |       |                                                               |       |   |   |   |   |
| INCOME  (LOSS) BEFORE INCOME TAXES                         |       | 8,453                                                              |       | 9,034 |   | (9,218 | ) |
|                                                       |       |                                                               |       |   |   |   |   |
| Income  tax expense (benefit)                              |       | 2,300                                                              |       | 2,467 |   | (3,384 | ) |
|                                                       |       |                                                               |       |   |   |   |   |
| NET  INCOME (LOSS)                                         |       | $                                                                  | 6,153      |   | $ | 6,567 |   | $ | (5,834 | ) |
| Earnings  (loss) per share—basic                      |       | $                                                                  | 2.25       |   | $ | 2.44 |   | $ | (2.30 | ) |
| Earnings  (loss) per share—diluted                    |       | $                                                                  | 2.20       |   | $ | 2.33 |   | $ | (2.30 | ) |

 

The accompanyingnotes are an integral part of these statements.

 

19

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**TFFinancial Corporation and Subsidiaries**

 

**CONSOLIDATEDSTATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY ANDCOMPREHENSIVE INCOME (LOSS)**

 

**Yearsended December 31, 2005, 2004 and 2003**

 

**(inthousands, except share data)**

 
| ** **                                            | ** ** | ** **            | ** ** | ** **     | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** | ** **   | ** ** | ** **   | ** ** | **Accumulated**        | ** ** | ** ** | ** ** | ** **             | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|----------------|------------|------------|------------|--------------|------------|--------------|------------|------------------------|------------|------------|------------|------------------------|------------|
| ** **                                            | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | **Unearned** | ** ** | **Unearned**   | ** ** | ** ** | ** ** | ** **   | ** ** | **other**    | ** ** | ** **             | ** ** | ** ** | ** ** |
| ** **                                            | ** ** | ** **            | ** ** | **Par**        | ** ** | **paid-in**  | ** ** | **restricted** | ** ** | **ESOP**   | ** ** | **Treasury** | ** ** | **Retained** | ** ** | **comprehensive**      | ** ** | ** ** | ** ** | **Comprehensive**      | ** ** |
| ** **                                            | ** ** | **Shares**            | ** ** | **value**      | ** ** | **capital**  | ** ** | **stock**      | ** ** | **shares** | ** ** | **stock**    | ** ** | **Earnings** | ** ** | **income (loss)** | ** ** | **Total**  | ** ** | **income (loss)** | ** ** |
| Balance at  December 31, 2002                    |       | 2,482,586             |       | $              | 529        |         | $          | 51,647         |       | $          | —     |         | $          | (2,401       | )          | $                      | (48,809    | )          | $          | 59,978                 |       | $ | 1,896 |   | $ | 62,840 |   |   |   |
| Allocation of  ESOP shares                            |       | 20,549                |       | —         |       | 401          |       | —         |       | 205        |       | —       |       | —       |       | —                 |       | 606        |       |                   |       |
| Cash  dividends—common stock                     |       | —                |       | —         |       | —       |       | —         |       | —     |       | —       |       | (1,518       | )          | —                 |       | (1,518     | )          |                   |       |
| Exercise of  options                                  |       | 92,902                |       | —         |       | (618         | )          | —         |       | —     |       | 1,766        |       | —       |       | —                 |       | 1,148      |       |                   |       |
| Income tax  benefit arising from stock compensation   |       | —                |       | —         |       | 552          |       | —         |       | —     |       | —       |       | —       |       | —                 |       | 552        |       |                   |       |
| Other  comprehensive loss, net of taxes               |       | —                |       | —         |       | —       |       | —         |       | —     |       | —       |       | —       |       | (2,314                 | )          | (2,314     | )          | $                      | (2,314     | ) |
| Net loss for the  year ended December 31, 2003   |       | —                |       | —         |       | —       |       | —         |       | —     |       | —       |       | (5,834       | )          | —                 |       | (5,834     | )          | (5,834                 | )          |
| Comprehensive  loss                                   |       | —                |       |           |       |         |       |           |       |       |       |         |       |         |       |                   |       |       |       | $                      | (8,148     | ) |
| 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 income, 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 |   |   |   |

 

The accompanyingnotes are an integral part of this statement

 

20

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**TFFinancial Corporation and Subsidiaries**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                                          | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                          | ** ** | **(in thousands)**                    | ** ** |
| OPERATING  ACTIVITIES                                                                               |       |                                       |       |   |   |   |   |
| Net income  (loss)                                                                                  |       | $                                          | 6,153      |   | $ | 6,567 |   | $ | (5,834 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities |       |                                       |       |   |   |   |   |
| Amortization of                                                                                     |       |                                       |       |   |   |   |   |
| Mortgage loan  servicing rights                                                                     |       | 8                                          |       | — |   | 11 |   |
| Deferred loan  origination fees                                                                     |       | (96                                        | )          | (50 | ) | (259 | ) |
| Premiums and  discounts on investment securities, net                                               |       | 81                                         |       | 74 |   | 170 |   |
| Premiums and  discounts on mortgage-backed securities, net                                          |       | 386                                        |       | 775 |   | 1,527 |   |
| Premiums and  discounts on loans, net                                                               |       | 123                                        |       | 127 |   | 414 |   |
| Core deposit  intangibles                                                                           |       | 130                                        |       | 155 |   | 185 |   |
| Deferred income  taxes                                                                              |       | (403                                       | )          | (343 | ) | 596 |   |
| Provision for  loan losses and provision for losses on real estate                                  |       | 540                                        |       | 737 |   | 443 |   |
| Provision for  decrease in fair value of mortgage service rights                                    |       | 1                                          |       | — |   | — |   |
| Depreciation of  premises and equipment                                                             |       | 961                                        |       | 973 |   | 1,041 |   |
| Increase in  value of bank-owned life insurance                                                     |       | (501                                       | )          | (525 | ) | (553 | ) |
| Stock-based  benefit programs                                                                       |       | 509                                        |       | 531 |   | 606 |   |
| Proceeds from  sale of loans originated for sale                                                    |       | 9,765                                      |       | 657 |   | — |   |
| Origination of  loans held for sale                                                                 |       | (8,995                                     | )          | (1,329 | ) | — |   |
| Tax benefit  arising from stock compensation                                                        |       | 144                                        |       | 1,616 |   | 552 |   |
| (Gain) loss on  sale of                                                                             |       |                                       |       |   |   |   |   |
| Investment and  mortgage-backed securities                                                          |       | —                                     |       | — |   | (208 | ) |
| Real estate  acquired through foreclosure                                                           |       | —                                     |       | (1 | ) | (23 | ) |
| Real estate                                                                                         |       | —                                     |       | — |   | (110 | ) |
| Mortgage loans  available for sale                                                                  |       | (158                                       | )          | (8 | ) | — |   |
| Income from  mortgage loan derivatives                                                              |       | (8                                         | )          | — |   | — |   |
| Expense  associated with forward loan sales                                                         |       | 7                                          |       | — |   | — |   |
| (Increase)  decrease in                                                                             |       |                                       |       |   |   |   |   |
| Accrued interest  receivable                                                                        |       | (548                                       | )          | 171 |   | 905 |   |
| Other assets                                                                                        |       | 763                                        |       | 3,709 |   | (3,924 | ) |
| Increase  (decrease) in                                                                             |       |                                       |       |   |   |   |   |
| Accrued interest  payable                                                                           |       | 414                                        |       | (270 | ) | (989 | ) |
| Other  liabilities                                                                                  |       | 758                                        |       | (10 | ) | (1,427 | ) |
| NET CASH  PROVIDED BY (USED IN) OPERATING ACTIVITIES                                                |       | 10,034                                     |       | 13,556 |   | (6,877 | ) |
|                                                                                                     |            |                                            |            |  |  |  |  |  |  |  |

 

