UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K





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





For the fiscal year ended December 31,
2008





OR





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





For
the transition period from _________________________ to
_____________





Commission
File Number: 0-51856





NEWPORT
BANCORP, INC.


(Exact
name of registrant as specified in its charter)





MARYLAND
                      20-4465271(State
      or other jurisdiction of incorporation or
    organization)
                      (I.R.S.
      Employer Identification No.)100 Bellevue Avenue, Newport,
      Rhode Island
                      02840(Address
      of principal executive offices)
                      (Zip
      Code)





(401)
847-5500


(Registrant’s
telephone number, including area code)





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




Title of each class
                        
                        Name of each exchange on which
      registeredCommon
      Stock, par value $0.01 per share
                        
                        The
      Nasdaq Stock Market LLC




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





Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.  Yes   o     No  x





Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act.  Yes  o     No  x





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





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





Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company.




Large
      accelerated filer     o
              Accelerated
      filer                   
       oNon-accelerated
      filer       o
              Smaller
      reporting company  x





Indicate by check mark whether the
registrant is a shell company (as defined by Rule 12b-2 of the
Act).


Yes      o    No     x





The aggregate market value of the
voting and non-voting common equity held by nonaffiliates as of June 30,
2008 was approximately $34,509,988.




The number of shares outstanding of the
registrant’s common stock as of March 16, 2009 was 3,997,044.




DOCUMENTS
INCORPORATED BY REFERENCE:


Portions
of the Proxy Statement for the 2009 Annual Meeting of Stockholders are
incorporated by reference in Part III of this Form 10-K.













INDEX





Part
      IPageItem
      1.
                    
                    Business
                    2-14Item
      1A.
                    
                    Risk Factors
                    14-17Item
      1B.
                    
                    Unresolved Staff Comments
                    17Item
      2.
                    
                    Properties
                    18Item
      3.
                    
                    Legal Proceedings
                    18Item
      4.
                    
                    Submission of Matters to a Vote of Security
      Holders
                    18Part
      IIItem
      5.
                    
                    Market for Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity Securities
                    19-20Item
      6.
                    
                    Selected Financial Data
                    21Item
      7.
                    
                    Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
                    21-43Item
      7A.
                    
                    Quantitative and Qualitative Disclosures About Market
      Risk
                    43Item
      8.
                    
                    Financial Statements and Supplementary Data
                    43Item
      9.
                    
                    Changes in and Disagreements With Accountants on Accounting and
      Financial Disclosure
                    43Item
      9A(T).
                    
                    Controls and Procedures
                    43-44Item
      9B.
                    
                    Other Information
                    44Part
      IIIItem
      10.
                    
                    Directors, Executive Officers and Corporate
      Governance
                    44Item
      11.
                    
                    Executive Compensation
                    44Item
      12.
                    
                    Security Ownership of Certain Beneficial Owners and Management
      and Related Stockholder Matters
                    45Item
      13.
                    
                    Certain Relationships and Related Transactions, and Director
      Independence
                    45Item
      14.
                    
                    Principal Accounting Fees and Services
                    45Part
      IVItem
      15.
                    
                    Exhibits and Financial Statement Schedules
                    46-47SIGNATURES
                    48-49





Index





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





Management’s ability to predict results
or the effect of future plans or strategies is inherently
uncertain.  Factors which could affect actual results include interest
rate trends, the general economic climate in the market area in which Newport
Bancorp, Inc. operates, as well as nationwide, Newport Bancorp, Inc.’s ability
to control costs and expenses, competitive products and pricing, loan
delinquency rates and changes in federal and state legislation and
regulation.  For further discussion of factors that may affect the
results, see “Item 1A. Risk Factors” in this Annual Report on Form 10-K (“Form
10-K”). These factors should be considered in evaluating the forward-looking
statements and undue reliance should not be placed on such
statements.  Newport Bancorp, Inc. assumes no obligation to update any
forward-looking statements.





PARTI





Item
1.    
             
 BUSINESS





General





Newport Bancorp, Inc. (“Newport
Bancorp” or the “Company”) is a Maryland chartered company established in March
2006 to become the holding company for Newport Federal Savings Bank (“Newport
Federal” or the “Bank”).  Newport Bancorp’s business activity is the
ownership of the outstanding capital stock of Newport
Federal.  Newport Bancorp does not own or lease any property but
instead uses the premises, equipment and other property of Newport Federal with
the payment of appropriate rental fees, as required by applicable law and
regulations, under the terms of an expense allocation agreement.  In
the future, Newport Bancorp may acquire or organize other operating
subsidiaries; however, there are no current plans, arrangements, agreements or
understandings, written or oral, to do so.





Newport Federal is a federally
chartered savings bank originally founded as a Rhode Island institution in
1888.  In October 2005, Newport Federal merged with Westerly Savings
Bank, a Rhode Island mutual financial institution with two branch locations in
Westerly, Rhode Island. The Bank operates as a community-oriented financial
institution offering traditional financial services to consumers and businesses
in the Bank’s market area.  Newport Federal attracts deposits from the
general public and uses those funds to originate one-to-four family residential
loans, multi-family loans, commercial real estate loans, construction loans and
consumer loans.





In
connection with the conversion on July 6, 2006, the Company established and
funded the Newportfed Charitable Foundation (the “Foundation”) with shares of
Company common stock equal to 7.4% of the shares sold in the stock
offering.  The Foundation provides funding to support charitable
causes and community development activities in the communities served by the
Company.





Available
Information





The Bank’s website address is
www.newportfederal.com.  Information on this website should not be
considered a part of this Form 10-K.





2
 Index





Market
Area





Newport Federal is headquartered in
Newport, Rhode Island.  In addition to the Bank’s main office in
Newport, the Bank operates five other full-service branch offices in Rhode
Island:  one each in Middletown and in Wakefield, two in Westerly, and
our new branch location in Portsmouth, which we opened on January 23,
2009.  On November, 21, 2007, the Bank entered into a twenty-year
lease agreement for land in Stonington, Connecticut to construct a new
branch.  We expect that this branch will open in May
2009.  The Bank considers Newport and Washington Counties, Rhode
Island to be its primary market area.  The economy in our market area
is primarily oriented to the retail and hospitality industries.





Competition





Newport Federal faces significant
competition for the attraction of deposits and origination of
loans.  The Bank’s most direct competition for deposits has
historically come from the several financial institutions operating in its
market area and, to a lesser extent, from other financial service companies such
as brokerage firms, credit unions and insurance companies.  Newport
Federal also faces competition for investors’ funds, from money market funds,
mutual funds and other corporate and government securities.  At June
30, 2008, which is the most recent date for which data is available from the
FDIC, the Bank held approximately 11.46% of the deposits in Newport County,
Rhode Island and approximately 4.02% of the deposits in Washington County, Rhode
Island.  In addition, banks owned by large holding companies such as
Bank of America, Citizens and Sovereign also operate in our market
area.  These institutions are significantly larger than the Bank and,
therefore, have significantly greater resources.





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





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





Lending
Activities





General.  The
largest segment of the Bank’s loan portfolio is real estate mortgage loans,
primarily one-to-four family residential loans. The other significant segment of
the Bank’s loan portfolio is commercial real estate loans.  To a
lesser degree, Newport Federal also originates multi-family and construction
loans, as well as consumer loans.  The Bank originates loans for
investment purposes, although the Bank occasionally may sell a portion of its
one-to-four family residential loans into the secondary market.





One-to-Four
Family Residential Loans.  The Bank’s
origination of mortgage loans enables borrowers to purchase or refinance
existing homes located in Rhode Island, Southeastern Connecticut and, to a
lesser extent, Southeastern Massachusetts, although our primary lending market
is Newport and Washington Counties, Rhode Island.





Newport Federal’s residential lending
policies and procedures conform to the secondary market guidelines as we
occasionally sell qualifying fixed-rate loans into the secondary
market.  The Bank offers fixed-rate mortgage loans with terms of 10 to
30 years, and to a lesser extent, 40 years.  Newport Federal also
offers adjustable-rate mortgage loans.  Borrower demand for
adjustable-rate loans compared to fixed-rate loans is a function of the level of
interest rates, the expectations of changes in the level of interest rates, and
the difference between the interest rates and loan fees offered for fixed-rate
mortgage loans as compared to an initially discounted interest rate and loan
fees for multi-year adjustable-rate mortgages (“ARMs”).  The relative
amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can
be originated at any time is largely determined by the demand for each in a
competitive environment.  The loan fees, interest rates and other
provisions of mortgage loans are determined by us on the basis of our own
pricing criteria and competitive market conditions.





3
 Index





Interest rates and payments on the
Bank’s adjustable-rate mortgage loans generally adjust annually after an initial
fixed period that typically ranges from one to three years.  Interest
rates and payments on the Bank’s adjustable-rate loans generally are adjusted to
a rate typically equal to a percentage above the one-year U.S. Treasury
index.  The maximum amount by which the interest rate may be increased
or decreased is generally 2% per adjustment period and the lifetime interest
rate cap is generally 6% over the initial interest rate of the
loan.





While one-to-four family residential
real estate loans are normally originated with up to 30-year terms, such loans
typically remain outstanding for substantially shorter periods because borrowers
often prepay their loans in full either upon sale of the property pledged as
security or upon refinancing the original loan.  Therefore, average
loan maturity is a function of, among other factors, the level of purchase and
sale activity in the real estate market, prevailing interest rates and the
interest rates payable on outstanding loans.  Newport Federal does not
offer loans with negative amortization and generally does not offer
interest-only loans.





The Bank generally does not make
conventional loans with loan-to-value ratios exceeding 95%.  Loans
with loan-to-value ratios in excess of 80% generally require private mortgage
insurance.  Newport Federal requires all properties securing first
mortgage loans to be appraised by an independent appraiser, who is approved by
the Board of Directors.  The Bank generally requires title insurance
on all first mortgage loans.  Borrowers must obtain hazard insurance,
and flood insurance is required for loans on properties located in a flood
zone.





Multi-Family and
Commercial Real Estate Loans.  Newport Federal
offers fixed- and adjustable-rate mortgage loans secured by commercial and
multi-family real estate.  The Bank’s commercial and multi-family real
estate loans are generally secured by five to ten unit apartment buildings,
small office buildings, two to four unit mixed-use retail and residential
properties and hospitality establishments.  These properties are
primarily located in Newport and Washington Counties in Rhode Island, and to a
lesser extent other cities and towns in Rhode Island and New London County,
Connecticut.





Newport Federal originates a variety of
fixed- and adjustable-rate commercial real estate and multi-family real estate
loans generally for terms up to 10 years.  These adjustable-rate loans
include loans that adjust based on the five-year FHLB Classic Rate Advance
Index, adjustable every five years.  Loans are secured by first
mortgages, and amounts generally do not exceed 75% of the property’s appraised
value.





As of December 31, 2008, the Bank’s
largest commercial loan was $2.3 million.  This loan is secured by
three non-residential real estate properties.  This loan was
performing in accordance with its original terms at December 31,
2008.





Home Equity Loans
and Lines.Newport Federal offers home equity loans with a maximum
combined loan to value ratio of 80% or less.  Home equity lines of
credit have adjustable rates of interest that are indexed to the Prime Rate as
published by The Wall Street
Journal.  Home equity loans have fixed interest rates and terms
that typically range from five to 15 years, but may have terms as long as 20
years.





Construction
Loans.Newport Federal
originates construction loans for one-to-four family homes and commercial,
multi-family and other nonresidential purposes. The Bank’s residential
construction loans generally provide for the payment of only interest during the
construction phase, which is usually six to twelve months.  At the end
of the construction phase, the loan converts to a permanent mortgage loan. One-to-four family
residential construction loans are made with a maximum loan to value ratio of
80% of the market value of the real estate and
improvements.  Commercial, multi-family and other nonresidential loans
can be made with a maximum loan to value ratio of 75% of the upon completion
market value of the real estate and improvements.  At December 31,
2008, the largest construction loan was for $4.0 million, of which $601,000 was
advanced.  This loan was performing according to its original terms at
December 31, 2008.  Construction loans to individuals are generally
made on the same terms as Newport Federal’s one-to-four family mortgage
loans.





4
 Index





Consumer
Loans.  The Bank offers a
variety of consumer and other loans, including auto loans and loans secured by
passbook savings or certificate accounts.





The procedures for underwriting
consumer loans include an assessment of the applicant’s payment history on other
debts and ability to meet existing obligations and payments on the proposed
loan.  Although the applicant’s creditworthiness is a primary
consideration, the underwriting process also includes a comparison of the value
of the collateral, if any, to the proposed loan amount.





Loan Underwriting Risks.





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





Multi-family and Commercial Real
Estate Loans.  Loans secured by multi-family and commercial
real estate generally have larger balances and involve a greater degree of risk
than one-to-four family residential mortgage loans.  Of primary
concern in multi-family and commercial real estate lending is the borrower’s
creditworthiness and the feasibility and cash flow potential of the
project.  Payments on loans secured by income properties often depend
on successful operation and management of the properties.  As a
result, repayment of such loans may be subject to a greater extent than
residential real estate loans, to adverse conditions in the real estate market
or the economy.  To monitor cash flows on income properties, the Bank
requires borrowers and loan guarantors, if any, to provide annual financial
statements on multi-family and commercial real estate loans.  In
reaching a decision on whether to make a multi-family or commercial real estate
loan, Newport Federal considers and reviews a global cash flow analysis of the
borrower and considers the net operating income of the property, the borrower’s
expertise, credit history and profitability and the value of the underlying
property.  The Bank has generally required that the properties
securing these real estate loans have debt service coverage ratios (the ratio of
earnings before debt service to debt service) of at least 1.25.  An
environmental survey or environmental risk insurance is obtained when the
possibility exists that hazardous materials may have existed on the site, or the
site may have been impacted by adjoining properties that handled hazardous
materials.





Construction
Loans.  Construction financing is generally considered to
involve a higher degree of risk of loss than long-term financing on improved,
occupied real estate.  Risk of loss on a construction loan depends
largely upon the accuracy of the initial estimate of the property’s value at
completion of construction and the estimated cost of
construction.  During the construction phase, a number of factors
could result in delays and/or cost overruns.  If the estimate of
construction costs proves to be inaccurate, the Bank may be required to advance
funds beyond the amount originally committed to permit completion of the
building.  Also, the Bank may be confronted, at or before the maturity
of the loan, with a building having a value that is insufficient to assure full
repayment.  If Newport Federal is forced to foreclose on such a
building before or at completion due to a default, there can be no assurance
that the Bank will be able to recover all of the unpaid balance of, and accrued
interest on, the loan as well as related foreclosure and holding
costs.





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





Loan Originations, Purchases and
Sales.  Loan originations come from a number of
sources.  The primary source of loan originations are existing
customers, walk-in traffic, advertising and referrals from
customers.




5
 Index







From time to time, Newport Federal will
purchase whole loans or participation loans to supplement its lending
portfolio.Whole
loans purchased totaled $926,000 at December 31, 2008. The Bank performs its own
underwriting analysis on each loan purchased using the same standards used for
loans originated.  The Bank does not service purchased
loans.





Loan participations, purchased and
sold, totaled $2.1 million at December 31, 2008.  Loan participations
are also subject to the same credit analysis and loan approvals as loans Newport
Federal originates. The Bank is permitted to review all of the documentation
relating to any loan in which Newport Federal participates.  However,
in a purchased participation loan, the Bank does not service the loan and thus
is subject to the policies and practices of the lead lender with regard to
monitoring delinquencies, pursuing collections and instituting foreclosure
proceedings.





Loan Approval Procedures and
Authority.  Newport Federal’s lending activities follow
written, non-discriminatory, underwriting standards and loan origination
procedures established by the Board of Directors and management.  The
President, Chief Lending Officer and Chief Operating Officer have authority to
approve secured loans in amounts up to $2.8 million and unsecured loans up to
$300,000.  Secured loans from $2.8 million to $3.2 million must be
approved by four of the following persons: recommending loan officer, Chief
Lending Officer, President, Chief Operating Officer and one non-employee member
of the Board of Directors.  Secured loans from $3.2 million to $3.6
million must be approved by a majority of the Executive Committee of the Board
of Directors.  Unsecured loans over $600,000 and secured loans greater
than $3.6 million up to the legal lending limit must be approved by a majority
vote of the Board of Directors.  Smaller loans may be approved by
individual loan officers; however, the Chief Lending Officer oversees the
origination of all loans.





Loans to One
Borrower.  The maximum amount the Bank may lend to one borrower
and the borrower’s related entities is limited, by regulation, to generally 15%
of its stated capital and reserves.  At December 31, 2008, Newport
Federal’s regulatory limit on loans to one borrower was $6.4
million.  At that date, the Bank’s largest lending relationship was
$4.0 million and was secured by a commercial property located in Medfield,
Massachusetts.  This loan was performing in accordance with its
original terms at December 31, 2008.





Loan
Commitments.  The Bank issues commitments for fixed- and
adjustable-rate mortgage loans conditioned upon the occurrence of certain
events.  Commitments to originate mortgage loans are legally binding
agreements to lend to our customers.  Generally, these loan
commitments expire after 60 days.





Investment
Activities





Newport Federal has legal authority to
invest in various types of liquid assets, including U.S. Treasury obligations,
securities of various Government-sponsored enterprises and of state and
municipal governments, mortgage-backed securities and certificates of deposit of
federally insured institutions.  Within certain regulatory limits, the
Bank also may invest a portion of its assets in corporate securities and mutual
funds.  Newport Federal also is required to maintain an investment in
Federal Home Loan Bank of Boston stock.





At December 31, 2008, the Bank’s
investment portfolio consisted of mortgage-backed securities issued primarily by
Fannie Mae and mutual funds, the underlying assets of which consist of
short-term agency securities and mortgage-backed securities.





Newport Federal’s investment objectives
are to provide and maintain liquidity, to establish an acceptable level of
interest rate and credit risk, to provide an alternate source of low-risk
investments when demand for loans is weak and to generate a favorable
return.  The Bank’s Board of Directors has the overall responsibility
for the investment portfolio, including approval of the investment
policy.  The Chief Executive Officer and Chief Financial Officer are
responsible for implementation of the investment policy and monitoring the
Bank’s investment performance.The Board of Directors
of Newport Federal reviews the status of the investment portfolio on a quarterly
basis, or more frequently if warranted.





6
 Index





Deposit
Activities and Other Sources of Funds





General.  Deposits,
borrowings and loan repayments are the major sources of Newport Federal’s funds
for lending and other investment purposes.  Scheduled loan repayments
are a relatively stable source of funds, while deposit inflows and outflows and
loan prepayments are significantly influenced by general interest rates and
money market conditions.