21

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| ** **                                                                                  | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                  | ** ** | **(in thousands)**                    | ** ** |
| INVESTING  ACTIVITIES                                                                       |       |                                       |       |   |   |   |   |
| Loan  originations                                                                          |       | $                                          | (147,629   | ) | $ | (151,517 | ) | $ | (178,578 | ) |
| Purchases of loans                                                                          |       | —                                     |       | (3,922 | ) | (24,176 | ) |
| Loan principal  payments                                                                    |       | 96,579                                     |       | 117,896 |   | 165,855 |   |
| Principal  repayments on mortgage-backed securities held to maturity                        |       | 4,709                                      |       | 8,730 |   | 31,013 |   |
| Principal  repayments on mortgage-backed securities available for sale                      |       | 26,959                                     |       | 30,099 |   | 62,169 |   |
| Proceeds from  loan sales                                                                   |       | 1,108                                      |       | — |   | — |   |
| (Purchases) and  maturities of certificates of deposit in other financial institutions, net |       | (2                                         | )          | 117 |   | 65 |   |
| Purchase of  investment securities available for sale                                       |       | (13,170                                    | )          | (3,040 | ) | (98,708 | ) |
| Purchase of  mortgage-backed securities available for sale                                  |       | (8,956                                     | )          | (27,701 | ) | (82,350 | ) |
| Purchase of  bank-owned life insurance                                                      |       | —                                     |       | — |   | (1,500 | ) |
| Proceeds from  maturities of investment securities held to maturity                         |       | 2,280                                      |       | 3,295 |   | 4,105 |   |
| Proceeds from  maturities of investment securities available for sale                       |       | —                                     |       | — |   | 40,000 |   |
| Proceeds from  the sale of investment and mortgage-backed securities available for sale     |       | —                                     |       | — |   | 95,193 |   |
| (Purchase)  redemption of Federal Home Loan Bank stock                                      |       | 28                                         |       | (635 | ) | 4,599 |   |
| (Purchase) sale  of property, equipment and real estate held for investment                 |       | —                                     |       | 3 |   | 8 |   |
| Proceeds from  sale of real estate                                                          |       | —                                     |       | 32 |   | 1,277 |   |
| Purchase of  premises and equipment                                                         |       | (1,287                                     | )          | (668 | ) | (751 | ) |
| NET CASH  PROVIDED BY (USED IN) INVESTING ACTIVITIES                                        |       | (39,381                                    | )          | (27,311 | ) | 18,221 |   |
|                                                                                        |       |                                       |       |   |   |   |   |
| FINANCING  ACTIVITIES                                                                       |       |                                       |       |   |   |   |   |
| Net increase in  deposits                                                                   |       | 10,618                                     |       | 560 |   | 16,785 |   |
| Net increase  (decrease) in short-term Federal Home Loan Bank advances                      |       | 7,483                                      |       | (1,179 | ) | 9,887 |   |
| Proceeds of  long-term Federal Home Loan Bank advances                                      |       | 26,367                                     |       | 30,000 |   | 80,000 |   |
| Repayment of  long-term Federal Home Loan Bank advances                                     |       | (15,337                                    | )          | (12,927 | ) | (210,393 | ) |
| Net increase in  advances from borrowers for taxes and insurance                            |       | 137                                        |       | 40 |   | 408 |   |
| Treasury stock  acquired                                                                    |       | (2,830                                     | )          | (4,725 | ) | — |   |
| Exercise of  stock options                                                                  |       | 801                                        |       | 3,410 |   | 1,148 |   |
| Common stock  dividends paid                                                                |       | (1,971                                     | )          | (1,765 | ) | (1,518 | ) |
| NET CASH  PROVIDED BY (USED IN) FINANCING ACTIVITIES                                        |       | 25,268                                     |       | 13,414 |   | (103,683 | ) |
|   NET  DECREASE IN CASH AND CASH EQUIVALENTS                                      |       | (4,079                                     | )          | (341 | ) | (92,339 | ) |
| Cash and cash  equivalents at beginning of year                                             |       | 7,900                                      |       | 8,241 |   | 100,580 |   |
| Cash and cash  equivalents at end of year                                                   |       | $                                          | 3,821      |   | $ | 7,900 |   | $ | 8,241 |   |
|                                                                                        |       |                                       |       |   |   |   |   |   |   |   |
| Supplemental  disclosure of cash flow information                                           |       |                                       |       |   |   |   |   |
| Cash paid for                                                                               |       |                                       |       |   |   |   |   |
| Interest on  deposits and advances from Federal Home Loan Bank                              |       | $                                          | 11,118     |   | $ | 9,136 |   | $ | 16,241 |   |
| Income taxes                                                                                |       | $                                          | 1,475      |   | $ | 1,330 |   | $ | 250 |   |
| Non-cash  transactions                                                                      |       |                                       |       |   |   |   |   |
| Transfers from  loans to real estate acquired through foreclosure                           |       | $                                          | —     |   | $ | — |   | $ | 1,857 |   |

 

Theaccompanying notes are an integral part of these statements.

 

22

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**TF Financial Corporation andSubsidiaries**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**December 31, 2005 and 2004**

 

**NOTEA—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.

 

The Bank is subject toregulations of certain state and federal agencies and, accordingly, thoseregulatory authorities conduct periodic examinations. As a consequence of theextensive regulation of commercial banking activities, the Bank’s business isparticularly susceptible to being affected by state and federal legislation andregulations.

 

*1.*   Principlesof Consolidation and Basis of Presentation

* *

The consolidatedfinancial statements 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.

 

The accounting policiesof the Company conform to accounting principles generally accepted in theUnited States of America (US GAAP) and predominant practices within the bankingindustry. The preparation of financial statements in conformity with US GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements, and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates. The more significant accounting policies are summarized below.

 

*2.*   Cashand Cash Equivalents

* *

The Company considerscash, due from banks, federal funds sold and interest-bearing deposits in otherfinancial institutions, with original terms to maturity of less than threemonths, as cash equivalents for presentation purposes in the consolidatedstatements of financial position and cash flows. The Company is required tomaintain certain cash reserves relating to deposit liabilities. Thisrequirement 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

 

23

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Equity Securities.” TheCompany classifies its investment, mortgage-backed and marketable equitysecurities in one of three categories: held to maturity, trading, or availablefor 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.

 

Investment andmortgage-backed securities held to maturity are carried at cost, net of unamortizedpremiums and discounts, which are recognized in interest income using theinterest method. Decreases in fair value deemed to be other than temporary arereported as a component of income. The Company has the ability and it ismanagement’s intention to hold such assets to maturity.

 

*4.*   LoansReceivable

* *

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 unamortizedpremiums on mortgage loans are amortized to income using the interest methodover the remaining period to contractual maturity, adjusted for actualprepayments.

 

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 the 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 that a creditor 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.

 

24

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The Company adopted FASBInterpretation (FIN) 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, including Indirect Guarantees of Indebtedness ofOthers”. FIN 45 requires certain disclosures regarding the nature of theguarantee, the maximum potential amount of future payments that the guarantorcould be required to make under the guarantee, and the current amount of theliability, if any, for the guarantor’s obligations under the guarantee. TheBank issues financial and performance letters of credit. Financial letters ofcredit require the Bank to make payment if the customer’s financial conditiondeteriorates, as defined in the agreements. Performance letters of creditrequire the Bank to make payments if the customer fails to perform identifiednon-financial contractual obligations.

 

On December 12,2003, the American Institute of Certified Public Accountants issued Statementof Position No. 03-3, “Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer” (SOP 03-3). SOP 03-3 requires that acquiredimpaired loans for which it is probable that the investor will be unable tocollect all contractually required payments receivable be recorded at thepresent value of amounts expected to be received and prohibits carrying over orcreation of valuation allowances in the initial accounting for these loans. SOP03-3 is effective for loans acquired in fiscal years beginning afterDecember 31, 2004. The adoption of SOP 03-3 did not have a material impacton the Company’s results of operations or financial position.

 

*5.*   MortgageLoans Held-for-Sale

* *

Mortgages loansoriginated and intended for sale in the secondary market are carried at thelower of aggregate cost or estimated fair value. Any resulting unrealizedlosses are included in other income. The fair value of the Bank’s loans held asavailable was valued in excess of cost at December 31, 2005 and 2004.

 

The Company adopted SFASNo. 149, “Amendment of Statement 133 on Derivative Instruments and HedgingActivities,” on July 1, 2004. Implementation issue C13, “When a LoanCommitment Is Included in the Scope of Statement 133” is included in SFASNo. 149. SFAS No. 149 amends SFAS No. 133 to add a scopeexception for borrowers (all commitments) and lenders (all commitments exceptthose relating to mortgage loans that will be held for sale). SFAS No. 149also amends SFAS No. 133 to require a lender to account for as derivativesloan commitments related to mortgage loans that will be held for sale. SFASNo. 149 is effective for contracts entered into or modified afterJune 30, 2004. The Bank periodically enters into commitments with itscustomers for loans, which it intends to sell in the future. The Bank’scommitments to extend credit for loans intended for resale were not material atDecember 31, 2005 and 2004.

 

On March 2005, theSecurities and Exchange Commission released Staff Accounting Bulletin (SAB)105, “Loan Commitments Accounted for as Derivative Instruments.” SAB 105requires that a lender should not consider the expected cash flows related toloan servicing or include any internally developed intangible assets indetermining the fair value of loan commitments accounted for as derivatives.The Company adopted SAB 105 effective for commitments entered into afterJune 30, 2004. The requirements of SAB 105 apply to the Bank’s mortgageinterest rate lock commitments related to loans held for sale. The Company’sapplication of SAB 105 did not have a material impact of the Company’sfinancial position or results of operations.

 

25

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*6.*   Transfersof Financial Assets

* *

The Company accounts forthe transfer of financial assets in accordance with SFAS No. 140 “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities.” 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

* *

Land is carried at cost.Buildings and furniture, fixtures and equipment are carried at cost lessaccumulated depreciation. Depreciation is provided by the straight-line methodover the estimated useful lives of the assets. The Company accounts for theimpairment of long-lived assets in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal ofLong-Lived Assets”. The standard requires recognition and measurementfor the impairment of long-lived assets to be held and used or to be disposedof by sale. The Company had no impaired long-lived assets at December 31,2005 and 2004.

 

*8.*   Goodwilland Other Intangible Assets

* *

Goodwill does notrequire amortization but is subject to annual impairment testing. The Companyhas tested the goodwill for impairment prior to its fiscal year endingDecember 31, 2005. No impairment has been recognized.

 

Core deposit intangibleasset is the result of the Company’s 1996 acquisition of the deposits of CenlarFederal Savings Bank. The core deposit intangible acquired is being amortizedover 10 years and is scheduled to be fully amortized by September 30,2006.

 

*9.*   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 for sharesof stock issued to employees by an ESOP. SOP 93-6 requires that the employerrecord compensation expense in the amount equal to the fair value of sharescommitted to be released from the ESOP to employees.

 

The Company has adefined benefit pension plan covering substantially all full-time employeesmeeting certain requirements. The Company accounts for the defined benefit planin accordance 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”.

 

26

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The Company purchased$10.5 million in life insurance policies on the lives of its executives andofficers prior to 2004. The Company is the owner and beneficiary of thepolicies. The cash surrender values of the policies are approximately $12.8million and $12.3 million at December 31, 2005 and 2004, respectively.

 

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 either immediately or over a three to five year period. Theexercise price of each option equals the market price of the Company’s stock onthe date of grant. The Company accounts for stock-based compensation inaccordance with SFAS No. 123, “Accounting for Stock-Based Compensation,”which contains a fair value-based method for valuing stock-based compensationthat entities may use, which measures compensation cost at the grant date basedon the fair value of the award. Compensation is then recognized over theservice period, which is usually the vesting period. Alternatively, thestandard permits entities to continue accounting for employee stock options andsimilar instruments under Accounting Principles Board (APB) OpinionNo. 25, “Accounting for Stock Issued to Employees.” Entities that continueto account for stock options using APB Opinion No. 25 are required to makepro forma disclosures of net income and earnings per share, as if the fairvalue-based method of accounting defined in SFAS No. 123 had been applied.The Company’s employee stock option plans are accounted for using the intrinsicvalue method under APB Opinion No. 25. No stock-based compensation expenseis reflected in net income, as all options granted under the plans had anexercise price equal to the market value of the underlying common stock on thedate of the grant.