Deposit
Accounts.  Substantially all
of the Bank’s depositors are residents of Rhode Island.  Deposits are
attracted from within our market area through the offering of a broad selection
of deposit instruments, including non-interest-bearing demand deposits (such as
checking accounts), interest-bearing demand accounts (such as NOW and money
market accounts), regular savings accounts and certificates of deposit. Deposit account terms
vary according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors.  In
determining the terms of Newport Federal’s deposit accounts, the Bank considers
the rates offered by the Bank’s competition, Newport Federal’s liquidity needs,
profitability to the Bank, matching deposit and loan products and customer
preferences and concerns.  Newport Federal generally reviews the
deposit mix and pricing weekly.  The Bank’s current strategy is to
offer competitive rates and to be in the middle of the market for rates on all
types of deposit products; however, the Bank selectively competes for various
certificates of deposit.





In addition to accounts for
individuals, Newport Federal also offers deposit accounts designed for the
businesses operating in our market area.  The Bank’s business banking
deposit products include commercial checking accounts and money market
accounts.





Borrowings.  Newport Federal
utilizes advances from the Federal Home Loan Bank of Boston to supplement the
Bank’s investable funds.  The Federal Home Loan Bank functions as a
central reserve bank providing credit for member financial
institutions.  As a member, the Bank is required to own capital stock
in the Federal Home Loan Bank and is authorized to apply for advances on the
security of such stock and certain of the Bank’s mortgage loans and other assets
(principally securities which are obligations of, or guaranteed by, the United
States), provided certain standards related to creditworthiness have been
met.  Advances are made under several different programs, each having
its own interest rate and range of maturities.  Depending on the
program, limitations on the amount of advances are based either on a fixed
percentage of an institution’s net worth or on the Federal Home Loan Bank’s
assessment of the institution’s creditworthiness.





Personnel





At December 31, 2008, the Bank had 68
full-time employees and 20 part-time employees, none of whom is represented by a
collective bargaining unit.  Newport Federal believes that its
relationship with its employees is good.





Subsidiaries





Newport Bancorp conducts its principal
business activities through its wholly-owned subsidiary, Newport Federal Savings
Bank.  The
Newport Federal Savings Bank has one wholly-owned subsidiary, NewportFed
Investments, Inc., which was established to hold certain investments, consisting
primarily of commercial mortgages and loans.





REGULATION
AND SUPERVISION


General





As a savings and loan holding company,
the Company is required by federal law to report to, and otherwise comply with
the rules and regulations of, the Office of Thrift Supervision.  The
Bank is subject to extensive regulation, examination and supervision by the
Office of Thrift Supervision, as its primary federal regulator, and the Federal
Deposit Insurance Corporation, as the deposit insurer.  The Bank is a
member of the Federal Home Loan Bank System and, with respect to deposit
insurance, of the Deposit Insurance Fund managed by the Federal Deposit
Insurance Corporation.  The Bank must file reports with the Office of
Thrift Supervision and the Federal Deposit Insurance Corporation concerning its
activities and financial condition in addition to obtaining regulatory approvals




7
 Index







Holding
Company Regulation





The Company is a non-diversified
unitary savings and loan holding company within the meaning of federal
law.  Under prior law, a unitary savings and loan holding company,
such as the Company, was not generally restricted as to the types of business
activities in which it may engage, provided that the Bank continued to be a
qualified thrift lender.  See “Federal Savings Institution
Regulation - QTL Test.”  The Gramm-Leach-Bliley Act of 1999
provided that no company may acquire control of a savings institution after May
4, 1999 unless the company engages only in the financial activities permitted
for financial holding companies under law or for multiple savings and loan
holding companies as described below.  Further, the Gramm-Leach-Bliley
Act specified that existing savings and loan holding companies may only engage
in such activities.  The Gramm-Leach-Bliley Act, however,
grandfathered the unrestricted authority for activities with respect to unitary
savings and loan holding companies existing prior to May 4, 1999, so long as the
holding company’s savings institution subsidiary continues to comply with the
QTL Test.  The Company does not qualify for the
grandfathering.  Upon any non-supervisory acquisition by the Company
of another savings institution or savings bank that meets the qualified thrift
lender test and is deemed to be a savings institution by the Office of Thrift
Supervision, the Company would become a multiple savings and loan holding
company (if the acquired institution is held as a separate subsidiary) and would
generally be limited to activities permissible for bank holding companies under
Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval
of the Office of Thrift Supervision, and certain activities authorized by Office
of Thrift Supervision regulation.  However, the OTS has issued an
interpretation concluding that multiple savings and loan holding companies may
also engage in activities permitted for financial holding
companies.





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





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





Although savings and loan holding
companies are not currently subject to specific regulatory capital requirements
or specific restrictions on the payment of dividends or other capital
distributions, federal regulations do prescribe such restrictions on subsidiary
savings institutions.  The Bank must notify the Office of Thrift
Supervision thirty days before declaring any dividend to the Company, and comply
with the additional restrictions described below.  In addition, the
financial impact of a holding company on its subsidiary institution is a matter
that is




8
 Index







In addition, Maryland law prohibits the
Company from making a distribution to its stockholders if, after giving effect
to the distribution: (1) the Company would not be able to pay indebtedness of
the Company as the indebtedness becomes due in the usual course of business; or
(2) the Company’s total assets would be less than the sum of the Company’s total
liabilities plus the amount that would be needed, if the Company were to be
dissolved at the time of the distribution, to satisfy the preferential rights
upon dissolution of stockholders whose preferential rights on dissolution are
superior to those receiving the distribution.




Acquisition of
the Company.  Under the Federal Change in Control Act, a notice
must be submitted to the Office of Thrift Supervision if any person (including a
company), or group acting in concert, seeks to acquire “control” of a savings
and loan holding company or savings association.  Under certain
circumstances, a change of control may occur, and prior notice is required, upon
the acquisition of 10% or more of the Company’s outstanding voting stock, unless
the Office of Thrift Supervision has found that the acquisition will not result
in control of the Company.  Under the Change in Control Act, the
Office of Thrift Supervision generally has 60 days from the filing of a complete
notice to act, taking into consideration certain factors, including the
financial and managerial resources of the acquirer and the competitive effects
of the acquisition.  Any company that acquires control would then be
subject to regulation as a savings and loan holding company.





Federal
Savings Institution Regulation





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





Capital
Requirements.The Office of Thrift Supervision capital
regulations require savings institutions to meet three minimum capital
standards:  a 1.5% tangible capital to total assets ratio; a 4% Tier 1
capital to total assets leverage ratio (3% for institutions receiving the
highest rating on the CAMELS examination rating system); and an 8% risk-based
capital ratio.  In addition, the prompt corrective action standards
discussed below also establish, in effect, a minimum 2% tangible capital
standard, a 4% leverage ratio (3% for institutions receiving the highest rating
on the CAMELS system) and, together with the risk-based capital standard itself,
a 4% Tier 1 risk-based capital standard.  The Office of Thrift
Supervision regulations also require that, in meeting the tangible, leverage and
risk-based capital standards, institutions must generally deduct investments in
and loans to subsidiaries engaged in activities as principal that are not
permissible for a national bank.





The risk-based capital standard for
savings institutions requires the maintenance of Tier 1 (core) and total risk
based capital (which is defined as core capital and supplementary capital less
certain specified deductions from total capital such as reciprocal holdings of
depository institution capital instruments and equity investments), to
risk-weighted assets of at least 4% and 8%, respectively.  In
determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet activities, recourse obligations, residual interests and
direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%,
assigned by the Office of Thrift Supervision capital regulation based on the
risks believed inherent in the type of asset.  Core (Tier 1) capital
is generally defined as common stockholders’ equity (including retained
earnings), certain non-cumulative perpetual preferred stock and related surplus
and minority interests in equity accounts of consolidated subsidiaries less
intangibles other than certain mortgage servicing rights and credit card
relationships.  The components of supplementary capital (Tier 2
Capital) currently include cumulative preferred stock, long-term perpetual
preferred stock, mandatory convertible debt securities, subordinated debt and
intermediate preferred stock, the allowance for loan and lease losses limited to
a maximum of 1.25% of risk-weighted assets, and up to 45% of unrealized gains on
available-for-sale equity securities with readily determinable fair market
values.  Overall, the amount of supplementary capital included as part
of total capital cannot exceed 100% of core capital.





The Office of Thrift Supervision also
has authority to establish individual minimum capital requirements in
appropriate cases upon a determination that an institution’s capital level is or
may become inadequate in light of the particular circumstances.  At
December 31, 2008, the Bank met each of its capital requirements.





9
 Index





In October 2008, the United States
Department of Treasury announced a voluntary Capital Purchase Program to
encourage U.S. financial institutions to build capital to increase the flow of
financing to U.S. businesses and consumers and to support the U.S. economy. The
Bank chose not to participate in the Department of Treasury’s Capital Purchase
Program.





Prompt Corrective
Regulatory Action.The Office of Thrift Supervision is required to take
certain supervisory actions against undercapitalized institutions, the severity
of which depends upon the institution’s degree of
undercapitalization.  Generally, a savings institution that has a
ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier
1 (core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be “undercapitalized.”  A
savings institution that has a total risk-based capital ratio less than 6%, a
Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be “significantly undercapitalized” and a savings institution that
has a tangible capital to assets ratio equal to or less than 2% is deemed to be
“critically undercapitalized.”  Subject to a narrow exception, the
Office of Thrift Supervision is required to appoint a receiver or conservator
within specified time frames for an institution that is “critically
undercapitalized.”  The regulation also provides that a capital
restoration plan must be filed with the Office of Thrift Supervision within 45
days of the date a savings institution is deemed to have received notice that it
is “undercapitalized,” “significantly undercapitalized” or “critically
undercapitalized.”  Compliance with the plan must be guaranteed by any
parent holding company in the amount of up to the lesser of 5% of the savings
association’s total assets when it was deemed to be undercapitalized or the
amount necessary to achieve compliance with applicable capital
requirements.  In addition, numerous mandatory supervisory actions
become immediately applicable to an undercapitalized institution, including, but
not limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion.  The Office of Thrift Supervision
could also take any one of a number of discretionary supervisory actions,
including the issuance of a capital directive and the replacement of senior
executive officers and directors.  Significantly and critically
undercapitalized institutions are subject to additional mandatory and
discretionary measures.





Insurance of
Deposit Accounts.Deposit accounts in the Bank are insured by
the Federal Deposit Insurance Corporation, generally up to a maximum of $100,000
per separately insured depositor and up to a maximum of $250,000 for
self-directed retirement accounts.  However, pursuant to its statutory
authority, the Board of Directors of the Federal Deposit Insurance Corporation
recently increased the deposit insurance available on deposit accounts to
$250,000 effective until December 31, 2009.




In
addition, in October 2008, the FDIC announced the Temporary Liquidity Guarantee
Program, part of which allows any participating depository institution to
provide full deposit insurance coverage for non-interest bearing transaction
accounts, regardless of the dollar amount. The Bank has opted to participate in
this part of the Temporary Liquidity Guarantee Program.   See
“—FDIC Temporary Liquidity
Guarantee Program” below.




The FDIC
imposes an assessment on all depository institutions for deposit insurance. This
assessment is based on the risk category of the institution and, prior to 2009,
ranged from five to 43 basis points of the institution’s deposits. On December
22, 2008, the FDIC published a final rule that raises the current deposit
insurance assessment rates uniformly for all institutions by 7 basis points (to
a range from 12 to 50 basis points) effective for the first quarter of
2009.  On February 27, 2009, the FDIC also issued a final rule that
revises the way the FDIC calculates federal deposit insurance assessment rates
beginning in the second quarter of 2009.  Under the new rule, the FDIC
will first establish an institution’s initial base assessment
rate.  This initial base assessment rate will range, depending on the
risk category of the institution, from 12 to 45 basis points.  The
FDIC will then adjust the initial base assessment (higher or lower) to obtain
the total base assessment rate.  The adjustments to the initial base
assessment rate will be based upon an institution’s levels of unsecured debt,
secured liabilities and brokered deposits.  The total base assessment
rate will range from 7 to 77.5 basis points of the institution’s deposits.
Additionally, the FDIC issued an interim rule that would impose a special 20
basis points assessment on June 30, 2009, which would be collected on September
30, 2009. The interim rule also allows for additional special
assessments.




Based
upon the Bank’s review of the Federal Deposit Insurance Corporation’s rule, its
Federal Deposit Insurance Corporation assessment for the first quarter of 2009
will increase by approximately $35,000.  Thereafter,




10
 Index







In
addition to the Federal Deposit Insurance Corporation assessments, the Financing
Corporation (“FICO”) is authorized to impose and collect, with the approval of
the Federal Deposit Insurance Corporation, assessments for anticipated payments,
issuance costs and custodial fees on bonds issued by the FICO in the 1980s to
recapitalize the former Federal Savings and Loan Insurance
Corporation.  The bonds issued by the FICO are due to mature in 2017
through 2019.  For the quarter ended September 30, 2008, the
annualized FICO assessment was equal to 1.12 basis points on domestic deposits
maintained at an institution.




Insurance of deposits may be terminated
by the FDIC upon a finding that the institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations or has
violated any applicable law, regulation, rule, order or condition imposed by the
FDIC or the OTS. The management of Newport Bancorp and the Bank does not know of
any practice, condition or violation that might lead to termination of deposit
insurance.





FDIC–Temporary
Liquidity Guarantee Program.On October 14, 2008, the FDIC announced a
new program – the Temporary Liquidity Guarantee Program
(“TLGP”).  This program has two components. One guarantees newly
issued senior unsecured debt of the participating organizations, up to certain
limits established for each institution, issued between October 14, 2008 and
June 30, 2009. The FDIC will pay the unpaid principal and interest on an
FDIC-guaranteed debt instrument upon the uncured failure of the participating
entity to make a timely payment of principal or interest in accordance with the
terms of the instrument.  The guarantee will remain in effect until
June 30, 2012. On February 27, 2009, the FDIC issued an interim rule allowing
participants to apply to have the FDIC guarantee newly issued senior unsecured
debt that mandatorily converts into common shares on a specified date that is on
or before June 30, 2012.  In return for the FDIC’s guarantee,
participating institutions will pay the FDIC a fee based on the amount and
maturity of the debt.  The Bank has opted to participate in this
component of the TLGP.





The other component of the program
provides full FDIC insurance coverage for non-interest bearing transaction
deposit accounts, regardless of dollar amount, until December 31, 2009. An
annualized 10 basis point assessment on balances in noninterest-bearing
transaction accounts that exceed the existing deposit insurance limit of
$250,000 will be assessed on a quarterly basis to insured depository
institutions that have not opted out of this component of the
TLGP.  The Bank chose to participate in this component of the program,
and therefore is providing the full FDIC insurance coverage on the related
transaction deposit accounts until year-end 2009.





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





QTL Test.Federal law requires savings institutions to meet a qualified thrift
lender test.  Under the test, a savings association is required to
either qualify as a “domestic building and loan association” under the Internal
Revenue Code or maintain at least 65% of its “portfolio assets” (total assets
less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles,
including goodwill; and (iii) the value of property used to conduct business) in
certain “qualified thrift investments” (primarily residential mortgages and
related investments, including certain mortgage-backed securities, but also
including education, credit card and small business loans) in at least 9 months
out of each 12 month period.





A savings institution that fails the
qualified thrift lender test is subject to certain operating restrictions and
may be required to convert to a bank charter.  At December 31, 2008,
the Bank maintained 96.79% of its portfolio assets in qualified thrift
investments and, therefore, met the qualified thrift lender test.





Limitation on
Capital Distributions.  Office of Thrift Supervision
regulations impose limitations upon all capital distributions by a savings
institution, including cash dividends, payments to repurchase its shares and
payments to shareholders of another institution in a cash-out
merger.  Under the regulations, an application to and




11
 Index







Standards for
Safety and Soundness.The federal banking agencies have adopted
Interagency Guidelines prescribing Standards for Safety and Soundness in various
areas such as internal controls and information systems, internal audit, loan
documentation and credit underwriting, interest rate exposure, asset growth and
quality, earnings and compensation, fees and benefits.  The guidelines
set forth the safety and soundness standards that the federal banking agencies
use to identify and address problems at insured depository institutions before
capital becomes impaired.  If the Office of Thrift Supervision
determines that a savings institution fails to meet any standard prescribed by
the guidelines, the Office of Thrift Supervision may require the institution to
submit an acceptable plan to achieve compliance with the standard.





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





The Sarbanes-Oxley Act of 2002
generally prohibits loans by the Company to its executive officers and
directors.  However,  the law contains a specific exception
for loans by the Bank to its executive officers and directors in compliance with
federal banking laws.  Under such laws, the Bank’s authority to extend
credit to executive officers, directors and 10% shareholders (“insiders”), as
well as entities such persons control, is limited.  The law limits
both the individual and aggregate amount of loans the Bank may make to insiders
based, in part, on the Bank’s capital level and requires that certain board
approval procedures be followed.  Such loans are required to be made
on terms substantially the same as those offered to unaffiliated individuals and
not involve more than the normal risk of repayment.  There is an
exception for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees.  Loans to executive
officers are subject to additional limitations based on the type of loan
involved.  (See Note 13 “Related Party Transactions” in the attached
Financial Statement Schedules).





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




12
 Index









Assessments.Savings institutions are required to pay assessments to the Office of
Thrift Supervision to fund the agency’s operations.  The general
assessments, paid on a semi-annual basis, are computed based upon the savings
institution’s (including consolidated subsidiaries) total assets, financial
condition and complexity of its portfolio.  The OTS assessments paid
by the Company for the year ended December 31, 2008 totaled
$101,000.





Federal
Home Loan Bank System





The Bank is a member of the Federal
Home Loan Bank System, which consists of (12) regional Federal Home Loan
Banks.  The Federal Home Loan Bank provides a central credit facility
primarily for member institutions.  The Bank, as a member of the
Federal Home Loan Bank, is required to acquire and hold shares of capital stock
in that Federal Home Loan Bank.  The Bank was in compliance with this
requirement with an investment in Federal Home Loan Bank stock at December 31,
2008 of $5.6 million.





The Federal Home Loan Banks are
required to provide funds for certain purposes including the resolution of
insolvent thrifts in the late 1980s and to contributing funds for affordable
housing programs.  These requirements could reduce the amount of
dividends that the Federal Home Loan Banks pay to their members and could also
result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members.  If dividends were reduced, or interest on
future Federal Home Loan Bank advances increased, the Bank’s net interest income
would likely also be reduced.