 

Had compensation costfor the plans been determined based on the fair value of options at the grantdates consistent with the method of SFAS No. 123, “Accounting forStock-Based Compensation,” the Company’s net income and earnings per sharewould have been reduced to the pro forma amounts indicated below.

 
| ** **                                                                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income  (loss)                                                                                            |       |     |       |     |       |     |       |
| As reported                                                                                                   |       | $        | 6,153      |     | $          | 6,567    |       | $ | (5,834 | ) |
| Deduct:  stock-based compensation expense determined using the fair value method, net  of related tax effects |       | 68       |       | 88       |       | 53       |       |
| Pro forma                                                                                                     |       | $        | 6,085      |     | $          | 6,479    |       | $ | (5,887 | ) |
|                                                                                                          |       |     |       |     |       |     |       |   |   |   |
| Basic earnings  (loss) per share                                                                              |       |     |       |     |       |     |       |
| As reported                                                                                                   |       | $        | 2.25       |     | $          | 2.44     |       | $ | (2.30 | ) |
| Deduct:  stock-based compensation expense determined using the fair value method, net  of related tax effects |       | 0.03     |       | 0.03     |       | 0.02     |       |
| Pro forma                                                                                                     |       | $        | 2.22       |     | $          | 2.41     |       | $ | (2.32 | ) |
|                                                                                                          |       |     |       |     |       |     |       |   |   |   |
| Diluted earnings  (loss) per share                                                                            |       |     |       |     |       |     |       |
| As reported                                                                                                   |       | $        | 2.20       |     | $          | 2.33     |       | $ | (2.30 | ) |
| Deduct:  stock-based compensation expense determined using the fair value method, net  of related tax effects |       | 0.01     |       | 0.02     |       | 0.02     |       |
| Pro forma                                                                                                     |       | $        | 2.19       |     | $          | 2.31     |       | $ | (2.32 | ) |

 

27

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There were no optionsgranted in 2004. The fair value of each option grant during 2005 and 2003 wasestimated on the date of grant using the Black-Scholes option-pricing modelwith the following weighted average assumptions:

 
| ** **                                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted average assumptions         |       |     |       |     |       |     |       |
| Dividend yield                                 |       | 2.41     | %          | N/A      |       | 2.09     | %          |
| Expected  volatility                           |       | 22.77    | %          | N/A      |       | 32.00    | %          |
| Risk-free  interest rate                       |       | 4.34     | %          | N/A      |       | 3.40     | %          |
| Fair value of  options granted during the year |       | $        | 6.15       |     | N/A        |     | $          | 9.50 |   |
| Expected lives  in years                       |       | 5.14     |       | N/A      |       | 6.00     |       |
|                                                |            |          |            |          |            |          |            |  |  |

 

*10.  *Income Taxes

* *

The Company accounts forincome taxes under the liability method specified in SFAS No. 109, “Accountingfor Income Taxes” whereby deferred income taxes are recognized for the taxconsequences of “temporary differences” by applying enacted statutory tax ratesapplicable to future years to differences between the financial statementcarrying amounts and the tax bases of existing assets and liabilities. Theeffect on deferred taxes of a change in tax rates is recognized in income inthe period that includes the enactment date.

 

*11.  *AdvertisingCosts

* *

The Company expensesmarketing and advertising costs as incurred.

 

*12.  *Earnings PerShare

* *

The Company follows theprovisions of SFAS No. 128, “Earnings Per Share.” Basic earnings per shareexcludes 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.

 

28

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** **

*13.  *ComprehensiveIncome

* *

The Company follows SFASNo. 130, “Reporting Comprehensive Income.” SFAS No. 130 establishesstandards to provide prominent disclosure of comprehensive income items.Comprehensive income is the change in equity of a business enterprise during aperiod from transactions and other events and circumstances from non-ownersources. The components of other comprehensive income (loss) are as follows:

 
| ** **                                       | ** ** | **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 |   |

 
| ** **                                                    | ** ** | **December 31, 2003** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **Before tax  amount**     | ** ** | **Tax  (expense)  benefit** | ** ** | **Net of tax  amount** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**         | ** ** |
| Unrealized  losses on securities                              |       |                            |       |   |   |   |   |
| Unrealized  holding (losses) arising during period            |       | $                               | (3,297     | ) | $ | 1,120 |   | $ | (2,177 | ) |
| Reclassification  adjustment for gains realized in net income |       | (208                            | )          | 71 |   | (137 | ) |
| Other  comprehensive loss, net                                |       | $                               | (3,505     | ) | $ | 1,191 |   | $ | (2,314 | ) |

 

*14.  *SegmentReporting

* *

The Company follows SFASNo. 131, “Disclosures about Segments of an Enterprise and RelatedInformation.” The Company has one reportable segment, “Community Banking.” Allof the Company’s activities are interrelated, and each activity is dependentand assessed based on how each of the activities of the Company supports theothers. For example, commercial lending is dependent upon the ability of theBank to fund itself with retail deposits and other borrowings and to manageinterest rate and credit risk. This situation is also similar for consumer andresidential mortgage lending. Accordingly, all significant operating decisionsare based upon analysis of the Company as one operating segment or unit.

 

29

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*15.  *Reclassifications

* *

Certain prior yearamounts have been reclassified to conform to the current period presentation.

 

**NOTEB—CASH AND CASH EQUIVALENTS**

 

Cash and cashequivalents consist of the following:

 
| ** **                                                 | ** ** | **December 31,**   | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                 | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | **(in thousands)** | ** ** |
| Cash and due  from banks                                   |       | $                       | 3,684      |   | $ | 7,686 |   |
| Interest-bearing  deposits in other financial institutions |       | 137                     |       | 214 |   |
|                                                       |       | $                       | 3,821      |   | $ | 7,900 |   |

 

**NOTEC—INVESTMENT AND MORTGAGE-BACKED SECURITIES**

 

The amortized cost,gross unrealized gains and losses, and fair value of the Company’s investmentsecurities at December 31, 2005 and 2004, are summarized as follows:

 
| ** **                                     | ** ** | **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 |   |

 

30

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| ** **                                     | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **Amortized  cost**             | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Fair  value** | ** ** |
| ** **                                     | ** ** | **(in thousands)**         | ** ** |
| Investment  securities held to maturity        |       |                            |       |   |   |   |   |   |   |
| State and  political subdivisions              |       | $                               | —     |   | $ | — |   | $ | — |   | $ | — |   |
| U.S. Government  and federal agencies          |       | 1,326                           |       | 69 |   | — |   | 1,395 |   |
| Corporate debt  securities                     |       | 5,701                           |       | 92 |   | — |   | 5,793 |   |
|                                           |       | $                               | 7,027      |   | $ | 161 |   | $ | — |   | $ | 7,188 |   |
| Investment  securities available for sale      |       |                            |       |   |   |   |   |   |   |
| U.S. Government  and federal agencies          |       | $                               | 2,978      |   | $ | — |   | $ | (20 | ) | $ | 2,958 |   |
| Corporate debt  securities                     |       | 1,000                           |       | — |   | (8 | ) | 992 |   |
| State and  political subdivisions              |       | 13,704                          |       | 121 |   | (150 | ) | 13,675 |   |
|                                           |       | $                               | 17,682     |   | $ | 121 |   | $ | (178 | ) | $ | 17,625 |   |
| Mortgage-backed  securities held to maturity   |       |                            |       |   |   |   |   |   |   |
| FHLMC  certificates                            |       | $                               | 5,195      |   | $ | 322 |   | — |   | 5,517 |   |
| FNMA  certificates                             |       | 5,182                           |       | 135 |   | (41 | ) | 5,276 |   |
| GNMA  certificates                             |       | 4,516                           |       | 230 |   | — |   | 4,746 |   |
| Real estate  mortgage investment conduit       |       | 7                               |       | — |   | — |   | 7 |   |
|                                           |       | $                               | 14,900     |   | $ | 687 |   | $ | (41 | ) | $ | 15,546 |   |
| Mortgage-backed  securities available for sale |       |                            |       |   |   |   |   |   |   |
| FHLMC  certificates                            |       | $                               | 6,635      |   | $ | 11 |   | $ | (32 | ) | $ | 6,614 |   |
| FNMA  certificates                             |       | 15,255                          |       | 5 |   | (152 | ) | 15,108 |   |
| Real estate  mortgage investment conduit       |       | 82,129                          |       | 218 |   | (459 | ) | 81,888 |   |
|                                           |       | $                               | 104,019    |   | $ | 234 |   | $ | (643 | ) | $ | 103,610 |   |

 

There were no sales ofinvestments and mortgage-backed securities during the years endedDecember 31, 2005 and 2004.

 

Gross realized gainswere $725,000 for the year ended December 31, 2003. These gains resultedfrom the sale of investment and mortgage-backed securities of$22.6 million for the year ended December 31, 2003.

 

Gross realized losseswere $517,000 for the year ended December 31, 2003. These losses resultedfrom the sale of investment and mortgage-backed securities of $72.4 millionfor the year ended December 31, 2003.