On February 26, 2009, the Federal Home
Loan Bank of Boston announced to their members that it has suspended its
dividend payment for the first quarter of 2009 and it is unlikely that it will
pay dividends in 2009.  In addition, the Federal Home Loan Bank of
Boston also stated the moratorium on excess stock repurchases declared in
December 2008 will continue during 2009.





Federal
Reserve System





The Federal Reserve Board regulations
require savings institutions to maintain non-interest earning reserves against
their transaction accounts (primarily Negotiable Order of Withdrawal (NOW) and
regular checking accounts).  The regulations generally provide that
reserves be maintained against aggregate transaction accounts as
follows:  a 3% reserve ratio is assessed on net transaction accounts
up to and including $44.4 million; a 10% reserve ratio is applied above $44.4
million.  The first $10.3 million of otherwise reservable balances
(subject to adjustments by the Federal Reserve Board) are exempted from the
reserve requirements.  The amounts are adjusted
annually.  The Bank complies with the foregoing
requirements.





Federal
Securities Laws





Newport Bancorp’s common stock is
registered with the Securities and Exchange Commission under the Securities
Exchange Act of 1934.  Newport Bancorp is subject to the information,
proxy solicitation, insider trading restrictions and other requirements under
the Securities Exchange Act of 1934.





Other
Regulations




Troubled Assets
Relief Program.  On October 3, 2008, the Emergency Economic
Stabilization Act of 2008 (“EESA”) was enacted.  The EESA provides the
U.S. Secretary of the Treasury with broad authority to implement certain actions
to help restore stability and liquidity to U.S. markets. One of the programs
resulting from the legislation is the Troubled Asset Relief Program Capital
Purchase Program (“CPP”), which provides direct equity investment in perpetual
preferred stock by the U.S. Treasury Department in qualified financial
institutions. The program is voluntary and requires an institution to comply
with a number of restrictions and provisions, including limits on executive
compensation, stock redemptions and declaration of dividends.  The CPP
provides for a minimum investment of one percent of total risk-weighted assets
and a maximum investment equal to the lesser of three percent of total
risk-weighted assets or $25 billion. The Bank opted not to participate in the
CPP.




13
 Index





On February 10, 2009, the U.S.
Department of the Treasury announced its Capital Assistance Program (“CAP”)
under which Treasury will make capital available to financial institutions
through Treasury’s purchase of cumulative mandatorily convertible preferred
stock. The preferred shares will mandatorily convert to common stock after seven
years. Prior to that time, the preferred shares are convertible in whole or in
part at the option of the institution, subject to the approval of the
institution’s primary federal regulator.  The minimum investment is an
amount equal to 1% of risk-weighted assets and the maximum is an amount equal to
2% of risk-weighted assets. Institutions may receive additional capital to the
extent such funds are used to redeem preferred shares issued in the CPP,
effectively exchanging the CAP convertible preferred stock for the preferred
stock sold under the CPP.   The Bank has not yet determined
whether it will participate in the CAP, or the amount of any investment it would
apply for if it does decide to participate.  The deadline for applying
for participation in the CAP is May 25, 2009.





ITEM1A.     
         RISK FACTORS





Our
business may be adversely affected by conditions in the financial markets and
economic conditions generally.





Since December 2007, the United States
has been in a recession. Business activity across a wide range of industries and
regions is greatly reduced and local governments and many businesses are in
serious difficulty due declines in revenues, the lack of consumer spending and
the lack of liquidity in the credit markets. Unemployment has increased
significantly. During 2008 and early 2009, the business environment has been
adverse for many households and businesses in the United States and worldwide.
It is expected that the business environment in the Company’s markets, the
United States and worldwide may continue to weaken for the near future. There
can be no assurance that these conditions will improve in the near term. Such
conditions could adversely affect the credit quality of the Company’s loans,
results of operations and financial condition.





Market conditions have also led to the
failure or merger of a number of prominent financial institutions. Financial
institution failures or near-failures have resulted in further losses as a
consequence of defaults on securities issued by them and defaults under
contracts entered into with such entities as counterparties. Furthermore,
declining asset values, defaults on mortgages and consumer loans, and the lack
of market and investor confidence, as well as other factors, have all combined
to increase the cost and decrease the availability of liquidity, despite very
significant declines in Federal Reserve borrowing rates and other government
actions. Some banks and other lenders have suffered significant losses and have
become reluctant to lend, even on a secured basis, due to the increased risk of
default and the impact of declining asset values on the value of collateral. The
foregoing has significantly weakened the strength and liquidity of some
financial institutions worldwide.





A
continued decline in real estate values could impact our profits.





Nearly all of Newport Federal’s loans
are secured by real estate in the State of Rhode Island.  As a result
of this concentration, a downturn in the local economy could cause significant
increases in nonperforming loans, which would impact the Bank’s
profits.  According to the Rhode Island State-Wide Multiple Listing
Service, the median price of a single family home sold in 2008 was 14.58% lower
than it was in 2007 ($234,900 versus $275,000).  A continued decline
in real estate values could cause some of Newport Federal’s mortgage loans to
become inadequately collateralized, which would expose the Bank to a greater
risk of loss.  Additionally, a decline in real estate values could
adversely impact the Bank’s portfolio of commercial real estate loans and could
result in a decline in the origination of such loans.





Changes
in interest rates may reduce our profits.





Net interest income is our largest
source of income.  Changes in interest rates can affect the level of
net interest income. The Company’s interest rate sensitivity is discussed in
more detail in Item 7 of this report.  We principally manage interest
rate risk by managing our volume and mix of our earning assets and funding
liabilities. In a changing interest rate environment, we may not be able to
manage this risk effectively. If we are unable to manage interest rate risk
effectively, our business, financial condition and results of operations could
be materially harmed.  Changes in interest rates can also affect the
demand for our products and services, and the supply conditions in the U.S.
financial and capital markets.  Changes in the level of interest rates
may negatively affect our




14
 Index







If
we do not achieve profitability on new branches, they may negatively impact our
earnings.





We opened our Portsmouth, Rhode Island
branch office in January 2009, and we expect to open another new branch in
Stonington, Connecticut in May 2009.   Numerous factors
contribute to the performance of a new branch, such as a suitable location,
qualified personnel and an effective marketing
strategy.  Additionally, it takes time for a new branch to generate
significant deposits and make sufficient loans to produce enough income to
offset expenses, some of which, like salaries and occupancy expense, are
relatively fixed costs. We expect that it may take a period of time before the
new branch offices can become profitable. During this period, operating these
new branch offices may negatively impact our net income.





Strong
competition within our market area could affect our profits and slow
growth.





Newport Federal faces intense
competition both in making loans and attracting deposits.  This
competition has made it more difficult for the Bank to make new loans and
attract deposits.  Price competition for loans and deposits might
result in the Bank earning less on the Bank’s loans and paying more on the
Bank’s deposits, which would reduce net interest income.  Competition
also makes it more difficult to grow loans and deposits.  At June 30,
2008, which is the most recent date for which data is available from the Federal
Deposit Insurance Corporation (“FDIC”), Newport Federal held approximately
11.46% of the deposits in Newport County, Rhode Island and approximately 4.02%
of the deposits in Washington County, Rhode Island.   Some of the
institutions with which the Bank competes have substantially greater resources
and lending limits than Newport Federal has and may offer services that the Bank
does not provide.  Newport Federal expects competition to increase in
the future as a result of legislative, regulatory and technological changes and
the continuing trend of consolidation in the financial services
industry.





Due to the interventions of the federal
government, some of the institutions that we compete with are receiving
substantial federal financial support which may not be available to our
Company.  Many institutions have been allowed to convert to banking
charters and to offer insured deposits for the first time.  The
federal government has guaranteed money market funds which traditionally compete
with bank deposits.  The federal government has offered significant
guarantees of new debt issuances to some of the Company’s competitors to help
them fund their operations.  The federal government now controls
Fannie Mae and Freddie Mac and may operate directly as a competitor in some
lending markets in the future.  Emergency measures designed to support
some of the Company’s competitors may provide no advantage to the Company or
place it at a disadvantage.   Emergency changes in deposit
insurance, financial market regulation, bank regulation, and policy of the
Federal Home Loan Bank system may all affect the competitive environment for the
Company and other market participants.  Our profitability depends upon
our continued ability to compete successfully in our market area.





Our
allowance for loan losses may prove to be insufficient to absorb losses in our
loan portfolio.





Like all financial institutions, we
maintain an allowance for loan losses to provide for loans in our portfolio that
may not be repaid in their entirety. We believe that our allowance for loan
losses is maintained at a level adequate to absorb probable losses inherent in
our loan portfolio as of the corresponding balance sheet date. However, our
allowance for loan losses may not be sufficient to cover actual loan losses, and
future provisions for loan losses could materially and adversely affect our
operating results.  The accounting measurements related to impairment
and the loan loss allowance require significant estimates which are subject to
uncertainty and changes relating to new information and changing
circumstances.  Our estimates of the risk of loss and amount of loss
on any loan are complicated by the significant uncertainties surrounding our
borrowers’ abilities to successfully execute their business models through
changing economic environments, competitive challenges and other factors.
Because of the degree of uncertainty and susceptibility of these factors to
change, our actual losses may vary from our current estimates.





Our regulators, as an integral part of
their examination process, periodically review our allowance for loan losses and
may require us to increase our allowance for loan losses by recognizing
additional provisions for loan losses charged to expense, or to decrease our
allowance for loan losses by recognizing loan charge-offs, net of




15
 Index







Our
expenses will increase as a result of increases in Federal Deposit Insurance
Corporation insurance premiums.





The FDIC imposes an assessment against
financial institutions for deposit insurance. This assessment is based on the
risk category of the institution and currently ranges from 5 to 43 basis points
of the institution’s deposits. The FDIC has issued final rules that increase the
current deposit insurance assessment rates to a range from 12 to 45 basis points
beginning April 1, 2009.  Additionally, the FDIC has issued an interim
rule that would impose a special 20 basis points assessment on deposits as of
June 30, 2009, which would be paid on September 30, 2009. The increase in the
assessment rates and the special assessment will increase our
expenses.





Continued
or further declines in the value of certain investment securities could require
write-downs, which would reduce our earnings.





At December 31, 2008, the Company
recognized a $706,000 impairment charge for the Bank’s holding in the AMF Ultra
Short Mortgage Fund.  The AMF Ultra Short Mortgage Fund has invested
in private label mortgage-backed securities and US Government Agency and
government sponsored agency securities. Although management believes it is
possible that all principal and interest payments will be received, general
market concerns over these and similar types of securities has caused the fair
value to decline severely enough to warrant an other-than-temporary impairment
charge.  Given the significant uncertainty and illiquidity in the
markets for such securities, the Bank cannot be certain that future impairment
charges will not be required against this investment, which had a remaining book
value of $2.0 million at December 31, 2008 (net of impairment charges), or on
other investment securities held by the Bank.





If
dividends paid on our investment in the Federal Home Loan Bank of Boston
continue to be suspended, or if our investment is classified as
other-than-temporarily impaired or as permanently impaired, our earnings and/or
stockholders’ equity could decrease.





We own common stock of the Federal Home
Loan Bank of Boston (“FHLBB”) to qualify for membership in the Federal Home Loan
Bank System and to be eligible to borrow funds under the FHLBB’s advance
program.  There is no market for our FHLBB common stock. On February
26, 2009, the FHLBB reported a net annual loss of $73.2 million. The loss was
primarily due to a other-than-temporary impairment charge of $339.1 million on
its private-label mortgage backed securities portfolio. The FHLBB believes that
it will recover a substantial portion of the impairment losses over time and
expects to hold the securities until maturity. As a result of the loss, the
FHLBB also announced that the dividend paid on its common stock has been
suspended indefinitely and that the payment of any dividend in 2009 is
unlikely.  The continued suspension of the dividend will decrease our
income.  In an extreme situation, it is possible that the
capitalization of a Federal Home Loan Bank, including the FHLBB, could be
substantially diminished or reduced to zero. Consequently, we believe that there
is a risk that our investment in FHLBB common stock could be deemed
other-than-temporarily impaired at some time in the future, and if this occurs,
it would cause our earnings and stockholders’ equity to decrease by the
after-tax amount of the impairment charge.  We have been notified by
the FHLBB that future dividend levels may be different from past levels, and a
reduction or elimination of this dividend would reduce our
earnings.





Economic
conditions may adversely affect our liquidity.





In the past year, significant declines
in the values of mortgage-backed securities and derivative securities issued by
financial institutions, government sponsored entities, and major commercial and
investment banks has led to decreased confidence in financial markets among
borrowers, lenders, and depositors, as well as disruption and extreme volatility
in the capital and credit markets and the failure of some entities in the
financial sector. As a result, many lenders and institutional investors have
reduced or ceased to provide funding to borrowers. Continued turbulence in the
capital and credit markets may adversely affect our liquidity and financial
condition and the willingness of certain counterparties and customers to do
business with us.





16
 Index





Future
legislative or regulatory actions responding to perceived financial and market
problems could impair our rights against borrowers.





As a result of the recent financial
crisis, the potential exists for the promulgation of new federal or state laws
and regulations regarding lending and funding practices and liquidity standards,
and bank regulatory agencies are expected to be active in responding to concerns
and trends identified in examinations, which are expected to result in the
issuance of many formal enforcement orders. Negative developments in the
financial services industry and the credit markets, and the impact of new
legislation in response to these developments, may negatively affect our
operations by restricting our business operations, including our ability to
originate or sell loans and pursue business opportunities. Compliance with such
regulation also will likely increase our costs.





There have been proposals made by
members of Congress and others that would reduce the amount distressed borrowers
are otherwise contractually obligated to pay under their mortgage loans and
limit an institution’s ability to foreclose on mortgage collateral. Were
proposals such as these, or other proposals limiting our rights as a creditor,
to be implemented, we could experience increased credit losses or increased
expense in pursuing our remedies as a creditor.




ITEM1B.
            UNRESOLVED
      STAFF COMMENTS





None.


17
 Index




ITEM2.
            PROPERTIES





We
conduct our business through our main office and branch offices.  The
following table sets forth certain information relating to these facilities as
of December 31, 2008.





Location
                                    
                                    Year
                                      Opened
                                    
                                    Square
                                      Footage
                                    
                                    Date
      of
                                      Lease
                                      Expiration
                                    
                                    Owned/
                                      Leased
                                    
                                    Net
      Book Value(Dollars
      in thousands)Main
      Office:100
      Bellevue Avenue
                                      Newport,
      RI  02840
                                    
                                    1964
                                    
                                    
                                    12,000
                                    
                                    N/A
                                    
                                    Owned
                                    
                                    $
                                    2,580Branches:165
      East Main Road
                                      Middletown,
      RI  02842
                                    
                                    1978
                                    
                                    
                                    3,000
                                    
                                    05/30/2020
                                    
                                    Leased
                                    
                                    $
                                    5491430
      East Main Road
                                      Portsmouth,
      RI  02871
                                    
                                    2009
                                    
                                    
                                    6,754
                                    
                                    N/A
                                    
                                    Owned
                                    
                                    $
                                    4,794121
      Old Tower Hill Road
                                      Wakefield,
      RI  02879
                                    
                                    1996
                                    
                                    
                                    3,000
                                    
                                    05/14/2011
                                    
                                    Leased
                                    
                                    $
                                    1358
      Union Street
                                      Westerly,
      RI  02891
                                    
                                    1958
                                    
                                    
                                    5,000
                                    
                                    N/A
                                    
                                    Owned
                                    
                                    $
                                    8302
      Wilder Avenue
                                      Westerly,
      RI  02891
                                    
                                    2001
                                    
                                    
                                    1,200
                                    
                                    N/A
                                    
                                    Owned
                                    
                                    $
                                    536445
      Liberty Street
                                      Stonington,
      CT 06379
                                    
                                    2009
                                    
                                    
                                    3,500
                                    
                                    4/30/2029
                                    
                                    Leased
                                    
                                    $
                                    586




ITEM3.
            LEGAL
      PROCEEDINGS





Periodically, there have been various
claims and lawsuits against us, such as claims to enforce liens, condemnation
proceedings on properties in which we hold security interests, claims involving
the making and servicing of real property loans and other issues incident to our
business.  Newport Federal is not a party to any pending legal
proceedings that we believe would have a material adverse effect on our
financial condition, results of operations or cash flows.





ITEM4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS





None.





18
 Index





PART
II





ITEM5.
            MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES





Market
and Dividend Information.





The Company’s common stock is listed on
the Nasdaq Global Market (“NASDAQ”) under the trading symbol
“NFSB.”





The following table sets forth the high
and low sales prices of the Company’s common stock since trading commenced, as
reported by NASDAQ.  The Company has not paid any dividends to
stockholders to date.  See “Dividends” below.





High
                
                
                Low2008:First
      Quarter
                
                $
                12.85
                
                
                $
                11.40Second
      Quarter
                
                $
                13.00
                
                
                $
                11.60Third
      Quarter
                
                $
                12.54
                
                
                $
                11.60Fourth
      Quarter
                
                $
                12.29
                
                
                $
                10.632007:First
      Quarter
                
                $
                14.00
                
                
                $
                13.52Second
      Quarter
                
                $
                13.99
                
                
                $
                13.16Third
      Quarter
                
                $
                13.54
                
                
                $
                11.61Fourth
      Quarter
                
                $
                12.75
                
                
                $
                11.25





Holders.





As of March 12, 2009, there were
approximately 612 holders of record of the Company’s common stock.





Dividends.





The Company has not paid any dividends
to its stockholders to date.  The payment of dividends in the future
will depend upon a number of factors, including capital requirements, the
Company’s financial condition and results of operations, tax considerations,
statutory and regulatory limitations and general economic
conditions.  In addition, the Company’s ability to pay dividends is
dependent on dividends received from Newport Federal.  For more
information regarding restrictions on the payment of cash dividends by the
Company and by Newport Federal, see “Business—Regulation and Supervision—Holding
Company Regulation” and “— Regulation and Supervision—Federal Savings
Institution Regulation—Limitation on Capital Distributions” and Note 10 to the
Consolidated Financial Statements included in this Annual Report.  No
assurances can be given that any dividends will be paid or that, if paid, will
not be reduced or eliminated in the future.




Securities
Authorized for Issuance under Equity Compensation Plans.





See Part III,  Item 12(d)
Equity Compensation Plan  Information, in this Annual Report on Form
10-K, for the table
providing information as of December 31, 2008 about Company common stock that
may be issued upon the exercise of options under the Newport Bancorp, Inc. 2007
Equity Incentive Plan.  The plan was approved by the Company’s
shareholders at the August 16, 2007 Annual Meeting of Stockholders.





19
 Index





Recent
Sales of Unregistered Securities; Use of Proceeds from Registered
Securities.





Not
applicable.





Purchases of Equity Securities by the
Issuer and Affiliated Purchasers.





The following table provides certain
information with regard to shares repurchased by the Company in the fourth
quarter of 2008.




Period
                
                (a)
                  Total
      Number of Shares Purchased
                
                
                (b)
                  Average
      Price Paid per Share
                
                
                (c)
                  Total
      Number of Shares Purchased as Part of Publicly Announced Plans or
      Programs(1)
                
                
                (d)
                  Maximum
      Number of Shares that May Yet Be Purchased Under the Plans or
      Programs(1)October
      1 - October 31
                
                
                83,500
                
                
                $
                11.61
                
                
                
                83,500
                
                
                
                308,750November
      1 - November 30
                
                
                77,000
                
                
                $
                11.21
                
                
                
                77,00
                
                
                
                231,570December
      1 - December 31
                
                
                6,200
                
                
                $
                11.09
                
                
                
                6,200
                
                
                
                225,370Total
                
                
                166,700
                
                
                $
                11.40
                
                
                
                166,700










(1) On
July 25, 2008, the Company announced the commencement of a stock repurchase
program to acquire up to 440,270 shares, or 10%, of the Company’s then
outstanding common stock.  At December 31, 2008, the Company has
purchased 214,900 shares under this program, at an average cost of
$11.56.  Repurchases, which are conducted through open market
purchases or privately negotiated transactions, are made from time to time
depending on market conditions and other factors.  On March 12, 2009,
the Company announced it had completed this stock repurchase program, acquiring
440,270 shares at an average cost of $11.54 per share.




20
 Index





ITEM6.
            SELECTED
      FINANCIAL DATA





At
      or For the Year Ended December 31,2008
                                                                              
                                                                              
                                                                              2007
                                                                              
                                                                              
                                                                              2006Performance
      Ratios:Return
      on average assets
                                                                              
                                                                              
                                                                              (0.22
                                                                              )%
                                                                              
                                                                              
                                                                              0.24
                                                                              %
                                                                              
                                                                              
                                                                              (0.59
                                                                              )%Return
      on average equity
                                                                              
                                                                              
                                                                              (1.47
                                                                              )
                                                                              
                                                                              
                                                                              1.25
                                                                              
                                                                              
                                                                              
                                                                              (4.32
                                                                              )Interest
      rate spread (1)
                                                                              
                                                                              
                                                                              2.76
                                                                              
                                                                              
                                                                              
                                                                              2.68
                                                                              
                                                                              
                                                                              
                                                                              2.97Net
      interest margin (2)
                                                                              
                                                                              
                                                                              3.32
                                                                              
                                                                              
                                                                              
                                                                              3.55
                                                                              
                                                                              
                                                                              
                                                                              3.67Non-interest
      expense to average assets
                                                                              
                                                                              
                                                                              3.29
                                                                              
                                                                              
                                                                              
                                                                              3.46
                                                                              
                                                                              
                                                                              
                                                                              4.68Efficiency
      ratio (3)
                                                                              
                                                                              
                                                                              90.08
                                                                              
                                                                              
                                                                              
                                                                              85.90
                                                                              
                                                                              
                                                                              
                                                                              84.94Average
      interest-earning assets to average interest-bearing
      liabilities
                                                                              
                                                                              
                                                                              121.01
                                                                              
                                                                              
                                                                              
                                                                              132.77
                                                                              
                                                                              
                                                                              
                                                                              130.13Average
      equity to average assets
                                                                              
                                                                              
                                                                              14.66
                                                                              
                                                                              
                                                                              
                                                                              19.28
                                                                              
                                                                              
                                                                              
                                                                              13.56Capital
      Ratios (Bank Only):Tangible
      capital
                                                                              
                                                                              
                                                                              8.9
                                                                              
                                                                              
                                                                              
                                                                              10.8
                                                                              
                                                                              
                                                                              
                                                                              13.0Core
      capital
                                                                              
                                                                              
                                                                              8.9
                                                                              
                                                                              
                                                                              
                                                                              10.8
                                                                              
                                                                              
                                                                              
                                                                              13.0Total
      risk-based capital
                                                                              
                                                                              
                                                                              14.3
                                                                              
                                                                              
                                                                              
                                                                              16.9
                                                                              
                                                                              
                                                                              
                                                                              19.5Asset
      Quality Ratios:Allowance
      for loan losses as a percent of total loans (4)
                                                                              
                                                                              
                                                                              0.87
                                                                              
                                                                              
                                                                              
                                                                              0.81
                                                                              
                                                                              
                                                                              
                                                                              0.76Allowance
      for loan losses as a percent of nonperforming loans
                                                                              
                                                                              
                                                                              N/M
                                                                              
                                                                              
                                                                              
                                                                              264.21
                                                                              
                                                                              
                                                                              
                                                                              N/MNet
      charge-offs to average outstanding loans during the period
                                                                              
                                                                              
                                                                              0.01
                                                                              
                                                                              
                                                                              
                                                                              0.00
                                                                              
                                                                              
                                                                              
                                                                              0.00Non-performing
      loans as a percent of total loans (4)
                                                                              
                                                                              
                                                                              0.00
                                                                              
                                                                              
                                                                              
                                                                              0.31
                                                                              
                                                                              
                                                                              
                                                                              0.00








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


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


(3)
            Represents
      non-interest expense minus the expense related to the contribution to the
      NewportFed Charitable Foundation in 2006 divided by the sum of net
      interest income and non-interest income. The December 31, 2008 ratio
      represents non-interest expense divided by the sum of net interest income
      and non-interest income, excluding the $706,000 impairment charge incurred
      in 2008.


(4)
            Loans
      are presented before the allowance for loan losses but include deferred
      costs/fees.  Construction loans are included net of loans in
      process.  Loans held for sale are
  included.


N/M
            Not
      meaningful because there are no nonperforming loans and, consequently, the
      denominator in the ratio was zero.






ITEM7.
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATION





Overview





Income.Newport Federal’s
primary source of pre-tax income is net interest income.  Net interest
income is the difference between interest income, which is the income that we
earn on our loans and investments, and interest expense, which is the interest
that the Bank pays on deposits and borrowings.  Other significant
sources of




21
 Index







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





Expenses.  The
non-interest expenses Newport Federal incurs in operating the Bank’s business
consist of compensation and employee benefits expenses, occupancy expenses, data
processing expenses and other miscellaneous expenses.





Compensation and employee benefits
consist primarily of salaries and wages paid to the Bank’s employees,
stock-based compensation, payroll taxes, expenses for health insurance,
retirement plans, and other employee benefits.





Occupancy expenses, which are the fixed
and variable costs of buildings and equipment, consist primarily of depreciation
charges, furniture and equipment expenses, maintenance, real estate taxes and
costs of utilities. Depreciation of premises and equipment is computed using the
straight-line method based on the useful lives of the related assets, which
range from three to forty years.  Leasehold improvements are amortized
over the shorter of the useful life of the asset or the expected term of the
lease.  The expected term includes lease option periods to the extent
that the exercise of such options is reasonably assured.





Data processing expenses are the fees
paid to third parties for processing customer information, deposits and
loans.





Other expenses include expenses for
professional services, advertising, office supplies, postage, telephone,
insurance, charitable contributions, regulatory assessments, FDIC deposit
insurance and other miscellaneous operating expenses.





Critical
Accounting Policies





Newport Bancorp considers accounting
policies involving significant judgments and assumptions by management that
have, or could have, a material impact on the carrying value of certain assets
or on results of operations to be critical accounting policies. The Company
considers the allowance for loan losses, other-than-temporary impairment of
securities and the valuation of the net deferred tax asset to be our critical
accounting policies.





Allowance
for Loan Losses.





The allowance for loan losses is the
amount estimated by management as necessary to cover losses inherent in the loan
portfolio at the balance sheet date. The allowance is established through the
provision for loan losses, which is charged to earnings. Loan losses are charged
against the allowance when management believes the uncollectibility of a loan
balance is confirmed.  Subsequent recoveries, if any, are credited to
the allowance.





Determining the amount of the allowance
for loan losses necessarily involves a high degree of judgment. Management
evaluates the level of the allowance at least quarterly and establishes the
provision for loan losses based upon a review of the collectability of the loans
in light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower’s ability to repay, estimated
value of any underlying collateral, prevailing economic conditions and other
factors related to the collectability of the loan portfolio. This evaluation is
inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available. Although management
uses the best information available to establish the allowance for loan losses,
future adjustments to the allowance may be necessary if economic conditions
differ substantially from the assumptions used in making the evaluation. In
addition, the Office of Thrift Supervision, as an integral part of its
examination process, periodically reviews Newport Federal’s allowance for loan
losses. Such agency may require the Bank to recognize adjustments to the
allowance based on its judgments about information available to it




22
 Index







The allowance consists of general and
unallocated loss components.  For loans that are classified as
impaired, an allowance is established when the collateral value of the impaired
loan is lower than the carrying value of that loan.  The general
component covers non-impaired loans and is based on historical loss experience
adjusted for qualitative factors.  An unallocated component is
maintained to cover uncertainties that could affect management’s estimate of
probable losses.  The unallocated component of the allowance reflects
the margin of imprecision inherent in the underlying assumptions used in the
methodologies for estimating the general losses in the portfolio.





A loan is considered impaired when,
based on current information and events, it is probable that the Company will be
unable to collect the scheduled payments of principal or interest when due
according to the contractual terms of the loan agreement.  Factors
considered by management in determining impairment include payment status,
collateral value, and the probability of collecting scheduled principal and
interest payments when due.  Impairment is measured on a loan by loan
basis by the fair value of the collateral.





Large groups of smaller balance
homogeneous loans are collectively evaluated for
impairment.  Accordingly, the Company does not separately identify
individual consumer and residential loans for impairment
disclosures.





Other-Than-Temporary
Impairment.





In estimating other than temporary
impairment losses, management considers (1) the length of time and the extent to
which the fair value has been less than cost, (2) the financial condition of the
issuer, and (3) the intent and ability of the Bank to retain its investment in
the issuer for a period of time sufficient to allow for any anticipated
recovery  in fair value.





Income Taxes.





Management considers accounting for
income taxes as a critical accounting policy due to the subjective nature of
certain estimates that are involved in the calculation.  Newport
Federal uses the asset and liability method of accounting for income taxes.
Under this method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases.  A valuation allowance related to deferred tax
assets is established when, in the judgment of management, it is more likely
than not that all or a portion of such deferred tax assets will not be
realized.  The Bank assesses the realizability of its deferred tax
assets by (1) reviewing taxable income in allowable federal carry-back periods,
and (2) assessing the likelihood of the Bank generating federal and state
taxable income, as applicable, in future periods in amounts sufficient to offset
the deferred tax charges they are expected to reverse.  Adjustments to
increase or decrease the valuation allowance are generally charged or credited,
respectively, to income tax expense.


Balance
Sheet Analysis





Overview.During
2008, the Company’s assets increased by $71.1 million, or 19.7%, to $432.3
million.  The majority of the asset growth was concentrated in net
loans, which increased by $39.9 million, and securities held to maturity, which
increased by $21.3 million.  The asset growth was principally funded
by a $40.1 million, or 38.0%, increase in borrowings, of which $15.0 million was
used to purchase securities, and deposit growth of $35.8 million.




Loans.Newport Federal’s
primary lending activity is the origination of loans secured by real
estate.  The Bank originates one-to-four family residential loans,
commercial real estate and multi-family loans and home equity
loans.  To a lesser extent, Newport Federal originates construction
loans and consumer loans.  Net loans increased from $293.1 million at
December 31, 2007 to $333.0 million at December 31, 2008, or
13.6%.  Net loans represented 77.03% of total assets at December 31,
2008.




23
 Index





The largest segment of the Bank’s loan
portfolio is one-to-four family residential loans, but the percentage of
one-to-four family loans as a percentage of total loans decreased in both 2008
and 2007 due to increases in other lending, particularly, multi-family and
commercial real estate lending.





One-to-four family loans totaled $183.8
million and represented 54.5% of total loans at December 31, 2008, compared to
$169.2 million, or 57.1% of total loans at December 31, 2007.  The
Bank offers fixed and adjustable rate one-to-four family residential loans. At
December 31, 2008, the Bank had $164.5 million in fixed rate and $19.3 million
in adjustable rate one-to-four family loans.





Commercial real estate loans totaled
$93.6 million and represented 27.8% of total loans at December 31, 2008,
compared to $76.9 million, or 26.0% of total loans at December 31,
2007.  The increase of $16.7 million, or 21.7%, was a result of the
Company’s concerted efforts to expand its commercial loan
portfolio.





Multi-family loans totaled $17.4
million, or 5.2% of total loans at December 31, 2008, compared to $9.5 million,
or 3.2% of total loans at December 31, 2007.  Construction loans
totaled $11.2 million, representing 3.3% of total loans at December 31, 2008,
compared to $9.4 million or 3.2% of total loans at December 31,
2007.





Home equity loans and lines totaled
$30.4 million, representing 9.0% of total loans at December 31, 2008, compared
to $30.9 million at December 31, 2007.





The Bank also originates consumer loans
secured by automobiles or passbook or certificate accounts.  Consumer
loans totaled $601,000 at December 31, 2008, compared to $442,000 at December
31, 2007.





24
 Index





The
following table sets forth the composition of the Bank’s loan portfolio at the
dates indicated.





At
      December 31,2008
                                                                                                              
                                                                                                              
                                                                                                              2007
                                                                                                              
                                                                                                              
                                                                                                              2006
                                                                                                              
                                                                                                              
                                                                                                              2005
                                                                                                              
                                                                                                              
                                                                                                              2004Amount
                                                                                                              
                                                                                                              
                                                                                                              Percent
                                                                                                              
                                                                                                              
                                                                                                              Amount
                                                                                                              
                                                                                                              
                                                                                                              Percent
                                                                                                              
                                                                                                              
                                                                                                              Amount
                                                                                                              
                                                                                                              
                                                                                                              Percent
                                                                                                              
                                                                                                              
                                                                                                              Amount
                                                                                                              
                                                                                                              
                                                                                                              Percent
                                                                                                              
                                                                                                              
                                                                                                              Amount
                                                                                                              
                                                                                                              
                                                                                                              Percent(Dollars
      in thousands)Real
      estate-mortgage:One-to-four
      family
                                                                                                              
                                                                                                              $
                                                                                                              183,767
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              54.53
                                                                                                              %
                                                                                                              
                                                                                                              $
                                                                                                              169,179
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              57.08
                                                                                                              %
                                                                                                              
                                                                                                              $
                                                                                                              157,448
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              60.67
                                                                                                              %
                                                                                                              
                                                                                                              $
                                                                                                              152,385
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              64.90
                                                                                                              %
                                                                                                              
                                                                                                              $
                                                                                                              137,790
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              62.96
                                                                                                              %Multi-family
                                                                                                              
                                                                                                              
                                                                                                              17,379
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              5.16
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              9,494
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              3.20
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              9,360
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              3.61
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              6,726
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              2.87
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              5,809
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              2.65Commercial
                                                                                                              
                                                                                                              
                                                                                                              93,632
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              27.78
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              76,919
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              25.95
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              57,650
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              22.21
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              47,742
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              20.33
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              46,406
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              21.20Home
      equity loans and lines
                                                                                                              
                                                                                                              
                                                                                                              30,425
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              9.03
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              30,934
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              10.44
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              29,275
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              11.28
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              23,538
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              10.02
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              19,714
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              9.01Total
      real estate-mortgage
                                                                                                              
                                                                                                              
                                                                                                              325,203
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              96.50
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              286,526
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              96.67
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              253,733
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              97.77
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              230,391
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              98.12
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              209,719
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              95.82Construction
                                                                                                              
                                                                                                              
                                                                                                              11,204
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              3.32
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              9,427
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              3.18
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              4,685
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              1.80
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              3,151
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              1.34
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              7,712
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              3.52Consumer
                                                                                                              
                                                                                                              
                                                                                                              601
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              0.18
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              442
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              0.15
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              1,112
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              0.43
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              1,263
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              0.54
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              1,437
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              0.66Total
      loans
                                                                                                              
                                                                                                              
                                                                                                              337,008
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              100.00
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              296,395
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              100.00
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              259,530
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              100.00
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              234,805
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              100.00
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              218,868
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              100.00
                                                                                                              %Allowance
      for losses
                                                                                                              
                                                                                                              
                                                                                                              (2,924
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (2,399
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (1,973
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (1,853
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (1,655
                                                                                                              )Net
      deferred loan fees
                                                                                                              
                                                                                                              
                                                                                                              (1,055
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (912
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (791
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (626
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (602
                                                                                                              )Loans,
      net
                                                                                                              
                                                                                                              $
                                                                                                              333,029
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              293,084
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              256,766
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              232,326
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              216,611





25
 Index





The
following table sets forth certain information at December 31, 2008
regarding the dollar amount of loan principal repayments coming due during the
periods indicated.  The table does not include any estimate of
prepayments, which significantly shorten the average life of all loans and may
cause our actual repayment experience to differ from that shown
below.  Demand loans having no stated schedule of repayments and no
stated maturity are reported as due in one year or less.





One-to-Four
                    Family
      Real Estate
                    Loans
                  
                  
                  Multi-
                    Family
                    Real
      Estate
                    Loans
                  
                  
                  Commercial
                    Real
      Estate Loans
                  
                  
                  Home
                    Equity
      Loans &
                    Lines(Dollars
      in thousands)Amounts
      due in:One
      year or less
                  
                  $
                  10
                  
                  
                  $
                  625
                  
                  
                  $
                  3,447
                  
                  
                  $
                  78More
      than one year to five years
                  
                  
                  4,220
                  
                  
                  
                  3,393
                  
                  
                  
                  11,465
                  
                  
                  
                  2,412More
      than five years to ten years
                  
                  
                  15,353
                  
                  
                  
                  12,236
                  
                  
                  
                  72,416
                  
                  
                  
                  12,248More
      than ten years to twenty years
                  
                  
                  38,922
                  
                  
                  
                  304
                  
                  
                  
                  6,213
                  
                  
                  
                  15,687More
      than twenty years
                  
                  
                  125,262
                  
                  
                  
                  821
                  
                  
                  
                  91
                  
                  
                  
                  -Total
                  
                  $
                  183,767
                  
                  
                  $
                  17,379
                  
                  
                  $
                  93,632
                  
                  
                  $
                  30,425





Construction
      Loans
                  
                  
                  Consumer
      Loans
                  
                  
                  Total
                    Loans(Dollars
      in thousands)Amounts
      due in:One
      year or less
                  
                  $
                  4,222
                  
                  
                  $
                  486
                  
                  
                  $
                  8,868More
      than one year to five years
                  
                  
                  4,527
                  
                  
                  
                  115
                  
                  
                  
                  26,132More
      than five years to ten years
                  
                  
                  2,455
                  
                  
                  
                  -
                  
                  
                  
                  114,708More
      than ten years to twenty years
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  61,126More
      than twenty years
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  126,174Total
                  
                  $
                  11,204
                  
                  
                  $
                  601
                  
                  
                  $
                  337,008





The following table sets forth the
dollar amount of all loans at December 31, 2008 that are due after
December 31, 2009 and have either fixed interest rates or floating or
adjustable interest rates.  The amounts shown below exclude the
allowance for loan losses and net deferred loan fees.