 

31

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The amortized cost andfair value of investment and mortgage-backed securities, by contractualmaturity, are shown below.

 
| ** **                             | ** ** | **December 31, 2005**  | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **Available for sale** | ** ** | **Held to maturity** | ** ** |
| ** **                             | ** ** | **Amortized  cost**              | ** ** | **Fair  value** | ** ** | **Amortized  cost** | ** ** | **Fair  value** | ** ** |
| ** **                             | ** ** | **(in thousands)**          | ** ** |
| Investment  securities                 |       |                             |       |   |   |   |   |   |   |
| Due in one year  or less               |       | $                                | —     |   | $ | — |   | $ | 3,675 |   | $ | 3,671 |   |
| Due after one  year through five years |       | 10,588                           |       | 10,431 |   | 800 |   | 821 |   |
| Due after five  years through 10 years |       | 7,634                            |       | 7,572 |   | 215 |   | 215 |   |
| Due after 10  years                    |       | 12,606                           |       | 12,398 |   | — |   | — |   |
|                                   |       | 30,828                           |       | 30,401 |   | 4,690 |   | 4,707 |   |
| Mortgage-backed  securities            |       | 85,644                           |       | 83,511 |   | 10,177 |   | 10,385 |   |
|                                   |       | $                                | 116,472    |   | $ | 113,912 |   | $ | 14,867 |   | $ | 15,092 |   |

 

Investment securitieshaving an aggregate amortized cost of approximately $3.0 million werepledged to secure public deposits at December 31, 2005 and 2004.

 

There were no securitiesheld other than U.S. Government and agencies from a single issuer thatrepresented more than 10% of stockholders’ equity at year end.

 

The table belowindicates the length of time individual securities, both held-to-maturity andavailable-for-sale, have been in a continuous unrealized loss position atDecember 31, 2005:

 
| ** **                              | ** ** | **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                       |       | $                                      | 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 oninvestments in securities issued by the U. S. Treasury and Government agencies,U. S. Government sponsored agencies and agency mortgage-backed securities werecaused by changes in market interest rates. The contractual terms andcontractual cash flows of these securities do not permit the issuer to settleat a price less than the amortized cost of the investment. The Company has theability and intent to hold these investments until a market price recovery ormaturity. Accordingly, the Company has determined that the unrealized losses atDecember 31, 2005 are not considered other-than-temporary.

 

32

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The table belowindicates the length of time individual securities, both held-to-maturity andavailable-for-sale, have been in a continuous unrealized loss position atDecember 31, 2004:

 
| ** **                              | ** ** | **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   |       | 1                       |       | $                                      | —     |                                   | $          | —              |       | $ | 2,957 |   | $ | (20 | ) | $ | 2,957 |   | $ | (20 | ) |
| Corporate debt  securities              |       | 1                       |       | —                                 |       | —                                 |       | 993                 |       | (8 | ) | 993 |   | (8 | ) |
| State and  political subdivisions       |       | 7                       |       | —                                 |       | —                                 |       | 5,092               |       | (150 | ) | 5,092 |   | (150 | ) |
| Mortgage-backed  securities             |       | 25                      |       | 22,901                                 |       | (130                                   | )          | 46,367              |       | (554 | ) | 69,268 |   | (684 | ) |
| Total  temporarily impaired securities  |       | 34                      |       | $                                      | 22,901     |                                   | $          | (130                | )          | $ | 55,409 |   | $ | (732 | ) | $ | 78,310 |   | $ | (862 | ) |

 

The Company hasattributed interest rate fluctuations as the underlying factor causing thedecline in fair value of these securities. The Company maintains the intent andability to hold such securities until recovery or maturity at which point themarket value of the security will no longer reflect impairment. Accordingly, ithas been concluded that there are no securities that are other-than-temporarilyimpaired as of December 31, 2004.

 

**NOTED—LOANS RECEIVABLE**

 

Loans receivable aresummarized as follows:

 
| ** **                                                    | ** ** | **December 31,**   | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                    | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                                    | ** ** | **(in thousands)** | ** ** |
| First mortgage  loans (principally conventional)              |       |                    |       |   |   |
| Secured by one-to-four  family residences                     |       | $                       | 289,746    |   | $ | 284,645 |   |
| Secured by other  non-residential properties                  |       | 89,489                  |       | 83,559 |   |
| Construction  loans                                           |       | 24,888                  |       | 10,286 |   |
|                                                          |       | 404,123                 |       | 378,490 |   |
| Net deferred  loan origination costs and unamortized premiums |       | 504                     |       | 700 |   |
| Total first  mortgage loans                                   |       | 404,627                 |       | 379,190 |   |
| Other loans                                                   |       |                    |       |   |   |
| Commercial  non-real estate                                   |       | 48,471                  |       | 30,543 |   |
| Home equity and  second mortgage                              |       | 37,479                  |       | 29,522 |   |
| Commercial  leases                                            |       | 186                     |       | 857 |   |
| Other                                                         |       | 2,836                   |       | 4,384 |   |
|                                                          |       | 88,972                  |       | 65,306 |   |
| Unamortized premiums                                          |       | 1                       |       | 6 |   |
| Total other  loans                                            |       | 88,973                  |       | 65,312 |   |
| Less allowance  for loan losses                               |       | (2,641                  | )          | (2,307 | ) |
| Total loans  receivable                                       |       | $                       | 490,959    |   | $ | 442,195 |   |

 

33

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** **

Activity in theallowance for loan losses is summarized as follows:

 
| ** **                    | ** ** | **December 31,**   | ** ** |
|-------------------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                    | ** ** | **(in thousands)** | ** ** |
| Balance at  beginning of year |       | $                       | 2,307      |   | $ | 2,111 |   | $ | 2,047 |   |
| Provision  charged to income  |       | 540                     |       | 600 |   | 330 |   |
| Charge-offs, net              |       | (206                    | )          | (404 | ) | (266 | ) |
| Balance at end  of year       |       | $                       | 2,641      |   | $ | 2,307 |   | $ | 2,111 |   |

 

Non-performing loans,which include non-accrual loans for which the accrual of interest has beendiscontinued and loan balances past due over 90 days that are not on anon-accrual status but that management expects will eventually be paid in full,totaled approximately $1.6 million and $960,000 at December 31, 2005 and2004, respectively. The Company has reviewed these loans and has determinedthere was no impairment at December 31, 2005 and 2004.

 

The Bank has noconcentration of loans to borrowers engaged in similar activities that exceeded10% of loans at December 31, 2005 and 2004. 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 $70,000and $82,000 at December 31, 2005 and 2004, respectively. For the yearended December 31, 2005, principal repayments of approximately $12,000were received. No new loans to related parties were issued during the year.

 

**NOTEE—LOAN SERVICING**

 

Mortgage loans servicedfor others are not included in the accompanying consolidated statements offinancial position. The unpaid principal balances of these loans are summarizedas follows:

 
| ** **                          | ** ** | **December 31,**   | ** ** |
|-------------------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                          | ** ** | **(in thousands)** | ** ** |
| Mortgage loan  servicing portfolios |       |                    |       |   |   |
| FHLMC                               |       | $                       | 1,182      |   | $ | 1,619 |   |
| FNMA                                |       | 9,696                   |       | 653 |   |
| Other investors                     |       | 6,173                   |       | 6,997 |   |
|                                |       | $                       | 17,051     |   | $ | 9,269 |   |

 

Custodial balancesmaintained in connection with the foregoing loan servicing totaledapproximately $168,000 and $198,000 at December 31, 2005 and 2004,respectively. The net servicing revenue on mortgage loans serviced for othersis immaterial for all periods presented. Mortgage servicing rights are reportedas a component of other assets and were not material at December 31, 2005 and2004.

 

34

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**NOTEF—PREMISES AND EQUIPMENT**

 

Premises and equipmentare summarized as follows:

 
| ** **                         | ** ** | **Estimated**         | ** ** | **December 31,**   | ** ** |
|------------------------------------|------------|-----------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **useful lives** | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                         | ** ** | ** **            | ** ** | **(in thousands)** | ** ** |
| Buildings                          |       | 30 years              |       | $                       | 6,472      |   | $ | 6,063 |   |
| Leasehold  improvements            |       | 5 years               |       | 1,429                   |       | 1,429 |   |
| Furniture,  fixtures and equipment |       | 3-7 years             |       | 10,178                  |       | 9,398 |   |
|                               |       |                  |       | 18,079                  |       | 16,890 |   |
| Less accumulated  depreciation     |       |                  |       | 13,482                  |       | 12,619 |   |
|                               |       |                  |       | 4,597                   |       | 4,271 |   |
| Land                               |       |                  |       | 1,692                   |       | 1,692 |   |
|                               |       |                  |       | $                       | 6,289      |   | $ | 5,963 |   |

 

**NOTEG—DEPOSITS**

** **

Deposits are summarizedas follows:

 
| ** **                                       | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| **Deposit type**                            | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| Demand                                           |       | $                       | 37,138     |   | $ | 32,636 |   |
| NOW                                              |       | 52,319                  |       | 54,887 |   |
| Money Market                                     |       | 79,666                  |       | 42,496 |   |
| Passbook savings                                 |       | 151,725                 |       | 182,945 |   |
| Total demand,  transaction and passbook deposits |       | 320,848                 |       | 312,964 |   |
| Certificates of  deposit                         |       | 149,673                 |       | 146,939 |   |
|                                             |       | $                       | 470,521    |   | $ | 459,903 |   |

 

The aggregate amount ofcertificates of deposit with a minimum denomination of $100,000 was approximately$31.3 million and $26.6 million at December 31, 2005 and 2004,respectively. The Bank had no broker-originated certificates of deposit atDecember 31, 2005 and 2004.

 

At December 31,2005, scheduled maturities of certificates of deposit are as follows:

 
| **Year ending December 31,** | ** ** |
|---------------------------------------------|------------|
| **2006**                                    | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| **(in thousands)**                     | ** ** |
| $                                           | 92,402     |   | $ | 34,239 |   | $ | 7,009 |   | $ | 7,643 |   | $ | 7,766 |   | $ | 614 |   | $ | 149,673 |   |
|                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Related party depositsare on substantially the same terms as for comparable transactions withunrelated persons. The aggregate dollar amount of these deposits wasapproximately $2.0 million and $1.4 million at December 31, 2005 and 2004,respectively.