Fixed
      Rates
                  
                  
                  Floating
      or
                    Adjustable
      Rates
                  
                  
                  Total(Dollars
      in thousands)Real
      estate-mortgage loans:One-to-four
      family
                  
                  $
                  164,625
                  
                  
                  $
                  19,132
                  
                  
                  $
                  183,757Multi-family
                  
                  
                  5,542
                  
                  
                  
                  11,212
                  
                  
                  
                  16,754Commercial
                  
                  
                  34,611
                  
                  
                  
                  55,574
                  
                  
                  
                  90,185Home
      equity loans and lines
                  
                  
                  18,312
                  
                  
                  
                  12,035
                  
                  
                  
                  30,347Construction
                  
                  
                  -
                  
                  
                  
                  6,982
                  
                  
                  
                  6,982Consumer
                  
                  
                  115
                  
                  
                  
                  -
                  
                  
                  
                  115Total
                  
                  $
                  223,205
                  
                  
                  $
                  104,935
                  
                  
                  $
                  328,140





26
 Index





Securities.The securities portfolio
consists of mutual funds and mortgage-backed securities.





At
      December 31,2008
                
                
                2007
                
                
                2006Amortized
                  Cost
                
                
                Fair
                  Value
                
                
                Amortized
                  Cost
                
                
                Fair
                  Value
                
                
                Amortized
                  Cost
                
                
                Fair
                  Value(Dollars
      in thousands)Securities
      available for sale:Mutual
      funds
                
                $
                6,651
                
                
                $
                6,390
                
                
                $
                7,117
                
                
                $
                6,966
                
                
                $
                6,775
                
                
                $
                6,614Securities
      held to maturity:Mortgage-backed
      securities
                
                $
                52,162
                
                
                $
                54,198
                
                
                $
                30,886
                
                
                $
                30,751
                
                
                $
                1,922
                
                
                $
                1,869





All mortgage-backed securities are from
government sponsored enterprises.  Newport Federal had no investments
that had an aggregate book value in excess of 10% of our equity at December 31,
2008.





At December 31, 2008, the Company
recognized a $706,000 impairment charge for the Bank’s holding in the AMF Ultra
Short Mortgage Fund.  The AMF Ultra Short Mortgage Fund has invested
in private label mortgage-backed securities and US Government Agency and
government sponsored agency securities. Although management believes it is
possible that all principal and interest payments will be received, general
market concerns over these and similar types of securities has caused the fair
value to decline severely enough to warrant an other-than-temporary impairment
charge.  Given the significant uncertainty and illiquidity in the
markets for such securities, the Bank cannot be certain that future impairment
charges will not be required against this investment, which had a remaining book
value of $2.0 million at December 31, 2008 (net of impairment
charges).





27
 Index





The
following table sets forth the stated maturities and weighted average yields of
debt securities at December 31, 2008.





One
      Year
                                                or
      Less
                                              
                                              
                                              More
      than
                                                One
      Year to
                                                Five
      Years
                                              
                                              
                                              More
      than
                                                Five
      Years to
                                                Ten
      Years
                                              
                                              
                                              More
      than
                                                Ten
      Years
                                              
                                              
                                              TotalCarrying
                                                Value
                                              
                                              
                                              Weighted
      Average Yield
                                              
                                              
                                              Carrying
                                                Value
                                              
                                              
                                              Weighted
      Average Yield
                                              
                                              
                                              Carrying
                                                Value
                                              
                                              
                                              Weighted
      Average Yield
                                              
                                              
                                              Carrying
                                                Value
                                              
                                              
                                              Weighted
      Average Yield
                                              
                                              
                                              Carrying
                                                Value
                                              
                                              
                                              Weighted
      Average Yield(Dollars
      in thousands)Securities
      held to maturity:Mortgage-backed
      securities
                                              
                                              $
                                              -
                                              
                                              
                                              
                                              -
                                              %
                                              
                                              $
                                              1,297
                                              
                                              
                                              
                                              3.50
                                              %
                                              
                                              $
                                              -
                                              
                                              
                                              
                                              -
                                              %
                                              
                                              $
                                              50,865
                                              
                                              
                                              
                                              5.00
                                              %
                                              
                                              $
                                              52,162
                                              
                                              
                                              
                                              4.96
                                              %





28
 Index





Deposits.  Newport Federal’s
deposit base is comprised of demand deposits, money market and savings accounts
and time deposits.  The Bank considers demand deposits, money market
and savings accounts to be core deposits.  Deposits increased$35.8 million, or 18.5%,
for the year ended December 31, 2008.  Deposit growth was focused in
NOW/Demand accounts, which increased by $31.5 million, or 53.2%, and money
market accounts, which increased $10.8 million, or 37.5%.  These
increases were partially offset by a decrease in time deposit accounts of $6.1
million, or 7.7%, and a decrease in savings accounts of $372,000, or
1.4%.





The
following table sets forth the balances of the Bank’s deposit products at the
dates indicated.





At
      December 31,2008
                  
                  
                  2007
                  
                  
                  2006(Dollars
      in thousands)Noninterest-bearing
      demand deposits
                  
                  $
                  57,982
                  
                  
                  $
                  31,162
                  
                  
                  $
                  30,773Interest-bearing
      demand deposits
                  
                  
                  32,776
                  
                  
                  
                  28,061
                  
                  
                  
                  27,515Money
      market deposit accounts
                  
                  
                  39,540
                  
                  
                  
                  28,763
                  
                  
                  
                  21,356Regular
      savings
                  
                  
                  25,591
                  
                  
                  
                  25,963
                  
                  
                  
                  30,499Certificates
      of deposit
                  
                  
                  73,234
                  
                  
                  
                  79,336
                  
                  
                  
                  82,831Total
                  
                  $
                  229,123
                  
                  
                  $
                  193,285
                  
                  
                  $
                  192,974





The following table indicates the
amount of jumbo certificates of deposit by time remaining until maturity as of
December 31, 2008.  Jumbo certificates of deposit require minimum
deposits of $100,000.  The Bank does not offer special rates for jumbo
certificates.





Maturity
      Period
                    
                    Certificates
      of Deposit(Dollars
      in thousands)Three
      months or less
                    
                    $
                    1,625Over
      three through six months
                    
                    
                    3,472Over
      six through twelve months
                    
                    
                    14,802Over
      twelve months
                    
                    
                    2,067Total
                    
                    $
                    21,966





Borrowings.Newport Federal
utilizes borrowings from the Federal Home Loan Bank of Boston and repurchase
agreements to supplement the Bank’s supply of funds for loans and
investments.





Year
      Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006(Dollars
      in thousands)Maximum
      amount outstanding at any month end during the year
                      
                      $
                      145,490
                      
                      
                      $
                      105,356
                      
                      
                      $
                      66,384Average
      balance outstanding
                      
                      $
                      118,538
                      
                      
                      $
                      56,412
                      
                      
                      $
                      44,814Weighted
      average interest rate during the year
                      
                      
                      4.02
                      %
                      
                      
                      4.97
                      %
                      
                      
                      5.23
                      %Balance
      outstanding at end of period
                      
                      $
                      145,438
                      
                      
                      $
                      105,356
                      
                      
                      $
                      34,450Weighted
      average interest rate at end of year
                      
                      
                      3.73
                      %
                      
                      
                      4.14
                      %
                      
                      
                      5.05
                      %





Federal Home Loan Bank advancesincreased by $25.0
million to $105.4 million at December 31, 2008.  During 2008, the Bank
borrowed $15.0 million using a repurchase agreement.  These borrowings
were used to help fund loan originations and to purchase securities held to
maturity during 2008.  During 2007, the Bank borrowed $25.0 million
using a repurchase agreement.





29
 Index





Results
of Operations for the Years Ended December 31, 2008 and 2007





Overview.




2008
                  
                  
                  2007(Dollars
      in thousands)Net
      income (loss)
                  
                  $
                  (848
                  )
                  
                  $
                  757Return
      on average assets
                  
                  
                  (0.22
                  )%
                  
                  
                  0.24
                  %Return
      on average equity
                  
                  
                  (1.47
                  )%
                  
                  
                  1.25
                  %Average
      equity to average assets
                  
                  
                  14.66
                  %
                  
                  
                  19.28
                  %





Net loss in 2008 was $848,000 compared
to the net income of $757,000 in 2007. The decrease in non-interest income of
$743,000, the increase in non-interest expenses of $2.1 million and the increase
in the tax provision of $400,000, partially offset by increases in the Bank’s
net interest income of $1.8 million, contributed towards the net loss in
2008.  The $1.8 million increase in net interest income was primarily
the result of higher levels of interest-earning assets and an increase in the
interest rate spread, partially offset by expense from borrowings utilized to
fund the year’s asset growth.  The $743,000 decrease in non-interest
income is primarily a result of the $706,000 impairment charge recorded for the
Bank’s holding in the AMF Ultra Short Mortgage Fund.  Non-interest
expense for 2008 increased to $12.9 million from $10.8 million in 2007, an
increase of 19.2%.  The increase in non-interest expense between the
two years is primarily due to an increase of $1.7 million in salaries and
employee benefits, an increase of $160,000 in marketing costs, an increase of
$99,000 in data processing fees, and an overall increase in FDIC insurance costs
and other general operating costs.  The increase in salaries and
benefits is due to the stock-based compensation expense associated with stock
options and restricted stock awards granted on October 1, 2007.  There
was no stock-based compensation expense incurred during the first nine months of
2007.   Effective tax rates were 673.0% and 44.1% for 2008 and
2007, respectively.  The higher effective tax rate in 2008, was
primarily due to an increase in the valuation reserve against deferred tax
assets and the write-down of the state deferred tax assets in conjunction with
the formation of a passive investment company subsidiary.





30
 Index





Average Balances
and Yields.The following
table presents information regarding average balances of assets and liabilities,
the total dollar amounts of interest income and dividends from average
interest-earning assets, the total dollar amounts of interest expense on average
interest-bearing liabilities, and the resulting annualized average yields and
costs.  The yields and costs for the periods indicated are derived by
dividing income or expense by the average balances of assets or liabilities,
respectively, for the periods presented.  For purposes of this table,
average balances have been calculated using month-end balances, and nonaccrual
loans are included in average balances only.  Management does not
believe that use of month-end balances instead of daily average balances has
caused any material differences in the information presented.  None of
the income reflected in the following table is tax-exempt income.





Year
      Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Average
                      Balance
                    
                    
                    Interest
                      and
                      Dividends
                    
                    
                    Yield/
                      Cost
                    
                    
                    Average
                      Balance
                    
                    
                    Interest
                      and
                      Dividends
                    
                    
                    Yield/
                      Cost
                    
                    
                    Average
      Balance
                    
                    
                    Interest
      and Dividends
                    
                    
                    Yield/
      Cost(Dollars
      in thousands)Assets:Interest-earning
      assets:Loans
                    
                    $
                    313,126
                    
                    
                    $
                    19,296
                    
                    
                    
                    6.16
                    %
                    
                    $
                    272,615
                    
                    
                    $
                    17,195
                    
                    
                    
                    6.31
                    %
                    
                    $
                    248,361
                    
                    
                    $
                    15,280
                    
                    
                    
                    6.15
                    %Securities
                    
                    
                    40,778
                    
                    
                    
                    2,079
                    
                    
                    
                    5.10
                    
                    
                    
                    11,203
                    
                    
                    
                    567
                    
                    
                    
                    5.06
                    
                    
                    
                    8,543
                    
                    
                    
                    386
                    
                    
                    
                    4.52Other
      interest-earning assets
                    
                    
                    9,467
                    
                    
                    
                    269
                    
                    
                    
                    2.83
                    
                    
                    
                    5,975
                    
                    
                    
                    226
                    
                    
                    
                    3.78
                    
                    
                    
                    12,640
                    
                    
                    
                    425
                    
                    
                    
                    3.36Total
      interest-earning assets
                    
                    
                    363,371
                    
                    
                    
                    21,644
                    
                    
                    
                    5.96
                    
                    
                    
                    289,793
                    
                    
                    
                    17,988
                    
                    
                    
                    6.21
                    
                    
                    
                    269,544
                    
                    
                    
                    16,091
                    
                    
                    
                    5.97Bank-owned
      life insurance
                    
                    
                    9,667
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    9,024
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,878Noninterest-earning
      assets
                    
                    
                    19,549
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    14,480
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    11,335Total
      assets
                    
                    $
                    392,587
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    313,297
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    282,757Liabilities
      and equity:Interest-bearing
      liabilities:Interest-bearing
      demand deposits
                    
                    $
                    43,333
                    
                    
                    
                    983
                    
                    
                    
                    2.27
                    
                    
                    $
                    26,011
                    
                    
                    
                    98
                    
                    
                    
                    0.38
                    
                    
                    $
                    26,404
                    
                    
                    
                    59
                    
                    
                    
                    0.22Savings
      accounts
                    
                    
                    25,527
                    
                    
                    
                    83
                    
                    
                    
                    0.33
                    
                    
                    
                    29,131
                    
                    
                    
                    94
                    
                    
                    
                    0.32
                    
                    
                    
                    33,774
                    
                    
                    
                    109
                    
                    
                    
                    0.32Money
      market accounts
                    
                    
                    34,655
                    
                    
                    
                    1,004
                    
                    
                    
                    2.90
                    
                    
                    
                    23,123
                    
                    
                    
                    900
                    
                    
                    
                    3.89
                    
                    
                    
                    24,211
                    
                    
                    
                    630
                    
                    
                    
                    2.60Certificates
      of deposit
                    
                    
                    78,232
                    
                    
                    
                    2,751
                    
                    
                    
                    3.52
                    
                    
                    
                    83,593
                    
                    
                    
                    3,796
                    
                    
                    
                    4.54
                    
                    
                    
                    77,927
                    
                    
                    
                    3,070
                    
                    
                    
                    3.94Total
      interest-bearing deposits
                    
                    
                    181,747
                    
                    
                    
                    4,821
                    
                    
                    
                    2.65
                    
                    
                    
                    161,858
                    
                    
                    
                    4,888
                    
                    
                    
                    3.02
                    
                    
                    
                    162,316
                    
                    
                    
                    3,868
                    
                    
                    
                    2.38Borrowings
                    
                    
                    118,538
                    
                    
                    
                    4,767
                    
                    
                    
                    4.02
                    
                    
                    
                    56,412
                    
                    
                    
                    2,806
                    
                    
                    
                    4.97
                    
                    
                    
                    44,814
                    
                    
                    
                    2,343
                    
                    
                    
                    5.23Total
      interest-bearing liabilities
                    
                    
                    300,285
                    
                    
                    
                    9,588
                    
                    
                    
                    3.19
                    
                    
                    
                    218,270
                    
                    
                    
                    7,694
                    
                    
                    
                    3.52
                    
                    
                    
                    207,130
                    
                    
                    
                    6,211
                    
                    
                    
                    3.00Demand
      deposits
                    
                    
                    32,258
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    32,400
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    35,601Noninterest-bearing
      liabilities
                    
                    
                    2,479
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,221
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,674Total
      liabilities
                    
                    
                    335,022
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    252,891
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    244,405Equity
                    
                    
                    57,565
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    60,406
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    38,352Total
      liabilities and equity
                    
                    $
                    392,587
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    313,297
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    282,757Net
      interest income
                    
                    
                    
                    
                    
                    $
                    12,056
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    10,294
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    9,880Interest
      rate spread
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2.77
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2.69
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2.97
                    %Net
      interest margin
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.32
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.55
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.67
                    %Average
      interest-earning assets to average interest- bearing
      liabilities
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    121.01
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    132.77
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    130.13
                    %





31
 Index





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





2008
      Compared to 2007Increase
      (Decrease)
                                          Due
      toVolume
                                        
                                        
                                        Rate
                                        
                                        
                                        Net(Dollars
      in thousands)Interest
      and dividend income:Loans
                                        
                                        $
                                        2,486
                                        
                                        
                                        $
                                        (384
                                        )
                                        
                                        $
                                        2,102Securities
                                        
                                        
                                        1,508
                                        
                                        
                                        
                                        4
                                        
                                        
                                        
                                        1,512Other
      interest-earning assets
                                        
                                        
                                        74
                                        
                                        
                                        
                                        (32
                                        )
                                        
                                        
                                        42Total
      interest-earning assets
                                        
                                        
                                        4,068
                                        
                                        
                                        
                                        (412
                                        )
                                        
                                        
                                        3,656Interest
      expense:Deposits
                                        
                                        
                                        (6,640
                                        )
                                        
                                        
                                        6,573
                                        
                                        
                                        
                                        (67
                                        )Borrowings
                                        
                                        
                                        2,374
                                        
                                        
                                        
                                        (413
                                        )
                                        
                                        
                                        1,961Total
      interest-bearing liabilities
                                        
                                        
                                        (4,266
                                        )
                                        
                                        
                                        6,160
                                        
                                        
                                        
                                        1,894Net
      change in interest income
                                        
                                        
                                        8,334
                                        
                                        
                                        
                                        (6,572
                                        )
                                        
                                        $
                                        1,762





Net Interest
Income.Net
interest income for the year ended December 31, 2008 was $12.1 million, compared
to $10.3 million for year December 31, 2007, an increase of
17.1%.  The increase in net interest income is due to the increase in
interest-earning assets and an increase in interest rate spread, partially
offset by increased expense from borrowings utilized to fund the year’s asset
growth.  The yield on interest-earning assets decreased to 5.96% in
2008 from 6.21% in 2007, a decrease of 25 basis points.  The cost of
interest-bearing liabilities decreased to 3.19% in 2008 from 3.52% in 2007, a
decrease of 33 basis points.  The average cost of interest-bearing
demand deposits increased by 189 basis points due to the new rewards checking
product, launced late in 2007. While, the total cost of other interest-bearing
deposits decreased by 200 basis points from 2007 to 2008. With decreases in
short-term market interest rates, customers have increasingly shown a preference
for higher-yielding core accounts, rather than the longer-term time deposit
accounts.   The low short-term market  interest rate
environment  has also contributed towards the 95 basis points decrease
in total cost of borrowings from 2007 to 2008.  The interest rate
spread increased to 2.77% for 2008 from 2.69% in 2007, up 8 basis
points.





Provision for
Loan Losses.The loan loss provision for the years ended
December 31, 2008 and December 31, 2007 was $568,000 and $426,000,
respectively.  The provision was increased primarily due to the growth
and changes in the composition of the loan portfolio, including the increase in
commercial mortgages and changes in general economic conditions including the
slowing economy and falling housing prices.





32
 Index





Non-Interest
Income.The following table shows the components of
non-interest income and the percentage changes from year to year.





Year
      Ended December 31,2008
                  
                  
                  2007
                  
                  
                  %
      Change(Dollars
      in thousands)Customer
      service fees
                  
                  $
                  1,801
                  
                  
                  $
                  1,839
                  
                  
                  
                  (2.1
                  )%Impairment
      loss on available-for-sale securities
                  
                  
                  (706
                  )
                  
                  
                  -
                  
                  
                  
                  -Bank-owned
      life insurance
                  
                  
                  409
                  
                  
                  
                  392
                  
                  
                  
                  4.3Other
                  
                  
                  72
                  
                  
                  
                  88
                  
                  
                  
                  (18.2
                  )Total
                  
                  $
                  1,576
                  
                  
                  $
                  2,319
                  
                  
                  
                  (32.0
                  )%





Non-interest income for 2008
totaled $1.6 million, a decrease of $743,000, or 32.0%, compared to
2007.  The decrease in non-interest income is primarily due to the
$706,000 impairment charge recorded for the Bank’s holdings in the AMF Ultra
Short Mortgage Fund.




Non-Interest
Expense.The following table shows the components of
non-interest expense and the percentage changes for the years
indicated.





2008
                    
                    
                    2007
                    
                    
                    %
      Change(Dollars
      in thousands)Salaries
      and employee benefits
                    
                    $
                    7,836
                    
                    
                    $
                    6,171
                    
                    
                    
                    27.0
                    %Occupancy
      and equipment, net
                    
                    
                    1,372
                    
                    
                    
                    1,282
                    
                    
                    
                    7.0Data
      processing
                    
                    
                    1,103
                    
                    
                    
                    1,004
                    
                    
                    
                    9.9Professional
      fees
                    
                    
                    490
                    
                    
                    
                    563
                    
                    
                    
                    (13.0
                    )Marketing
                    
                    
                    1,245
                    
                    
                    
                    1,085
                    
                    
                    
                    14.7All
      other
                    
                    
                    870
                    
                    
                    
                    729
                    
                    
                    
                    19.3Total
                    
                    $
                    12,916
                    
                    
                    $
                    10,834
                    
                    
                    
                    19.2
                    %Efficiency
      ratio
                    
                    
                    90.08
                    %
                    
                    
                    85.90
                    %
                    
                    
                    8.85
                    %





Total non-interest expenses for 2008
increased to $12.9 million from $10.8 million for 2007, an increase of
19.2%.  Non-interest expenses increased due to an increase in salaries
and employee benefits, marketing, data processing fees, increased FDIC insurance
costs and overall other operating costs.  The increase in salaries and
benefits is due to the stock-based compensation expense associated with stock
options and restricted stock awards granted on October 1, 2007.  There
was no stock-based compensation expense incurred during the first nine months of
2007.  Data processings costs increased as a direct result of the
increase in number of deposit and loan accounts maintained by the Bank’s
computer systems.  Marketing expense increased primarily due to the
strategic efforts devoted to marketing and advertising projects throughout the
year, in addition to a strong promotional effort during the fourth quarter of
2008 for the Company’s grand opening of its new Portsmouth, Rhode Island branch
in January 2009.  A decrease in professional fees during 2008 was
primarily due to a reduction in professional services associated with
Sarbanes-Oxley section 404 reporting.  All other expenses increased
due to an overall increase in costs and FDIC insurance premiums as a result of
the FDIC’s increase in rates and insurance coverage
limits.  Management expects FDIC insurance costs to continue to
increase in 2009, due to rate increases and special assessments declared by the
FDIC.




Income Tax
Expense.The incometax expense for 2008
was $996,000 compared to an income tax expense of $596,000 for
2007.  The effective tax rates were 673.0% and 44.1% in 2008 and 2007,
respectively.  The effective tax rate in 2008 includes the
non-deductible compensation expense recorded for a portion of the incentive
stock options and additional valuation reserves against the Company’s deferred
tax assets (discussed below), and the write-down of state deferred tax assets in
conjunction with the formation of a passive investment company subsidiary, which
were partially offset by non-taxable BOLI income.





33
 Index





The
deferred tax assets applicable to loss carry forwards relating to the deduction
for the donation to the charitable foundation in 2006 are recoverable, only to
the extent that 10% pre-tax of income exceeds the deduction during the five-year
carry forward period.  Newport Bancorp had previously recognized a
valuation allowance of $492,000 against the deferred tax asset related to this
loss carry forward at December 31, 2007. This valuation allowance is assessed
quarterly for recoverability.  Based on management’s assessment in the
fourth quarter of 2008, the valuation allowance on this asset was increased by
$250,000 due to changes in projected future taxable income.  At
December 31, 2008, the valuation allowance for this deferred tax asset amounted
to $742,000.





In
addition, a valuation reserve of $240,000 was established against the deferred
tax asset resulting from the 2008 securities impairment loss, as the Bank has no
history of capital gains to carryback.





On
December 31, 2008, the Bank established NewportFed Investments, Inc., a passive
investment company subsidiary allowed under Rhode Island state law to hold
certain investments consisting primarily of commercial mortgages and
loans.  Such assets were transferred from Newport Federal Savings Bank
to this subsidiary, and as of December 31, 2008, the subsidiary had $119.8
million of assets.  Based on current Rhode Island state law, it is
expected that future income from assets held by this subsidiary will not be
taxable to the Company for state income tax purposes.  As a result,
the Company incurred additional income tax provision of $300,000 during this
quarter in connection with a revaluation of the Company’s deferred state tax
asset.





Risk
Management





Overview.  Managing risk is
an essential part of successfully managing a financial
institution.  Newport Bancorp’s most prominent risk exposures are
credit risk, interest rate risk and market risk.  Credit risk is the
risk of not collecting the interest and/or the principal balance of a loan or
investment when it is due.  Interest rate risk is the potential
reduction of interest income as a result of changes in interest
rates.  Market risk arises from fluctuations in interest rates that
may result in changes in the values of financial instruments, such as
available-for-sale securities that are accounted for on a mark-to-market
basis.  Other risks that the Company faces are operational risks,
liquidity risks and reputation risk.  Operational risks include risks
related to fraud, regulatory compliance, processing errors, technology and
disaster recovery.  Liquidity risk is the possible inability to fund
obligations to depositors, lenders or borrowers.  Reputation risk is
the risk that negative publicity or press, whether true or not, could cause a
decline in our customer base or revenue.





Credit Risk
Management.  Newport Federal’s
strategy for credit risk management focuses on having well-defined credit
policies and uniform underwriting criteria and providing prompt attention to
potential problem loans.





When a borrower fails to make a
required loan payment, the Bank takes a number of steps to have the borrower
cure the delinquency and restore the loan to current status.  When the
loan becomes 15 days past due a late notice is sent to the
borrower.  When the loan becomes 18 days past due, a more formal
letter is sent.  When a loan becomes 25 days past due, the borrower is
typically called.  After 30 days, the Bank regards the borrower as in
default.  The borrower is promptly sent a letter from the Bank’s
attorney and the Bank may commence collection proceedings.  If a
foreclosure action is instituted and the loan is not brought current, paid in
full, or refinanced before the foreclosure sale, the real property securing the
loan generally is sold at foreclosure.  Generally, when a consumer
loan becomes 60 days past due, the Bank institutes collection proceedings and
attempts to repossess any personal property that secures the
loan.  Management informs the board of directors monthly of the amount
of loans delinquent more than 30 days, all loans in foreclosure and repossessed
property that it owns.





Analysis of
Nonperforming and Classified Assets.  Newport Bancorp
considers repossessed assets and loans that are 90 days or more past due to be
nonperforming assets.  Loans are generally placed on nonaccrual status
when they become 90 days delinquent at which time the accrual of interest ceases
and the allowance for any uncollectible accrued interest is established and
charged against operations.  Typically, payments received on a
nonaccrual loan are applied to the outstanding principal and interest as
determined at the time of collection of the loan.





34
 Index





The
following table provides information with respect to the Bank’s nonperforming
assets at the dates indicated.





At
      December 31,2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005
                  
                  
                  2004(Dollars
      in thousands)Nonaccrual
      loans:Real
      estate mortgage:One-to-four
      family
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  78Commercial
                  
                  
                  –
                  
                  
                  
                  908
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –Total
                  
                  
                  –
                  
                  
                  
                  908
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  78Accruing
      loans past due 90 days or more
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –Total
      nonperforming loans
                  
                  
                  –
                  
                  
                  
                  908
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  78Real
      estate owned
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –Other
      nonperforming assets
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –Total
      nonperforming assets
                  
                  $
                  –
                  
                  
                  $
                  908
                  
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  78Total
      nonperforming loans to total loans
                  
                  
                  0.00
                  %
                  
                  
                  0.31
                  %
                  
                  
                  0.00
                  %
                  
                  
                  0.00
                  %
                  
                  
                  0.04
                  %Total
      nonperforming loans to total assets
                  
                  
                  0.00
                  %
                  
                  
                  0.25
                  %
                  
                  
                  0.00
                  %
                  
                  
                  0.00
                  %
                  
                  
                  0.03
                  %Total
      nonperforming assets to total assets
                  
                  
                  0.00
                  %
                  
                  
                  0.25
                  %
                  
                  
                  0.00
                  %
                  
                  
                  0.00
                  %
                  
                  
                  0.03
                  %





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





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





At
      December 31,2008
                  
                  
                  2007
                  
                  
                  2006(Dollars
      in thousands)Special
      mention assets
                  
                  $
                  73
                  
                  
                  $
                  -
                  
                  
                  $
                  -Substandard
      assets
                  
                  
                  -
                  
                  
                  
                  908
                  
                  
                  
                  -Doubtful
      assets
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Loss
      assets
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      classified assets
                  
                  $
                  73
                  
                  
                  $
                  908
                  
                  
                  $
                  -





35
 Index





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





At December 31,2008
                
                
                2007
                
                
                200630-59
                  Days
                  Past Due
                
                
                60-89
                  Days
                  Past Due
                
                
                30-59
                  Days
                  Past Due
                
                
                60-89
                  Days
                  Past Due
                
                
                30-59
                  Days
                  Past Due
                
                
                60-89
                  Days
                  Past Due(Dollars
      in thousands)Real
      estate mortgage:One-to-four
      family
                
                $
                688
                
                
                $
                118
                
                
                $
                468
                
                
                $
                82
                
                
                $
                59
                
                
                $
                -Commercial
                
                
                336
                
                
                
                -
                
                
                
                -
                
                
                
                76
                
                
                
                295
                
                
                
                -Consumer
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                7
                
                
                
                -
                
                
                
                -Total
                
                $
                1,024
                
                
                $
                118
                
                
                $
                468
                
                
                $
                165
                
                
                $
                354
                
                
                $
                -Delinquent
      loans to total loans
                
                
                0.31
                %
                
                
                0.04
                %
                
                
                0.16
                %
                
                
                0.06
                %
                
                
                0.14
                %
                
                
                0.00
                %





Analysis and
Determination of the Allowance for Loan Losses.The allowance for loan
losses is a valuation allowance for probable losses inherent in the loan
portfolio.  Newport Federal evaluates the need to establish allowances
against losses on loans on a quarterly basis.  When additional
allowances are necessary, a provision for loan losses is charged to
earnings.





Our methodology for assessing the
appropriateness of the allowance for loan losses consists of:  (1) a
specific valuation allowance on identified impaired loans; and (2) a general
valuation allowance on the remainder of the loan portfolio.  Although
the Bank determines the amount of each element of the allowance separately, the
entire allowance for loan losses is available to absorb losses in the loan
portfolio.





Specific
Valuation Allowance on Identified Impaired Loans.  Newport
Federal identifies loans that may need to be charged off as a loss, or need a
specific reserve in accordance with SFAS 114, by reviewing all delinquent loans,
classified loans and other loans that management may have concerns about
collectability.  All identified impaired loans are reviewed to assess
the borrower’s inability to make payments under the terms of the loan and/or a
shortfall in collateral value that would result in charging off the loan or the
portion of the loan that was impaired.





General Valuation
Allowance on the Remainder of the Loan Portfolio.  Newport
Federal establishes a general allowance for loans that are not problem loans, to
recognize the inherent losses associated with lending
activities.  This general valuation allowance is determined by
segregating the loans by loan category and assigning allowance percentages to
each category.  The percentages are adjusted for significant changes
in factors that, in management’s judgment, affect the collectability of the
portfolio as of the evaluation date.  These significant factors may
include changes in lending policies and procedures, changes in existing general
economic and business conditions affecting our primary lending areas, credit
quality trends, collateral value, loan volumes and concentrations, seasoning of
the loan portfolio, recent loss experience in particular segments of the
portfolio, duration of the current business cycle and bank regulatory
examination results.  The applied loss factors are reevaluated
periodically to ensure their relevance in the current economic
environment.





The Bank engages an independent third
party to conduct an annual review of its commercial real estate
portfolio.  This loan review, which typically includes a 50%
penetration of the commercial real estate portfolio, provides a credit
evaluation of individual loans to determine whether the risk ratings assigned
are appropriate.





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





36
 Index





At December 31, 2008 and 2007, the
allowance for loan losses represented 0.87% and 0.81% of total loans,
respectively.  No portion of the allowance was allocated to impaired
loans at December 31, 2008 or 2007. The allowance for loan
losses increased from $2,399,000 at December 31, 2007, to $2,924,000 at December
31, 2008, or 21.9%.  The increase in 2008, was primarily due to the
growth, changes in the composition of the loan portfolio and changes in general
economic conditions. The increase in the allowance for loan losses as a
percentage of the loan portfolio was primarily due to an increase in the
proportion of commercial loans in the portfolio and the increase in the
percentage used to calculate the allowance on such loans due to general economic
conditions.





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





At
      December 31,2008
                          
                          
                          2007Amount
                          
                          
                          %
      of
                            Allowance
                            to
      Total
                            Allowance
                          
                          
                          %
      of
                            Loans
      in
                            Category
                            to
      Total
                            Loans
                          
                          
                          Amount
                          
                          
                          %
      of
                            Allowance
                            to
      Total
                            Allowance
                          
                          
                          %
      of
                            Loans
      in
                            Category
                            to
      Total
                            Loans(Dollars
      in thousands)Real
      estate mortgage:One-to-four
      family
                          
                          $
                          916
                          
                          
                          
                          31.33
                          %
                          
                          
                          54.53
                          %
                          
                          $
                          835
                          
                          
                          
                          34.80
                          %
                          
                          
                          57.08
                          %Multi-family
                          
                          
                          260
                          
                          
                          
                          8.89
                          
                          
                          
                          5.16
                          
                          
                          
                          137
                          
                          
                          
                          5.71
                          
                          
                          
                          3.20Commercial
                          
                          
                          1,404
                          
                          
                          
                          48.02
                          
                          
                          
                          27.78
                          
                          
                          
                          1,115
                          
                          
                          
                          46.48
                          
                          
                          
                          25.95Home
      equity loans and lines
                          
                          
                          167
                          
                          
                          
                          5.71
                          
                          
                          
                          9.03
                          
                          
                          
                          170
                          
                          
                          
                          7.09
                          
                          
                          
                          10.44Construction
                          
                          
                          168
                          
                          
                          
                          5.74
                          
                          
                          
                          3.32
                          
                          
                          
                          136
                          
                          
                          
                          5.67
                          
                          
                          
                          3.18Other
      consumer
                          
                          
                          9
                          
                          
                          
                          0.31
                          
                          
                          
                          0.18
                          
                          
                          
                          6
                          
                          
                          
                          0.25
                          
                          
                          
                          0.15Total
      allowance for loan losses
                          
                          $
                          2,924
                          
                          
                          
                          100.00
                          %
                          
                          
                          100.00
                          %
                          
                          $
                          2,399
                          
                          
                          
                          100.00
                          %
                          
                          
                          100.00
                          %





At
      December 31,2006
                              
                              
                              2005
                              
                              
                              2004Amount
                              
                              
                              %
      of
                                Allowance
                                to
      Total
                                Allowance
                              
                              
                              %
      of
                                Loans
      in
                                Category
                                to
      Total
                                Loans
                              
                              
                              Amount
                              
                              
                              %
      of
                                Allowance
                                to
      Total
                                Allowance
                              
                              
                              %
      of
                                Loans
      in
                                Category
                                to
      Total
                                Loans
                              
                              
                              Amount
                              
                              
                              %
      of
                                Allowance
                                to
      Total
                                Allowance
                              
                              
                              %
      of
                                Loans
      in
                                Category
                                to
      Total
                                LoansReal
      estate mortgage:
                              
                              (Dollars
      in thousands)One-to-four
      family
                              
                              $
                              787
                              
                              
                              
                              39.89
                              %
                              
                              
                              60.67
                              %
                              
                              $
                              912
                              
                              
                              
                              49.22
                              %
                              
                              
                              64.90
                              %
                              
                              $
                              776
                              
                              
                              
                              46.89
                              %
                              
                              
                              62.96
                              %Multi-family
                              
                              
                              121
                              
                              
                              
                              6.13
                              
                              
                              
                              3.61
                              
                              
                              
                              81
                              
                              
                              
                              4.37
                              
                              
                              
                              2.87
                              
                              
                              
                              65
                              
                              
                              
                              3.93
                              
                              
                              
                              2.65Commercial
                              
                              
                              749
                              
                              
                              
                              37.96
                              
                              
                              
                              22.21
                              
                              
                              
                              573
                              
                              
                              
                              30.92
                              
                              
                              
                              20.33
                              
                              
                              
                              520
                              
                              
                              
                              31.42
                              
                              
                              
                              21.20Home
      equity loans and lines
                              
                              
                              241
                              
                              
                              
                              12.22
                              
                              
                              
                              11.28
                              
                              
                              
                              234
                              
                              
                              
                              12.63
                              
                              
                              
                              10.02
                              
                              
                              
                              192
                              
                              
                              
                              11.60
                              
                              
                              