 

35

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**NOTEH—ADVANCES FROM THE FEDERAL HOME LOAN BANK AND OTHER BORROWINGS**

 

Advancesfrom the Federal Home Loan Bank consist of the following:

 
| ** **                                       | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **2005**                | ** ** | **2004** | ** ** |
| **Principal payments due during** | ** ** | **Amount**              | ** ** | **Weighted  average rate** | ** ** | **Amount** | ** ** | **Weighted  average rate** | ** ** |
| ** **                                       | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| 2005                                             |       | $                       | —     |   | — | % | 23,448 |   | 2.90 | % |
| 2006                                             |       | 32,672                  |       | 3.81 |   | 15,237 |   | 3.32 |   |
| 2007                                             |       | 22,050                  |       | 3.73 |   | 15,750 |   | 3.32 |   |
| 2008                                             |       | 17,638                  |       | 3.40 |   | 16,280 |   | 3.32 |   |
| 2009                                             |       | 34,566                  |       | 3.84 |   | 28,147 |   | 3.60 |   |
| 2010                                             |       | 8,539                   |       | 4.25 |   | 2,058 |   | 3.89 |   |
| Thereafter                                       |       | 5,795                   |       | 4.20 |   | 1,827 |   | 3.94 |   |
|                                             |       | $                       | 121,260    |   | 3.79 | % | $ | 102,747 |   | 3.32 | % |
|                                                  |            |                         |            |  |  |  |  |  |  |  |  |

 

Theadvances are collateralized by Federal Home Loan Bank stock and certain firstmortgage loans and mortgage-backed securities. At December 31, 2005 principalpayments due during 2006 included $16.2 million at a daily variableinterest rate of 4.23%, pursuant to a line of credit agreement with the FederalHome Loan Bank. Unused lines of credit at the Federal Home Loan Bank were$13.8 million at December 31, 2005. The remaining long-term advancesfrom the Federal Home Loan Bank are fixed rate.

 

**NOTEI—BENEFIT PLANS**

 

TheBank maintains a 401(k) profit-sharing plan for eligible employees.Participants may contribute up to 15% of pretax eligible compensation. The Bankmakes matching discretionary contributions equal to 75% of the initial $1,000deferral. Contributions to the 401(k) plan totaled $61,000, $65,000, and$58,000 in 2005, 2004 and 2003, respectively.

 

TheBank has a non-contributory defined benefit pension plan covering substantiallyall full-time employees meeting certain eligibility requirements. The benefitsare based on each employee’s years of service and an average earnings formula.An employee becomes fully vested upon completion of five years of qualifyingservice. It is the policy of the Bank to fund the maximum amount allowableunder the individual aggregate cost method to the extent deductible underexisting federal income tax regulations.

 

36

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Thefollowing tables set forth the projected benefit obligation, funded status ofthe defined benefit pension plan and the amounts reflected in the consolidatedstatements of financial position, and fair value of assets of the plan.

 
| ** **                                      | ** ** | **December 31,**   | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(in thousands)** | ** ** |
| Reconciliation  of Projected Benefit Obligation |       |                    |       |   |   |
| Benefit  obligation at beginning of year        |       | $                       | 3,382      |   | $ | 3,028 |   |
| Service cost                                    |       | 314                     |       | 230 |   |
| Interest  cost                                  |       | 211                     |       | 190 |   |
| Plan  amendments                                |       | —                  |       | — |   |
| Actuarial  loss                                 |       | 122                     |       | 304 |   |
| Benefits  paid                                  |       | (408                    | )          | (370 | ) |
| Benefits  obligation at end of year             |       | $                       | 3,621      |   | $ | 3,382 |   |
|                                            |       |                    |       |   |   |
| Reconciliation  of Fair Value of Assets         |       |                    |       |   |   |
| Fair value  of plan assets at beginning of year |       | $                       | 2,490      |   | $ | 2,768 |   |
| Actual  return on plan assets                   |       | 77                      |       | 62 |   |
| Employer  contribution                          |       | 1,015                   |       | 30 |   |
| Benefits  paid                                  |       | (408                    | )          | (370 | ) |
| Fair value  of plan assets at end of year       |       | $                       | 3,174      |   | $ | 2,490 |   |
|                                            |       |                    |       |   |   |
| Reconciliation  of Funded Status                |       |                    |       |   |   |
| Funded  status                                  |       | $                       | (447       | ) | $ | (892 | ) |
| Unrecognized  transition obligation             |       | —                  |       | — |   |
| Unrecognized  net actuarial loss                |       | 1,162                   |       | 954 |   |
| Unrecognized  prior service cost                |       | 156                     |       | 219 |   |
| Prepaid  benefit cost at end of year            |       | $                       | 871        |   | $ | 281 |   |

 

Theaccumulated benefit obligation at December 31, 2005 and 2004 was$3,079,000 and $2,816,000 respectively.

 

Employercontributions and benefits paid in the above table include only those amountscontributed directly to, or paid directly from, Plan assets. The expectedemployer contribution for 2006 is $1.0 million.

 
| ** **                                                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Weighted-average  assumptions used to determine benefit obligations, end of year |       |     |       |     |       |
| Discount  rate                                                                   |       | 5.75     | %          | 6.00     | %          |
| Rate of  compensation increase                                                   |       | 4.00     |       | 4.00     |       |

 

37

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| ** **                                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Components  of net periodic benefit cost       |       |     |       |     |       |     |       |
| Service cost                                   |       | $        | 314        |     | $          | 230      |       | $ | 191 |   |
| Interest  cost                                 |       | 211      |       | 190      |       | 185      |       |
| Expected  return on plan assets                |       | (205     | )          | (210     | )          | (217     | )          |
| Amortization  of prior service cost            |       | 63       |       | 63       |       | 63       |       |
| Amortization  of transition obligation (asset) |       | —   |       | 4        |       | 4        |       |
| Recognized  net actuarial (gain) loss          |       | 42       |       | 24       |       | 13       |       |
| Net periodic  benefit cost                     |       | $        | 425        |     | $          | 301      |       | $ | 239 |   |

 
| ** **                                                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted-average  assumptions used to determine net benefit costs as of December 31 |       |     |       |     |       |     |       |
| Discount  rate                                                                                |       | 6.00     | %          | 6.25     | %          | 6.75     | %          |
| Expected return  on plan assets                                                               |       | 8.00     |       | 8.00     |       | 8.00     |       |
| Rate of  compensation increase                                                                |       | 4.00     |       | 4.00     |       | 4.00     |       |

 

Theexpected rate of return was determined by applying the average rates of returnover the past ten years on the assets which the Plan is currently invested.

 

Estimatedfuture benefits payments are as follows:

 
| ** ** | ** ** | **(in thousands)** | ** ** |
|------------|------------|-------------------------|------------|
| 2006       |       | $                       | 324        |   |
| 2007       |       | 49                      |       |
| 2008       |       | 65                      |       |
| 2009       |       | 89                      |       |
| 2001       |       | 88                      |       |
| 2011-2015  |       | 689                     |       |
|            |            |                         |            |  |

 

ThePlan’s weighted-average asset allocations by asset category is as follows:

 
| ** **         | ** ** | **Percentage of Plan Assets  at Year End** | ** ** |
|--------------------|------------|---------------------------------------------------------------------|------------|
| ** **         | ** ** | **2005**                                                            | ** ** | **2004** | ** ** |
| Asset Category     |       |                                                                |       |   |   |
| Equity  securities |       | 64                                                                  | %          | 57 | % |
| Debt  securities   |       | 27                                                                  |       | 26 |   |
| Other              |       | 9                                                                   |       | 17 |   |
| Total              |       | 100                                                                 | %          | 100 | % |

 

Trusteesof the Plan are responsible for defining and implementing the investmentobjectives and policies for the Plan’s assets. Assets are invested inaccordance with sound investment practices that

 

38

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emphasizelong-term investment fundamentals that closely match the demographics of theplan’s participants. The Plan’s goal is to earn long-term returns that match orexceed the 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 securities.

 

TheCompany also maintains the following benefit plans:

 

1.*   EmployeeStock Ownership Plan*

 

TheCompany has an internally leveraged ESOP for eligible employees who havecompleted six months of service with the Company or its subsidiaries. The ESOPborrowed $4.2 million from the Company in 1996 to purchase 423,200 newlyissued shares of common stock. The Company makes discretionary contributions tothe ESOP in order to service the ESOP’s debt. Any dividends received by theESOP will be used to pay debt service. The ESOP shares are pledged ascollateral for its debt. As the debt is repaid, shares are released fromcollateral and allocated to qualifying employees based on the proportion ofdebt service paid in the year. 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 $387,000,$431,000 and $523,000 in 2005, 2004 and 2003, respectively.

 
| ** **                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Allocated shares                                |       | 165,000  |       | 158,300  |       |
| Unreleased shares                               |       | 184,000  |       | 200,700  |       |
|                                            |       |     |       |     |       |
| Total ESOP  shares                              |       | 349,000  |       | 359,000  |       |
|                                            |       |     |       |     |       |
| Fair value of unreleased shares (in  thousands) |       | $        | 5,235      |     | $          | 6,422 |   |
|                                                 |            |          |            |          |            |  |  |

 

2.*   StockCompensation Plans*

 

Asummary of the status of the Company’s fixed stock option plans as of December 31,2005, and changes for each of the years in the three-year period then ended isas follows:

 
| ** **                       | ** ** | **2005**               | ** ** | **2004**                                               | ** ** | **2003**               | ** ** |
|----------------------------------|------------|------------------------|------------|--------------------------------------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **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 |       | 283,072                |       | $                                                      | 19.09      |                   | 585,714    |   | $ | 15.40 |   | 658,973 |   | $ | 14.11 |   |
| Options granted                  |       | 160,500                |       | 28.46                                                  |       | —                 |       | — |   | 40,248 |   | 32.42 |   |
| Options exercised                |       | (49,975                | )          | 16.01                                                  |       | (294,925               | )          | 11.56 |   | (92,902 | ) | 12.34 |   |
| Options forfeited                |       | (8,749                 | )          | 28.40                                                  |       | (7,717                 | )          | 26.75 |   | (20,605 | ) | 21.09 |   |
| Outstanding at end of year       |       | 384,848                |       | $                                                      | 23.18      |                   | 283,072    |   | $ | 19.09 |   | 585,714 |   | $ | 15.40 |   |