                              9.01Construction
                              
                              
                              61
                              
                              
                              
                              3.09
                              
                              
                              
                              1.80
                              
                              
                              
                              38
                              
                              
                              
                              2.05
                              
                              
                              
                              1.34
                              
                              
                              
                              86
                              
                              
                              
                              5.19
                              
                              
                              
                              3.53Other
      consumer
                              
                              
                              14
                              
                              
                              
                              0.71
                              
                              
                              
                              0.43
                              
                              
                              
                              15
                              
                              
                              
                              0.81
                              
                              
                              
                              0.54
                              
                              
                              
                              16
                              
                              
                              
                              0.97
                              
                              
                              
                              0.65Total
      allowance for loan losses
                              
                              $
                              1,973
                              
                              
                              
                              100.00
                              %
                              
                              
                              100.00
                              %
                              
                              $
                              1,853
                              
                              
                              
                              100.00
                              %
                              
                              
                              100.00
                              %
                              
                              $
                              1,655
                              
                              
                              
                              100.00
                              %
                              
                              
                              100.00
                              %





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





37
 Index





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





Years
      Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006
                      
                      
                      2005
                      
                      
                      2004(Dollars
      in thousands)Balance
      at beginning of period
                      
                      $
                      2,399
                      
                      
                      $
                      1,973
                      
                      
                      $
                      1,853
                      
                      
                      $
                      1,655
                      
                      
                      $
                      1,511Provision
      for loan losses
                      
                      
                      568
                      
                      
                      
                      426
                      
                      
                      
                      120
                      
                      
                      
                      198
                      
                      
                      
                      144Charge
      offs:Real
      estate mortgage:One-to-four
      family
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Non-residential
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Home
      equity loans and lines
                      
                      
                      40
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Consumer
      loans
                      
                      
                      7
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Total
      charge-offs
                      
                      
                      47
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Recoveries:Real
      estate mortgage:One-to-four
      family
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Non-residential
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Home
      equity loans and lines
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Consumer
      loans
                      
                      
                      4
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Total
      recoveries
                      
                      
                      4
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Net
      charge-offs
                      
                      
                      43
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Balance
      at end of period
                      
                      $
                      2,924
                      
                      
                      $
                      2,399
                      
                      
                      $
                      1,973
                      
                      
                      $
                      1,853
                      
                      
                      $
                      1,655Net
      charge-offs to average loans outstanding during the period
                      
                      
                      0.01
                      %
                      
                      
                      0.00
                      %
                      
                      
                      0.00
                      %
                      
                      
                      0.00
                      %
                      
                      
                      0.00
                      %





Qualitative Aspects of Market
Risk.The Company’s most significant form of market risk is
interest rate risk.  Newport Bancorp manages the interest rate
sensitivity of its interest-bearing liabilities and interest-earning assets in
an effort to minimize the adverse effects of changes in the interest rate
environment.  Deposit accounts typically react more quickly to changes
in market interest rates than mortgage loans because of the shorter maturities
of deposits.  As a result, sharp increases in interest rates may
adversely affect earnings while decreases in interest rates may beneficially
affect earnings.  To reduce the potential volatility of our earnings,
the Company has sought to improve the match between asset and liability
maturities and rates, while maintaining an acceptable interest rate
spread.  Newport Bancorp’s strategy for managing interest rate risk
emphasizes:  adjusting the maturities of borrowings; adjusting the
investment portfolio mix and duration; and periodically selling fixed-rate
mortgage loans and available-for-sale investment securities.





The Company has an Asset Liability
Management Committee to communicate, coordinate and control all aspects
involving asset/liability management. The committee establishes and monitors the
volume, maturities, pricing and mix of assets and funding sources with the
objective of managing assets and funding sources to provide results that are
consistent with liquidity, growth, risk limits and profitability
goals.





Quantitative Aspects of Market
Risk.The Company uses an interest rate sensitivity
analysis prepared by the Office of Thrift Supervision to review our level of
interest rate risk.  This analysis measures interest rate risk by
computing changes in net portfolio value of our cash flows from assets,
liabilities and off-balance sheet items in the event of a range of assumed
changes in market interest rates.  Net portfolio value represents the
market value of portfolio equity and is equal to the market value of assets
minus the market value of liabilities, with adjustments made for off-balance
sheet items.  This analysis assesses the risk of loss in market risk
sensitive instruments in the event of a sudden and sustained 100 to 300 basis
point increase or 100 basis point decrease in market interest rates with no
effect given to any steps that we might take to counter the effect of that
interest rate movement.  Newport





38
 Index









The
following table presents the change in the net portfolio value at September 30,
2008 (the most current information available), that would occur in the event of
an immediate change in interest rates based on Office of Thrift Supervision
assumptions, with no effect given to any steps that we might take to counteract
that change. The Bank expects that its net portfolio value at December 31, 2008
is consistent with the table below.





Net
      Portfolio Value
                  (Dollars
      in thousands)
                
                
                Net
      Portfolio Value as % of
                  Portfolio
      Value of AssetsBasis
      Point (“bp”)
                  Change
      in Rates
                
                Amount
                
                
                Change
                
                
                %
      Change
                
                
                NPV
      Ratio
                
                
                Change
      (bp)300
                
                $
                35,635
                
                
                $
                -15,360
                
                
                
                -30
                
                
                
                9.02
                %
                
                
                -315200
                
                
                40,852
                
                
                
                -10,144
                
                
                
                -20
                
                
                
                10.13
                %
                
                
                -204100
                
                
                46,103
                
                
                
                -4,893
                
                
                
                -10
                
                
                
                11.21
                %
                
                
                -9650
                
                
                48,608
                
                
                
                -2,388
                
                
                
                -5
                
                
                
                11.70
                %
                
                
                -460
                
                
                50,995
                
                
                
                0
                
                
                
                0
                
                
                
                12.17
                %
                
                
                0(50)
                
                
                52,283
                
                
                
                1,288
                
                
                
                3
                
                
                
                12.38
                %
                
                
                21(100)
                
                
                53,493
                
                
                
                2,497
                
                
                
                5
                
                
                
                12.58
                %
                
                
                42





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





The
Committee also measures and evaluates interest rate risk using income simulation
analysis. This analysis considers the maturity and repricing characteristics of
assets and liabilities, as well as the relative sensitivities of these balance
sheet components over a range of interest rate scenarios. Interest rate
scenarios tested generally include instantaneous rate shocks, rate ramps over a
one-year period, and static (or flat) rates. The simulation analysis is used to
measure the exposure of net interest income to changes in interest rates over a
specified time horizon, usually a two-year period.





The table
below sets forth, as of November 30, 2008, the estimated changes in Newport
Bancorp’s net interest income that would result from the designated
instantaneous changes in the U.S. Treasury yield curve. Computations of
prospective effects of hypothetical interest rate changes are based on numerous
assumptions including relative levels of market interest rates, loan prepayments
and deposit decay, and should not be relied upon as indicative of actual
results. The Bank expects that its percentage change in estimated net interest
income over the next 12 months and from months 13-24 at December 31, 2008 is
consistent with the table below.





39
 Index




%
      Change in Estimated
                  
                  
                  %
      Change in EstimatedNet
      Interest Income Over
                  
                  
                  Net
      Interest Income Overthe
      Next 12 Months
                  
                  
                  Months
      13-24200
      basis point increase in rates
                  
                  
                  0.1
                  %
                  
                  
                  (13.8
                  )%Flat
      interest rates
                  
                  
                  0.0
                  %
                  
                  
                  (5.0
                  )%100
      basis point decrease in rates
                  
                  
                  0.6
                  %
                  
                  
                  (5.5
                  )%





As
indicated in the table above, the result of an immediate 200 basis point
parallel increase in interest rates is estimated to increase net interest income
by 0.1% over a 12-month horizon, and decrease net interest income by 13.8% for
months 13-24, when compared to the flat rate scenario, which assumes no increase
in interest-bearing checking rates except for high balance interest bearing
checking which increase 75 basis points (BP), an increase in savings rates of
50-75 (BP) and an increase in money market rates of 150 basis
points.  These assumptions are based on the Bank’s past experience
with the changes in rates paid on these non-maturity deposits coincident with
changes in market interest rates.  The estimated change in net
interest income from the flat rate scenario for a 100 basis point parallel
decline in the level of interest rates is an increase of 0.6% over the 12 month
horizon and a decrease of 5.5% for months 13-24, which assumes no decrease in
interest-bearing checking rates, except for high balance accounts which decrease
30-50 BP, savings rates decreasing 20-33 BP and a decrease in money market rates
of 100 basis points. These assumptions are based on the Bank’s past
experience with the changes in rates paid on these non-maturity deposits
coincident with changes in market interest rates.





There are
inherent shortcomings in income simulation, given the number and variety of
assumptions that must be made in performing the analysis. The assumptions relied
upon in making these calculations of interest rate sensitivity include the level
of market interest rates, the shape of the yield curve, the degree to which
certain assets and liabilities with similar maturities or periods to repricing
react to changes in market interest rates, the degree to which non-maturity
deposits react to changes in market rates, the expected prepayment rates on
loans and mortgage-backed securities, the degree to which early withdrawals
occur on certificates of deposit and the volume of other deposit flows. As such,
although the analysis shown above provides an indication of Newport Bancorp’s
sensitivity to interest rate changes at a point in time, these estimates are not
intended to and do not provide a precise forecast of the effect of changes in
market interest rates on Newport Bancorp’s net interest income and will differ
from actual results.





The table
below shows Newport Bancorp’s interest sensitivity gap position at December 31,
2008, indicating the amount of interest-earning assets and interest-bearing
liabilities that are anticipated to mature or reprice in each of the future time
periods shown. Generally, these assets and liabilities are shown in the table
based on the earlier of the time remaining to repricing or contractual maturity.
However, savings, money market deposit and interest bearing deposit accounts are
assumed to have annual rates of withdrawal (decay rates) of 26%, 32% and 10%,
respectively.




40
 Index




Repricing
      Gap as of December 31, 2008More
      than
                                                                                    
                                                                                    
                                                                                    More
      than
                                                                                    
                                                                                    
                                                                                    More
      thanUp
      to
                                                                                    
                                                                                    
                                                                                    One
      Year to
                                                                                    
                                                                                    
                                                                                    Two
      Years
                                                                                    
                                                                                    
                                                                                    Three
      Years
                                                                                    
                                                                                    
                                                                                    More
      thanOne
      Year
                                                                                    
                                                                                    
                                                                                    Two
      Years
                                                                                    
                                                                                    
                                                                                    to
      Three Years
                                                                                    
                                                                                    
                                                                                    to
      Five Years
                                                                                    
                                                                                    
                                                                                    Five
      Years
                                                                                    
                                                                                    
                                                                                    Total(Dollars
      in thousands)Interest-earning
      assets:Loans
                                                                                    
                                                                                    $
                                                                                    8,868
                                                                                    
                                                                                    
                                                                                    $
                                                                                    9,372
                                                                                    
                                                                                    
                                                                                    $
                                                                                    5,797
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10,963
                                                                                    
                                                                                    
                                                                                    $
                                                                                    302,008
                                                                                    
                                                                                    
                                                                                    $
                                                                                    337,008Securities
                                                                                    
                                                                                    
                                                                                    6,390
                                                                                    
                                                                                    
                                                                                    
                                                                                    1,297
                                                                                    
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    50,865
                                                                                    
                                                                                    
                                                                                    
                                                                                    58,552Short-term
      investments
                                                                                    
                                                                                    
                                                                                    3,037
                                                                                    
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    3,037Total
      interest-earning assets
                                                                                    
                                                                                    
                                                                                    18,295
                                                                                    
                                                                                    
                                                                                    
                                                                                    10,669
                                                                                    
                                                                                    
                                                                                    
                                                                                    5,797
                                                                                    
                                                                                    
                                                                                    
                                                                                    10,963
                                                                                    
                                                                                    
                                                                                    
                                                                                    352,873
                                                                                    
                                                                                    
                                                                                    
                                                                                    398,597Interest-bearing
      liabilities:Savings
      deposits
                                                                                    
                                                                                    
                                                                                    5,118
                                                                                    
                                                                                    
                                                                                    
                                                                                    4,095
                                                                                    
                                                                                    
                                                                                    
                                                                                    3,275
                                                                                    
                                                                                    
                                                                                    
                                                                                    2,621
                                                                                    
                                                                                    
                                                                                    
                                                                                    10,482
                                                                                    
                                                                                    
                                                                                    
                                                                                    25,591Money
      market deposits
                                                                                    
                                                                                    
                                                                                    7,908
                                                                                    
                                                                                    
                                                                                    
                                                                                    6,326
                                                                                    
                                                                                    
                                                                                    
                                                                                    5,061
                                                                                    
                                                                                    
                                                                                    
                                                                                    4,049
                                                                                    
                                                                                    
                                                                                    
                                                                                    16,196
                                                                                    
                                                                                    
                                                                                    
                                                                                    39,540Interest-bearing
      demand deposits
                                                                                    
                                                                                    
                                                                                    11,596
                                                                                    
                                                                                    
                                                                                    
                                                                                    9,277
                                                                                    
                                                                                    
                                                                                    
                                                                                    7,422
                                                                                    
                                                                                    
                                                                                    
                                                                                    5,937
                                                                                    
                                                                                    
                                                                                    
                                                                                    23,749
                                                                                    
                                                                                    
                                                                                    
                                                                                    57,981Certificates
      of deposits
                                                                                    
                                                                                    
                                                                                    66,777
                                                                                    
                                                                                    
                                                                                    
                                                                                    1,858
                                                                                    
                                                                                    
                                                                                    
                                                                                    3,178
                                                                                    
                                                                                    
                                                                                    
                                                                                    941
                                                                                    
                                                                                    
                                                                                    
                                                                                    480
                                                                                    
                                                                                    
                                                                                    
                                                                                    73,234Borrowings
                                                                                    
                                                                                    
                                                                                    15,248
                                                                                    
                                                                                    
                                                                                    
                                                                                    17,000
                                                                                    
                                                                                    
                                                                                    
                                                                                    14,218
                                                                                    
                                                                                    
                                                                                    
                                                                                    14,472
                                                                                    
                                                                                    
                                                                                    
                                                                                    84,500
                                                                                    
                                                                                    
                                                                                    
                                                                                    145,438Total
      interest-bearing liabilities
                                                                                    
                                                                                    
                                                                                    106,648
                                                                                    
                                                                                    
                                                                                    
                                                                                    38,556
                                                                                    
                                                                                    
                                                                                    
                                                                                    33,154
                                                                                    
                                                                                    
                                                                                    
                                                                                    28,020
                                                                                    
                                                                                    
                                                                                    
                                                                                    135,407
                                                                                    
                                                                                    
                                                                                    
                                                                                    341,785Interest
      rate sensitivity gap
                                                                                    
                                                                                    $
                                                                                    (88,353
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (27,887
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (27,357
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (17,057
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    217,466
                                                                                    
                                                                                    
                                                                                    $
                                                                                    56,812Interest
      rate sensitivity gap as a % of total assets
                                                                                    
                                                                                    
                                                                                    (20.44
                                                                                    %)
                                                                                    
                                                                                    
                                                                                    (6.45
                                                                                    %)
                                                                                    
                                                                                    
                                                                                    (6.33
                                                                                    %)
                                                                                    
                                                                                    
                                                                                    (3.95
                                                                                    %)
                                                                                    
                                                                                    
                                                                                    50.30
                                                                                    %Cum.
      interest rate sensitivity gap
                                                                                    
                                                                                    $
                                                                                    (88,353
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (116,240
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (143,598
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (160,655
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    56,811Cum.
      interest rate sensitivity gap as a % of total assets
                                                                                    
                                                                                    
                                                                                    (20.44
                                                                                    %)
                                                                                    
                                                                                    
                                                                                    (26.89
                                                                                    %)
                                                                                    
                                                                                    
                                                                                    (33.21
                                                                                    %)
                                                                                    
                                                                                    
                                                                                    (37.16
                                                                                    %)
                                                                                    
                                                                                    
                                                                                    13.14
                                                                                    %





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





The Bank regularly adjusts our
investments in liquid assets based upon our assessment of (1) expected loan
demand, (2) expected deposit flows, (3) yields available on
interest-earning deposits and securities and (4) the objectives of our
asset/liability management policy.





The most liquid assets are cash and
cash equivalents and interest-bearing deposits.  The levels of these
assets depend on the operating, financing, lending and investing activities
during any given period.  At December 31, 2008,
cash and cash equivalents totaled $9.7 million.  Securities classified
as available for sale and whose market value exceeds their cost provide an
additional source of liquidity.  Securities classified as available
for sale totaled $6.4 million at December 31, 2008.  In addition, at
December 31, 2008, we had the ability to borrow a total of approximately $28.9
million of additional advances from the Federal Home Loan Bank of
Boston.  On December 31, 2008, we had $105.4 million of advances
outstanding.





41
 Index





At December 31, 2008, the Bank had
$36.3 million in loan commitments outstanding, which consisted of $8.9 million
of real estate loan commitments, $14.9 million in unused home equity lines of
credit, $9.0 million in construction loan commitments and $3.5 million in
commercial lines of credit commitments.  Certificates of deposit due
within one year of December 31, 2008 totaled $66.8 million, or 91.2% of
certificates of deposit.  The large percentage of certificates of
deposit that mature within one year reflects customer’s hesitancy to invest
their funds for long periods in the recent low interest rate
environment.  If these maturing deposits do not remain with us, we
will be required to seek other sources of funds, including other certificates of
deposit and borrowings.  Depending on market conditions, Newport
Federal may be required to pay higher rates on such deposits or other borrowings
than we currently pay on the certificates of deposit due on or before December
31, 2008.  The Bank believes, however, based on past experience, that
a significant portion of our certificates of deposit will remain with the
Bank.  Newport Federal has the ability to attract and retain deposits
by adjusting the interest rates offered.





The Bank’s primary investing activities
are the origination and purchase of loans and the purchase of
securities.  The primary financing activities consist of activity in
deposit accounts and Federal Home Loan Bank advances.  Deposit flows
are affected by the overall level of interest rates, the interest rates and
products offered by Newport Federal and our local competitors and other
factors.  The Bank generally manages the pricing of our deposits to be
competitive.  Occasionally, promotional rates are offered on certain
deposit products to attract deposits.





Capital
Resources.  The Bank is subject to various regulatory capital
requirements administered by the Office of Thrift Supervision, including a
risk-based capital measure.  The risk-based capital guidelines include
both a definition of capital and a framework for calculating risk-weighted
assets by assigning balance sheet assets and off-balance sheet items to broad
risk categories.  At December 31, 2008, we exceeded all of our
regulatory capital requirements.  We are considered “well capitalized”
under regulatory guidelines.