 

39

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Thefollowing table summarizes information about stock options outstanding at December 31,2005:

 
| ** **                             | ** ** | **Options outstanding**                             | ** ** | **Options exercisable**                                     | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| **Range of exercise prices** | ** ** | **Number  outstanding at  December 31,  2005** | ** ** | **Weighted  average  remaining  contractual  life (years)** | ** ** | **Weighted  average  exercise  price** | ** ** | **Number  exercisable at  December 31,  2005** | ** ** | **Weighted  average  exercise  price** | ** ** |
| $13.25-19.88                           |       | 154,743                                                  |       | 1.58 years                                                       |       | $ | 15.81 |   | 154,743 |   | $ | 15.81 |   |
| $19.89-29.84                           |       | 205,284                                                  |       | 5.50 years                                                       |       | 27.41 |   | 31,455 |   | 23.40 |   |
| $29.85-34.14                           |       | 24,821                                                   |       | 7.97 years                                                       |       | 34.14 |   | 9.928 |   | 34.14 |   |
|                                   |       | 384,848                                                  |       | 4.08 years                                                       |       | $ | 23.18 |   | 196,126 |   | $ | 17.96 |   |

 

TheCompany granted 39,000 shares of stock in December 2005 which will vestover a three-year period. As a result, the Company recognized $15,000 ofcompensation expense based on the market value of the stock on the date of thegrant and the vesting period. There were no stock grants in 2004 and 2003.

 

**NOTEJ—INCOME TAXES**

** **

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

 
| ** **                                                   | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**                    | ** ** |
| Federal                                                      |       |                                       |       |   |   |   |   |
| Current                                                      |       | $                                          | 1,753      |   | $ | 508 |   | $ | (4,364 | ) |
| Charge in  lieu of income tax relating to stock compensation |       | 144                                        |       | 1,616 |   | 379 |   |
| Deferred                                                     |       | 403                                        |       | 343 |   | 596 |   |
|                                                         |       | 2,300                                      |       | 2,467 |   | (3,389 | ) |
|                                                         |       |                                       |       |   |   |   |   |
| State and local—current                                 |       | —                                     |       | — |   | 5 |   |
| Income tax provision                                         |       | $                                          | 2,300      |   | $ | 2,467 |   | $ | (3,384 | ) |

 

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

 
| ** **                             | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Statutory federal income tax (benefit) |       | 34.0                                       | %          | 34.0 | % | (34.0 | )% |
| Increase (decrease) resulting from     |       |                                       |       |   |   |   |   |
| Tax-exempt  income                     |       | (5.7                                       | )          | (3.7 | ) | (2.6 | ) |
| State tax,  net of federal benefit     |       | (0.0                                       | )          | (0.0 | ) | (0.0 | ) |
| Other                                  |       | (1.1                                       | )          | (3.0 | ) | (0.1 | ) |
|                                   |       | 27.2                                       | %          | 27.3 | % | (36.7 | )% |

 

40

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Deferredtaxes are included in the accompanying consolidated statements of financialposition at December 31, 2005 and 2004, for the estimated future taxeffects of differences between the financial statement and federal income taxbases of assets and liabilities according to the provisions of currentlyenacted tax laws. No valuation allowance was recorded against deferred taxassets at December 31, 2005 and 2004. The Company’s net deferred tax assetat December 31, 2005 and 2004, was composed of the following:

 
| ** **                                        | ** ** | **December 31,**   | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                        | ** ** | **(in thousands)** | ** ** |
| Deferred tax assets                               |       |                    |       |   |   |
| Deferred  compensation                            |       | $                       | 208        |   | $ | 277 |   |
| Allowance  for loan losses, net                   |       | 885                     |       | 784 |   |
| Unrealized  loss on securities available for sale |       | 869                     |       | 158 |   |
| Minimum  pension liability adjustment             |       | —                  |       | 37 |   |
| Other                                             |       | 51                      |       | 9 |   |
|                                              |       | 2,013                   |       | 1,265 |   |
| Deferred tax liabilities                          |       |                    |       |   |   |
| Accrued  pension expense                          |       | 504                     |       | 399 |   |
| Prepaid  expenses                                 |       | 43                      |       | 51 |   |
| Deferred  loan costs                              |       | 472                     |       | 391 |   |
| Amortization  of goodwill                         |       | 263                     |       | 93 |   |
| Other                                             |       | 419                     |       | 290 |   |
|                                              |       | 1,701                   |       | 1,224 |   |
| Net deferred  tax asset                           |       | $                       | 312        |   | $ | 41 |   |

 

Priorto 2004 the Company filed its income tax returns on the basis of a fiscal taxyear ending June 30. Effective July 1, 2005, the Company changed thetax year end to coincide with the fiscal reporting period end of December 31.

 

TheBank is not required to recapture approximately $5.7 million of its taxbad debt reserve, attributable to bad debt deductions taken by it prior to1988, as long as the Bank continues to operate as a bank under federal tax lawand does not use the reserve for any other purpose. In accordance with SFAS No. 109,the Bank has not recorded any deferred tax liability on this portion of its taxbad debt reserve. The tax that would be paid were the Bank ultimately requiredto recapture that portion of the reserve would amount to approximately$1.9 million.

 

41

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**NOTEK—REGULATORY MATTERS**

 

TheBank is subject to minimum regulatory capital standards promulgated by theOffice of Thrift Supervision (OTS). Failure to meet minimum capitalrequirements can initiate certain mandatory—and possible additionaldiscretionary—actions by regulators that, if undertaken, could have a directmaterial effect on the Company’s consolidated financial statements. Undercapital adequacy guidelines and the regulatory framework for prompt correctiveaction, the Bank must meet specific capital guidelines that involve quantitativemeasures of the Bank’s assets, liabilities, and certain off-balance sheet itemsas calculated under regulatory accounting practices. The Company’s capitalamounts and classification are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors. Such minimumcapital standards generally require the maintenance of regulatory capitalsufficient to meet each of three tests, hereinafter described as the tangiblecapital requirement, the core capital requirement and the risk-based capitalrequirement. The tangible capital requirement provides for minimum tangiblecapital (defined as stockholders’ equity less all intangible assets) equal to1.5% of adjusted total assets. The core capital requirement provides forminimum core capital (tangible capital plus certain forms of supervisorygoodwill and other qualifying intangible assets) equal to 4% of adjusted totalassets at December 31, 2005. The risk-based capital requirement providesfor minimum core capital (tangible capital plus certain forms of supervisorygoodwill and other qualifying intangible assets) adjusted for the general  valuation allowances equal to 8% of  total assets classified in one of fourrisk-weighted categories at December 31, 2005.

 

Asof December 31, 2005, management believes that the Bank met all capitaladequacy requirements to which it was subject.

 
| ** **                                                | ** ** | **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     |   | 8.69 | % | $ | 57,421 |   | 8.69 | % | $ | 57,421 |   | 14.90 | % |
| Unrealized  loss on certain available-for-sale securities |       | 1,689                                                    |       | 0.25 |   | 1,689 |   | 0.25 |   | 1,689 |   | 0.44 |   |
| Goodwill and  other intangible assets                     |       | (3,774                                                   | )          | (0.57 | ) | (3,774 | ) | (0.57 | ) | (3,774 | ) | (0.98 | ) |
| Additional  capital items                                 |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| General  valuation allowances—limited                |       | —                                                   |       | — |   | — |   | — |   | 2,641 |   | 0.68 |   |
| Regulatory  capital computed                              |       | 55,336                                                   |       | 8.37 |   | 55,336 |   | 8.37 |   | 57,977 |   | 15.04 |   |
| Minimum capital  requirement                              |       | 9,913                                                    |       | 1.50 |   | 26,434 |   | 4.00 |   | 30,834 |   | 8.00 |   |
| Regulatory  capital—excess                           |       | $                                                        | 45,423     |   | 6.87 | % | $ | 28,902 |   | 4.37 | % | $ | 27,143 |   | 7.04 | % |

 

42

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| ** **                                                | ** ** | **Regulatory capital  December 31, 2004** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                | ** ** | **Tangible**                                             | ** ** | **Core** | ** ** | **Risk-based** | ** ** |
| ** **                                                | ** ** | **Capital**                                              | ** ** | **Percent** | ** ** | **Capital** | ** ** | **Percent** | ** ** | **Capital** | ** ** | **Percent** | ** ** |
| ** **                                                | ** ** | **(in thousands)**                                  | ** ** |
| Capital  under generally accepted accounting principles   |       | $                                                        | 55,143     |   | 8.81 | % | $ | 55,143 |   | 8.81 | % | $ | 55,143 |   | 16.30 | % |
| Unrealized  loss on certain available-for-sale securities |       | 307                                                      |       | 0.04 |   | 307 |   | 0.04 |   | 307 |   | 0.09 |   |
| Goodwill and  other intangible assets                     |       | (4,537                                                   | )          | (0.72 | ) | (4,537 | ) | (0.72 | ) | (4,537 | ) | (1.34 | ) |
| Additional  capital items                                 |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| General  valuation allowances—limited                |       | —                                                   |       | — |   | — |   | — |   | 2,104 |   | 0.62 |   |
| Regulatory capital  computed                              |       | 50,913                                                   |       | 8.13 |   | 50,913 |   | 8.13 |   | 53,017 |   | 15.67 |   |
| Minimum  capital requirement                              |       | 9,390                                                    |       | 1.50 |   | 25,041 |   | 4.00 |   | 27,060 |   | 8.00 |   |
| Regulatory  capital—excess                           |       | $                                                        | 41,523     |   | 6.63 | % | $ | 25,872 |   | 4.13 | % | $ | 25,957 |   | 7.67 | % |

 

AtDecember 31, 2005, the Bank met all regulatory requirements forclassification as a “well-capitalized” institution. A “well-capitalized”institution must have risk-based capital of 10% and core capital of 5%. TheBank’s capital exceeded the minimum required amounts for classification as a“well-capitalized” institution. There are no conditions or events that haveoccurred that management believes have changed the Bank’s classification as a“well-capitalized” institution.

 

TheBank maintains a liquidation account for the benefit of eligible savingsaccount holders who maintained deposit accounts in the Bank after the Bankconverted to a stock form of ownership. The Bank may not declare or pay a cashdividend on or repurchase any of its common shares if the effect thereof wouldcause the Bank’s stockholders’ equity to be reduced below either the amountrequired for the liquidation account or the regulatory capital requirements forinsured institutions.

 

**NOTEL—FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK**

** **

TheCompany is a party to financial instruments with off-balance-sheet risk in thenormal course of business to meet the financing needs of its customers. Thesefinancial instruments are primarily commitments to extend credit and standbyletters of credit. Such financial instruments are recorded in the consolidatedfinancial statements when they become receivable or payable. Those instrumentsinvolve, to varying degrees, elements of credit and interest rate risk inexcess of the amount recognized in the consolidated statements of financialposition. The contract or notional amounts of those instruments reflect theextent of the Bank’s involvement in particular classes of financialinstruments.

 

TheCompany’s exposure to credit loss in the event of non-performance by the otherparty to the financial instrument for commitments to extend credit and standbyletters of credit is represented by the contractual amount of thoseinstruments. The Company uses the same credit policies in making commitmentsand conditional obligations as it does for on-balance-sheet instruments.

 

Unlessnoted otherwise, the Company requires collateral to support financialinstruments with credit risk.

 

43

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

 
| ** **                   | ** ** | **December 31,**   | ** ** |
|------------------------------|------------|-------------------------|------------|
| ** **                   | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                   | ** ** | **(in thousands)** | ** ** |
| Commitments to extend credit |       | $                       | 69,822     |   | $ | 73,330 |   |
| Standby letters of credit    |       | 2,220                   |       | 1,201 |   |
| Loans sold with recourse     |       | 74                      |       | 109 |   |
|                         |       | $                       | 72,116     |   | $ | 74,640 |   |

 

Commitmentsto extend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract. Commitments generallyhave fixed expiration dates or other termination clauses and may requirepayment of a fee. The Company evaluates each customer’s creditworthiness on acase-by-case basis. The amount of collateral obtained, if it is deemednecessary by the Company upon extension of credit, is based on management’scredit evaluation of the borrower. Collateral held generally includesresidential and or commercial real estate.

 

Standbyletters of credit are conditional commitments issued by the Bank to guaranteethe performance of a customer to a third party. The credit risk involved inissuing letters of credit is essentially the same as that involved in extendingloan facilities to customers.

 

**NOTEM—COMMITMENTS AND CONTINGENCIES**

 

TheBank had optional commitments of $1,085,000 and $1,069,000 to sell mortgageloans to investors at December 31, 2005 and 2004 respectively.

 

TheBank leases branch facilities and office space for periods ranging up to tenyears. These leases are classified as operating leases and contain options torenew for additional periods. Rental expense was approximately $420,000,$359,000, and $304,000 for the years ended December 31, 2005, 2004 and2003, 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)** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| 2006                                        |       | $                       | 401        |   |
| 2007                                        |       | 344                     |       |
| 2008                                        |       | 255                     |       |
| 2009                                        |       | 179                     |       |
| 2010                                        |       | 100                     |       |
| Thereafter                                  |       | 445                     |       |
|                                        |       | $                       | 1,724      |   |

 

TheCompany has agreements with certain key executives that provide severance paybenefits if there is a change in control of the Company. The agreements willcontinue in effect until terminated or not

 

44

----

 

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. Themaximum contingent liability under the agreements at December 31, 2005 wasapproximately $1,691,000.

 

Fromtime to time, the Company and its subsidiaries are parties to routine litigationthat arises in the normal course of business. In the opinion of management, theresolution of these lawsuits would not have a material adverse effect on theCompany’s consolidated financial position or results of operations.

 

**NOTEN—SIGNIFICANT CONCENTRATIONS OF CREDIT RISK**

 

TheBank is principally engaged in originating and investing in one-to-four familyresidential real estate and commercial real estate loans in easternPennsylvania and New Jersey. The Bank offers both fixed and adjustable rates ofinterest on these loans that have amortization terms ranging to 30 years.The loans are generally originated or purchased on the basis of an 80%loan-to-value ratio, which has historically provided the Bank with more thanadequate collateral coverage in the event of default. Nevertheless, the Bank,as with any lending institution, is subject to the risk that residential realestate values in the primary lending area will deteriorate, thereby potentiallyimpairing underlying collateral values. However, management believes thatresidential and commercial real estate values are presently stable in itsprimary lending area and that loan loss allowances have been provided for inamounts commensurate with its current perception of the foregoing risks in theportfolio.

 

**NOTEO—FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

SFASNo. 107, “Disclosures about Fair Value of Financial Instruments,” requiresall entities to disclose the estimated fair value of their assets andliabilities considered to be financial instruments. For the Bank, as for mostfinancial institutions, the majority of its assets and liabilities areconsidered financial instruments as defined in SFAS No. 107. However, manysuch instruments lack an available trading market as characterized by a willingbuyer and willing seller engaging in an exchange transaction. Also, it is theCompany’s general practice and intent to hold its financial instruments tomaturity or available for sale and to not engage in trading or significantsales activities. Therefore, the Company and the Bank use significantestimations and present value calculations to prepare this disclosure.

 

Changesin the assumptions or methodologies used to estimate fair values may materiallyaffect the estimated amounts. In addition, there may not be reasonablecomparability between institutions due to the wide range of permittedassumptions and methodologies in the absence of active markets. This lack ofuniformity gives rise to a high degree of subjectivity in estimating financialinstrument fair values.

 

Fairvalues have been estimated using data which management considered the bestavailable, as generally provided by estimation methodologies deemed suitablefor the pertinent category of financial instrument. The estimationmethodologies, resulting fair values and recorded carrying amounts are asfollows:

 

Fairvalue of loans and deposits with floating interest rates is generally presumedto approximate the recorded carrying amounts.

 

45

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

 
| ** **                 | ** ** | **December 31,**   | ** ** |
|----------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                 | ** ** | **Fair  value**         | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** | **Carrying  value** | ** ** |
| ** **                 | ** ** | **(in thousands)** | ** ** |
| Cash and cash equivalents  |       | $                       | 3,821      |   | $ | 3,821 |   | $ | 7,900 |   | $ | 7,900 |   |
| Investment securities      |       | 35,108                  |       | 35,091 |   | 24,813 |   | 24,652 |   |
| Mortgage-backed securities |       | 93,896                  |       | 93,688 |   | 119,156 |   | 118,510 |   |
|                            |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

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,**   | ** ** |
|------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                         | ** ** | **Fair  value**         | ** ** | **Carrying  value** | ** ** | **Fair  Value** | ** ** | **Carrying  value** | ** ** |
| ** **                         | ** ** | **(in thousands)** | ** ** |
| Assets                             |       |                    |       |   |   |   |   |   |   |
| Certificates  of deposit           |       | $                       | 40         |   | $ | 40 |   | $ | 38 |   | $ | 38 |   |
| Liabilities                        |       |                    |       |   |   |   |   |   |   |
| Deposits  with stated maturities   |       | 147,561                 |       | 149,673 |   | 145,933 |   | 146,939 |   |
| Borrowings  with stated maturities |       | 118,352                 |       | 121,260 |   | 101,504 |   | 102,747 |   |
|                                    |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

Thefair value of financial instrument liabilities with no stated maturities isgenerally presumed to approximate the carrying amount (the amount payable ondemand).

 
| ** **                         | ** ** | **December 31,**   | ** ** |
|------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                         | ** ** | **Fair  value**         | ** ** | **Carrying  Value** | ** ** | **Fair  value** | ** ** | **Carrying  value** | ** ** |
| ** **                         | ** ** | **(in thousands)** | ** ** |
| Deposits with no stated maturities |       | $                       | 320,848    |   | $ | 320,848 |   | $ | 312,964 |   | $ | 312,964 |   |
|                                    |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

Thefair value of the net loan portfolio has been estimated using the present valueof cash flows, discounted at the approximate current market rates, and givingconsideration to estimated prepayment risk and credit loss factors.

 
| ** ** | ** ** | **December 31,**   | ** ** |
|------------|------------|-------------------------|------------|
| ** ** | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** ** | ** ** | **Fair  value**         | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** | **Carrying  value** | ** ** |
| ** ** | ** ** | **(in thousands)** | ** ** |
| Net loans  |       | $                       | 486,214    |   | $ | 490,959 |   | $ | 445,457 |   | $ | 442,195 |   |
|            |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

46

----

 

Thefair value of commitments to extend credit is estimated based on the amount ofunamortized deferred loan commitment fees. The fair value of letters of creditis based on the amount of unearned fees plus the estimated cost to terminatethe letters of credit. Fair values of unrecognized financial instrumentsincluding commitments to extend credit and the fair value of letters of creditare immaterial.

 

TheBank’s remaining assets and liabilities are not considered financialinstruments. No disclosure of the relationship value of the Bank’s deposits isrequired by SFAS No. 107.

 

**NOTEP—SERVICE FEES, CHARGES AND OTHER OPERATING INCOME AND OTHER OPERATING EXPENSE**

 
| ** **                                        | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                        | ** ** | **(in thousands)**                    | ** ** |
| Service fees, charges and other operating  income |       |                                       |       |   |   |   |   |
| Loan  servicing fees                              |       | $                                          | 363        |   | $ | 331 |   | $ | 358 |   |
| Late charge  income                               |       | 83                                         |       | 90 |   | 100 |   |
| Deposit  service charges                          |       | 1,061                                      |       | 1,092 |   | 923 |   |
| Bank-owned  life insurance value increase         |       | 501                                        |       | 525 |   | 553 |   |
| Other income                                      |       | 562                                        |       | 562 |   | 438 |   |
|                                              |       | $                                          | 2,570      |   | $ | 2,600 |   | $ | 2,372 |   |
| Other operating expense                           |       |                                       |       |   |   |   |   |
| Insurance  and surety bond                        |       | $                                          | 193        |   | $ | 190 |   | $ | 180 |   |
| Office  supplies                                  |       | 221                                        |       | 220 |   | 234 |   |
| Loan expense                                      |       | 337                                        |       | 444 |   | 491 |   |
| MAC expense                                       |       | 328                                        |       | 315 |   | 307 |   |
| Postage                                           |       | 272                                        |       | 237 |   | 299 |   |
| Telephone                                         |       | 306                                        |       | 273 |   | 283 |   |
| Supervisory  examination fees                     |       | 138                                        |       | 130 |   | 147 |   |
| Other  expenses                                   |       | 698                                        |       | 738 |   | 906 |   |
|                                              |       | $                                          | 2,493      |   | $ | 2,547 |   | $ | 2,847 |   |

 

47

----

 

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, 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 |   |

 

Therewere options to purchase 170,321 shares of common stock at a range of $28.48 to$34.14 per share which were outstanding during 2005 that were not included in thecomputation of diluted earnings per share because the options’ exercise priceswere greater than the average market price of the common 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 |   |

 

48

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Therewere options to purchase 30,029 shares of common stock at a price of $34.14 pershare which were outstanding during 2004 that were not included in thecomputation of diluted earnings per share because the options’ exercise priceswere greater than the average market price of the common shares.

 
| ** **                                                                  | ** ** | **Year ended December 31, 2003** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **Income  (numerator)**                              | ** ** | **Weighted  average  shares  (denominator)** | ** ** | **Per share  amount** | ** ** |
| Basic  earnings (loss) per share                                            |       |                                                 |       |   |   |   |   |
| Loss  available to common stockholders                                      |       | $                                                    | (5,834     | ) | 2,541,677 |   | $ | (2.30 | ) |
| Effect of  dilutive securities                                              |       |                                                 |       |   |   |   |   |
| Stock  compensation plans                                                   |       | —                                               |       | — |   | — |   |
| Diluted  earnings (loss) per share                                          |       |                                                 |       |   |   |   |   |
| Income  available to common stockholders plus effect of dilutive securities |       | $                                                    | (5,834     | ) | 2,541,677 |   | $ | (2.30 | ) |

 

Dueto the net loss in 2003, the effect of stock options on diluted loss per sharewas not included due to the anti-dilutive impact of such items on thecalculation.

 

**NOTER—SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATE (UNAUDITED)**

 
| ** **                                 | ** ** | **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 taxes                               |       | 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 |   |

 

49

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| ** **                                 | ** ** | **Three months ended**                                   | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Dec. 31,  2004**                                            | ** ** | **Sept. 30,  2004** | ** ** | **June 30,  2004** | ** ** | **March 31,  2004** | ** ** |
| ** **                                 | ** ** | **(in thousands, except per share data)** | ** ** |
| Total  interest income                     |       | $                                                                  | 7,848      |   | $ | 7,868 |   | $ | 7,775 |   | $ | 7,730 |   |
| Total  interest expense                    |       | 2,349                                                              |       | 2,214 |   | 2,151 |   | 2,152 |   |
| Net interest  income                       |       | 5,499                                                              |       | 5,654 |   | 5,624 |   | 5,578 |   |
| Provision  for possible loan losses        |       | 150                                                                |       | 150 |   | 150 |   | 150 |   |
| Net interest  income after provision       |       | 5,349                                                              |       | 5,504 |   | 5,474 |   | 5,428 |   |
| Other income                               |       | 623                                                                |       | 595 |   | 681 |   | 709 |   |
| Other  expenses                            |       | 3,800                                                              |       | 3,743 |   | 3,869 |   | 3,917 |   |
| Income before  income taxes                |       | 2,172                                                              |       | 2,356 |   | 2,286 |   | 2,220 |   |
| Income tax  expense                        |       | 584                                                                |       | 642 |   | 630 |   | 611 |   |
| Net income                                 |       | $                                                                  | 1,588      |   | $ | 1,714 |   | $ | 1,656 |   | $ | 1,609 |   |
| Earnings per  share—basic             |       | $                                                                  | 0.58       |   | $ | 0.64 |   | $ | 0.62 |   | $ | 0.61 |   |
| Earnings per  share—assuming dilution |       | $                                                                  | 0.56       |   | $ | 0.61 |   | $ | 0.58 |   | $ | 0.57 |   |

 

50

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**NOTES—CONDENSED FINANCIAL INFORMATION—PARENT COMPANY ONLY**

 

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

 

**BALANCESHEET**

 
| ** **                                       | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| ASSETS                                           |       |                    |       |   |   |
| Cash                                             |       | $                       | 3,452      |   | $ | 4,630 |   |
| Certificates of deposit—other institutions  |       | 40                      |       | 38 |   |
| Investment in Third Federal                      |       | 55,611                  |       | 53,054 |   |
| Investment in TF Investments                     |       | 2,392                   |       | 2,347 |   |
| Investment in Penns Trail Development            |       | 991                     |       | 1,001 |   |
| Other assets                                     |       | 240                     |       | 121 |   |
| Total assets                                     |       | $                       | 62,726     |   | $ | 61,191 |   |
|                                             |       |                    |       |   |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY       |       |                    |       |   |   |
|                                             |       |                    |       |   |   |
| Total liabilities                                |       | $                       | 78         |   | $ | 36 |   |
| Stockholders’ equity                        |       | 62,648                  |       | 61,155 |   |
| Total  liabilities and stockholders’ equity |       | $                       | 62,726     |   | $ | 61,191 |   |

 

**STATEMENTOF OPERATIONS**

 
| ** **                                 | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                    | ** ** |
| INCOME                                     |       |                                       |       |   |   |   |   |
| Equity in  earnings (loss) of subsidiaries |       | $                                          | 6,510      |   | $ | 6,906 |   | $ | (5,556 | ) |
| Interest and  dividend income              |       | 72                                         |       | 74 |   | 99 |   |
| Total income  (loss)                       |       | 6,582                                      |       | 6,980 |   | (5,457 | ) |
|                                       |       |                                       |       |   |   |   |   |
| EXPENSES                                   |       |                                       |       |   |   |   |   |
| Other                                      |       | 429                                        |       | 413 |   | 377 |   |
| Total  expenses                            |       | 429                                        |       | 413 |   | 377 |   |
| NET INCOME  (LOSS)                         |       | $                                          | 6,153      |   | $ | 6,567 |   | $ | (5,834 | ) |

 

51

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**STATEMENTOF CASH FLOWS**

 
| ** **                                                                                    | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                    | ** ** | **(in thousands)**                    | ** ** |
| Cash flows from operating activities                                                          |       |                                       |       |   |   |   |   |
| Net income  (loss)                                                                            |       | $                                          | 6,153      |   | $ | 6,567 |   | $ | (5,834 | ) |
| Adjustments  to reconcile net income to net cash provided by (used in) operating  activities  |       |                                       |       |   |   |   |   |
| Equity in  (earnings) loss of subsidiaries                                                    |       | (6,510                                     | )          | (6,906 | ) | 5,556 |   |
| Net change  in assets and liabilities                                                         |       | (74                                        | )          | 357 |   | (147 | ) |
| Net cash  provided by (used in) operating activities                                          |       | (431                                       | )          | 18 |   | (425 | ) |
|                                                                                          |       |                                       |       |   |   |   |   |
| Cash flows from investing activities                                                          |       |                                       |       |   |   |   |   |
| Capital  distribution from subsidiaries                                                       |       | 3,255                                      |       | 2,622 |   | — |   |
| (Purchase)  and maturities of certificates of deposit in other financial institutions,  net   |       | (2                                         | )          | 117 |   | 65 |   |
| Net cash  provided by investing activities                                                    |       | 3,253                                      |       | 2,739 |   | 65 |   |
| Cash flows from financing activities                                                          |       |                                       |       |   |   |   |   |
| Cash  dividends paid to stockholders                                                          |       | (1,971                                     | )          | (1,765 | ) | (1,518 | ) |
| Treasury  stock acquired                                                                      |       | (2,830                                     | )          | (4,725 | ) | — |   |
| Exercise of  stock options                                                                    |       | 801                                        |       | 3,410 |   | 1,148 |   |
| Net cash  used in financing activities                                                        |       | (4,000                                     | )          | (3,080 | ) | (370 | ) |
| NET DECREASE  IN CASH                                                                         |       | (1,178                                     | )          | (323 | ) | (730 | ) |
|                                                                                          |       |                                       |       |   |   |   |   |
| Cash at beginning of year                                                                     |       | 4,630                                      |       | 4,953 |   | 5,683 |   |
| Cash at end of year                                                                           |       | $                                          | 3,452      |   | $ | 4,630 |   | $ | 4,953 |   |
|                                                                                          |       |                                       |       |   |   |   |   |   |   |   |
| Supplemental  disclosure of cash flow information  Cash paid during the year for income taxes |       | $                                          | —     |   | $ | — |   | $ | — |   |

 

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**BOARD OF DIRECTORS ANDEXECUTIVE OFFICERS**

 

**TFFinancial Corporation**

 

**Boardof Directors**

 

RobertN. DusekChairman of the Board

 

CarlF. Gregory

 

DennisL. McCartney

 

GeorgeA. Olsen

 

JohnR. Stranford

 

AlbertM. Tantala

 

**ExecutiveOfficers**

 

KentC. LufkinPresident and Chief Executive Officer

 

DennisR. StewartExecutive Vice President and Chief Financial Officer

 

LorraineA. WolfCorporate Secretary

 

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