The initial public stock offering
increased the Company’s equity by approximately $43.6 million, which
significantly increased liquidity and capital resources.  The
financial condition and results of operations were enhanced by the capital from
the offering, resulting in increased net interest-earning assets and net
income.  However, the large increase in equity resulting from the
capital raised in the offering will, initially, have an adverse impact on our
return on equity.  The Company may use capital management tools such
as cash dividends and common share repurchases.  However, under Office
of Thrift Supervision regulations, we are not allowed to repurchase any shares
during the first year following our initial stock offering, except: (1) in
extraordinary circumstances, we may make open market repurchases of up to 5% of
our outstanding stock if we receive the prior non-objection of the OTS of such
repurchases; (2) repurchases of qualifying shares of a director or if we conduct
an OTS-approved offer to repurchase made to all shareholders; (3) if we
repurchase to fund a restricted stock award plan that has been approved by
shareholders; or (4) if we repurchase stock to fund a tax-qualified employee
stock benefit plan.  All repurchases are prohibited, however, if the
repurchase would reduce Newport Federal’s regulatory capital below regulatory
required levels.





Off-Balance Sheet
Arrangements.  In the normal
course of operations, Newport Federal engages in a variety of financial
transactions that, in accordance with generally accepted accounting principles,
are not recorded in our financial statements. These transactions involve, to
varying degrees, elements of credit, interest rate and liquidity risk. Such
transactions are used primarily to manage customers’ requests for funding and
take the form of loan commitments and lines of credit.  For
information about the Company’s loan commitments and unused lines of credit, see
Note 12 to the Consolidated Financial Statements included in this Annual
Report.





For the year ended December 31, 2008,
the Company did not engage in any off-balance sheet transactions reasonably
likely to have a material effect on our financial condition, results of
operations or cash flows.





Effect
of Inflation and Changing Prices





The financial statements and related
financial data presented in this Form 10-K have been prepared in accordance with
generally accepted accounting principles, which require the measurement of
financial position and operating results in terms of historical dollars without
considering the change in the relative purchasing power of





42
 Index







ITEM7A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





The information required by this item
is incorporated herein by reference to Part II, Item 7,  “Management’s Discussion and Analysis
of Financial Condition and Results of Operation.”





ITEM8.
            FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA





The Consolidated Financial Statements,
including supplemental data, of Newport Bancorp, Inc. begin on page F-1 of this
Annual Report.





ITEM9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





None.





ITEM
      9A(T).
            CONTROLS
      AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures.




The Company’s President and Chief
Executive Officer, its Chief Financial Officer, and other members of its senior
management team have evaluated the effectiveness of the Company’s disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) or
15d-15(e)), as of December 31, 2008. Based on such evaluation, the
President and Chief Executive Officer and Chief Financial Officer have concluded
that the Company’s disclosure controls and procedures, as of the end of the
period covered by this report, were adequate and effective to provide reasonable
assurance that information required to be disclosed by the Company, including
Newport Federal, in reports that are filed or submitted under the Exchange Act,
is recorded, processed, summarized and reported, within the time periods
specified in the Commission’s rules and forms.




Changes
in Internal Controls Over Financial Reporting.




There have been no changes in the
Company’s internal control over financial reporting during the quarter ended
December 31, 2008 that have materially affected, or are reasonably likely to
materially affect, the Company’s internal control over financial
reporting.





Management’s
Report on Internal Control Over Financial Reporting.




The
management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting. The internal control process
has been designed under our supervision to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of the
Company’s financial statements for external reporting purposes in accordance
with accounting principles generally accepted in the United States of
America.





Management conducted an
assessment of the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2008, utilizing the framework established in
Internal Control —
Integrated Frameworkissued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO). Based on this assessment, management has
determined that the Company’s internal control over financial reporting as of
December 31, 2008 is effective.




Our internal control over financial
reporting includes policies and procedures that pertain to the maintenance of
records that accurately and fairly reflect, in reasonable detail, transactions
and dispositions of assets;





43
 Index









All internal control systems, no matter
how well designed, have inherent limitations. Therefore, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may
deteriorate.





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





ITEM9B.
            OTHER
      INFORMATION





Not applicable.





PART
III





ITEM10.
            DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE





The information relating to the
directors and officers of the Company, information regarding compliance with
Section 16(a) of the Exchange Act and information regarding the audit committee
and audit committee financial expert is incorporated herein by reference to the
Company’s Proxy Statement for the 2009 Annual Meeting of Stockholders (the
“Proxy Statement”).




The Company has adopted a code of
ethics that applies to its principal executive officer, the principal financial
officer and principal accounting officer.  The Code of Ethics is
posted on the Company’s Internet Web site at www.newportfederal.com.




ITEM11.
            EXECUTIVE
      COMPENSATION





The
information regarding executive compensation, compensation committee interlocks
and insider participation is incorporated herein by reference to the Proxy
Statement.





44
 Index





ITEM12.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDERS MATTERS





(a)
            Security
      Ownership of Certain Beneficial
Owners





Information
required by this item is incorporated herein by reference to the section
captioned “Stock Ownership” in the Proxy Statement.





(b)
            Security
      Ownership of Management





Information
required by this item is incorporated herein by reference to the section
captioned “Stock Ownership” in the Proxy Statement.





(c)
            Changes
      in Control





Management
of the Company knows of no arrangements, including any pledge by any person or
securities of the Company, the operation of which may at a subsequent date
result in a change in control of the registrant.





(d)
            Equity
      Compensation Plan Information





The
following table sets forth information as of December 31, 2008 about Company
common stock that may be issued upon the exercise of options under the Newport
Bancorp, Inc. 2007 Equity Incentive Plan.  The plan was approved by
the Company’s stockholders.




Plan Category
                  
                  Number
      of securities
                    to
      be issued upon
                    the
      exercise of
                    outstanding
      options,
                    warrants
      and rights
                  
                  
                  Weighted-average
                    exercise
      price of
                    outstanding
      options,
                    warrants
      and rights
                  
                  
                  Number
      of securities
                    remaining
      available
                    for
      future issuance under equity compensation plans (excluding securities
      reflected in the first column)Equity
      compensation plans approved by security holders
                  
                  
                  437,900
                  
                  
                  $
                  12.53
                  
                  
                  
                  49,934Equity
      compensation plans not approved by security holders
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/ATotal
                  
                  
                  437,900
                  
                  
                  $
                  12.53
                  
                  
                  
                  49,934







ITEM13.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE





The information relating to certain
relationships and related transactions and director independence is incorporated
herein by reference to the Proxy Statement.





ITEM14.
            PRINCIPAL
      ACCOUNTING FEES AND SERVICES





The information relating to the
principal accounting fees and expenses is incorporated herein by reference to
the Proxy Statement.







45
 Index





PARTIV





ITEM
      15.
            EXHIBITS
      AND FINANCIAL STATEMENT SCHEDULES





(1)
            The
      financial statements required in response to this item are incorporated by
      reference from Item 8 of this
report.





(2)
            All
      financial statement schedules are omitted because they are not required or
      applicable, or the required information is shown in the consolidated
      financial statements or the notes
thereto.





(3)
            Exhibits





3.1
                
                Articles
      of Incorporation of Newport Bancorp, Inc. (1)3.2
                
                Bylaws
      of Newport Bancorp, Inc.4.1
                
                Specimen
      Stock Certificate of Newport Bancorp, Inc. (1)10.1
                
                Amended
      and Restated Supplemental Executive Retirement Plan10.2
                
                First
      Amendment to Form of Newport Federal Savings Bank Supplemental Director
      Retirement Agreement10.3
                
                Amended
      and Restated Employment Agreement between Newport Federal Savings Bank and
      Kevin M. McCarthy10.4
                
                Amended
      and Restated Employment Agreement between Newport Bancorp, Inc. and Kevin
      M. McCarthy10.5
                
                Amended
      and Restated Amendment to the Employment Agreement between Newport Federal
      Savings Bank and Nino Moscardi10.6
                
                Amended
      and Restated Employment Agreement between Newport Bancorp, Inc. and Nino
      Moscardi10.7
                
                Amended
      and Restated Employment Agreement between Newport Federal Savings Bank and
      Ray Gilmore10.8
                
                Amended
      and Restated Employment Agreement between Newport Bancorp, Inc. and Bruce
      A. Walsh10.9
                
                Amended
      and Restated Change in Control Agreement between Newport Federal Savings
      Bank and Bruce A. Walsh10.10
                
                Amended
      and Restated Change in Control Agreement between Newport Federal Savings
      Bank and Carol R. Silven10.11
                
                Amended
      and Restated Change in Control Agreement between Newport Federal Savings
      Bank and Paul F. Nardone10.12
                
                Form
      of First Amendment to Supplemental Executive Retirement Agreement between
      Newport Federal Savings Bank and Carol R. Silven, Kevin M. McCarthy, Nino
      Moscardi, Bruce A. Walsh and Ray D. Gilmore, II10.13
                
                Executive
      Split Dollar Life Insurance Agreements between Newport Federal Savings
      Bank and Kevin M. McCarthy, Nino Moscardi and Bruce A. Walsh
      (2)10.14
                
                Director
      Split Dollar Life Insurance Agreements between Newport Federal Savings
      Bank and Peter W. Rector, Donald N. Kaull, Robert S. Lazar, Michael S.
      Pinto, Michael J. Hayes, Barbara Saccucci Radebach, Alicia S. Quirk, Peter
      T. Crowley, Arthur H. Lathrop, Arthur H. Macauley and Kathleen A. Nealon
      (2)21.0
                
                List
      of Subsidiaries (3)23.0
                
                Consent
      of Wolf & Company, P.C.31.1
                
                Rule
      13a-14(a)/15d-14(a) Certification of Chief Executive
    Officer31.2
                
                Rule
      13a-14(a)/15d-14(a) Certification of Chief Financial
    Officer





46
 Index





______________________________





(1)
            Incorporated
      by reference to the Company’s Registration Statement on Form S-1, as
      amended, initially filed with the SEC on March 20,
  2006.


(2)
            Incorporated
      by reference to the Company’s Quarterly Report on Form 10-Q for the
      quarter ended March 31, 2007.


(3)
            Incorporated
      by reference to Exhibit 21.0 to the Company’s Annual Report on Form 10-K
      for the year ended December 31,
2006.





47
 Index





SIGNATURES





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







NEWPORT
      BANCORP, INC.Date:
      March 27, 2009
                                    By:
                                    /s/
      Kevin M. McCarthyKevin
      M. McCarthyPresident
      and Chief Executive
Officer





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





Name
                                  
                                  Title
                                  
                                  Date/s/
      Kevin M. McCarthy
                                  
                                  President,
      Chief Executive Officer,
                                  
                                  March
      27, 2009Kevin
      M. McCarthy
                                  
                                  and
      Director(principal
      executive officer)/s/
      Bruce A. Walsh
                                  
                                  Senior
      Vice President and Chief
                                  
                                  March
      27, 2009Bruce
      A. Walsh
                                  
                                  Financial
      Officer(principal
      accounting andfinancial
      officer)/s/
      John N. Conti
                                  
                                  Director
                                  
                                  March
      27, 2009John
      N. Conti/s/
      Peter T. Crowley
                                  
                                  Director
                                  
                                  March
      27, 2009Peter
      T. Crowley/s/
      William R. Harvey
                                  
                                  Director
                                  
                                  March
      27, 2009William
      R. Harvey/s/
      Michael J. Hayes
                                  
                                  Director
                                  
                                  March
      27, 2009Michael
      J. Hayes/s/
      Donald N. Kaull
                                  
                                  Director
                                  
                                  March
      27, 2009Donald
      N. Kaull/s/
      Arthur H. Lathrop
                                  
                                  Director
                                  
                                  March
      27, 2009Arthur
      H. Lathrop/s/
      Robert S. Lazar
                                  
                                  Director
                                  
                                  March
      27, 2009Robert
      S. Lazar





48
 Index





/s/
      Arthur P. Macauley
                            
                            Director
                            
                            March
      27, 2009Arthur
      P. Macauley/s/
      Nino Moscardi
                            
                            Director
                            
                            March
      27, 2009Nino
      Moscardi/s/
      Kathleen A. Nealon
                            
                            Director
                            
                            March
      27, 2009Kathleen
      A. Nealon/s/
      Michael S. Pinto
                            
                            Director
                            
                            March
      27, 2009Michael
      S. Pinto/s/
      Alicia S. Quirk
                            
                            Director
                            
                            March
      27, 2009Alicia
      S. Quirk/s/
      Peter W. Rector
                            
                            Director
                            
                            March
      27, 2009Peter
      W. Rector/s/
      Barbara Saccucci Radebach
                            
                            Director
                            
                            March
      27, 2009Barbara
      Saccucci Radebach


49
 Index
  NEWPORT
BANCORP, INC.
   CONSOLIDATED
FINANCIAL STATEMENTS
  Years
Ended December 31, 2008 and 2007
   INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
   PageReport
      of Independent Registered Public Accounting Firm
                  F-2Consolidated
      Balance Sheets
                  F-3Consolidated
      Statements of Operations
                  F-4Consolidated
      Statements of Changes in Stockholders’ Equity
                  F-5Consolidated
      Statements of Cash Flows
                  F-6
      - F-7Notes
      to Consolidated Financial Statements
                  F-8
      - F-42
  F-1
 Index
  Report of
Independent Registered Public Accounting Firm
  
  The Board
of Directors
 Newport
Bancorp, Inc.
 Newport,
Rhode Island
  We have
audited the accompanying consolidated balance sheets of Newport Bancorp, Inc.
and subsidiary as of December 31, 2008 and 2007, and the related
consolidated statements of operations, changes in stockholders’ equity and cash
flows for the years then ended.  These financial statements are the
responsibility of the Bank’s management.  Our responsibility is to
express an opinion on these financial statements based on our
audits.
  We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Newport Bancorp, Inc. and
subsidiary as of December 31, 2008 and 2007, and the results of its
operations and its cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of
America.
  
 /s/ Wolf
& Company, P.C.
 
  Boston,
Massachusetts
 March 19,
2009
  F-2
 Index
 
 NEWPORT
BANCORP, INC. AND SUBSIDIARY
  CONSOLIDATED
BALANCE SHEETS
  December 31,
2008 and 2007
  
 ASSETS2008
                    
                    
                    2007(In
      thousands)Cash
      and due from banks
                    
                    $
                    6,628
                    
                    
                    $
                    6,646Short-term
      investments
                    
                    
                    3,037
                    
                    
                    
                    59Cash
      and cash equivalents
                    
                    
                    9,665
                    
                    
                    
                    6,705Securities
      available for sale, at fair value
                    
                    
                    6,390
                    
                    
                    
                    6,966Securities
      held to maturity, at amortized cost
                    
                    
                    52,162
                    
                    
                    
                    30,886Federal
      Home Loan Bank stock, at cost
                    
                    
                    5,556
                    
                    
                    
                    4,163Loans
                    
                    
                    335,953
                    
                    
                    
                    295,483Allowance
      for loan losses
                    
                    
                    (2,924
                    )
                    
                    
                    (2,399
                    )Loans,
      net
                    
                    
                    333,029
                    
                    
                    
                    293,084Premises
      and equipment, net
                    
                    
                    10,722
                    
                    
                    
                    5,849Accrued
      interest receivable
                    
                    
                    1,429
                    
                    
                    
                    1,269Net
      deferred tax asset
                    
                    
                    2,342
                    
                    
                    
                    2,313Bank-owned
      life insurance
                    
                    
                    9,918
                    
                    
                    
                    9,509Other
      assets
                    
                    
                    1,122
                    
                    
                    
                    515Total
      assets
                    
                    $
                    432,335
                    
                    
                    $
                    361,259LIABILITIES
      AND STOCKHOLDERS' EQUITYDeposits
                    
                    $
                    229,123
                    
                    
                    $
                    193,285Short-term
      borrowings
                    
                    
                    4,000
                    
                    
                    
                    5,809Long-term
      borrowings
                    
                    
                    141,438
                    
                    
                    
                    99,547Accrued
      expenses and other liabilities
                    
                    
                    3,461
                    
                    
                    
                    3,666Total
      liabilities
                    
                    
                    378,022
                    
                    
                    
                    302,307Commitments
      and contingencies (Notes 5, 10 and 11)Stockholders'
      equity:Preferred
      stock, $.01 par value; 1,000,000 shares authorized; none
      issued
                    
                    
                    -
                    
                    
                    
                    -Common
      stock, $.01 par value; 19,000,000 shares authorized; 4,878,349 shares
      issued
                    
                    
                    49
                    
                    
                    
                    49Additional
      paid-in capital
                    
                    
                    50,438
                    
                    
                    
                    50,023Retained
      earnings
                    
                    
                    16,324
                    
                    
                    
                    17,234Unearned
      compensation (468,320 and 533,365 shares at December 31, 2008 and 2007,
      respectively)
                    
                    
                    (4,294
                    )
                    
                    
                    (5,548
                    )Treasury
      stock (655,935 and 213,660 shares at at December 31, 2008 and 2007,
      respectively)
                    
                    
                    (7,943
                    )
                    
                    
                    (2,655
                    )Accumulated
      other comprehensive loss
                    
                    
                    (261
                    )
                    
                    
                    (151
                    )Total
      stockholders' equity
                    
                    
                    54,313
                    
                    
                    
                    58,952Total
      liabilities and stockholders' equity
                    
                    $
                    432,335
                    
                    
                    $
                    361,259
 
  See
accompanying notes to consolidated financial statements.
  F-3
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  CONSOLIDATED
STATEMENTS OF OPERATIONS
  Years
Ended December 31, 2008 and 2007
  2008
                      
                      
                      2007(Dollars
      in thousands, except share data)Interest
      and dividend income:Loans
                      
                      $
                      19,296
                      
                      
                      $
                      17,195Securities
                      
                      
                      2,079
                      
                      
                      
                      567Federal
      Home Loan Bank stock
                      
                      
                      174
                      
                      
                      
                      177Other
      interest-earning assets
                      
                      
                      95
                      
                      
                      
                      49Total
      interest and dividend income
                      
                      
                      21,644
                      
                      
                      
                      17,988Interest
      expense:Deposits
                      
                      
                      4,821
                      
                      
                      
                      4,888Short-term
      borrowings
                      
                      
                      40
                      
                      
                      
                      349Long-term
      borrowings
                      
                      
                      4,727
                      
                      
                      
                      2,457Total
      interest expense
                      
                      
                      9,588
                      
                      
                      
                      7,694Net
      interest income
                      
                      
                      12,056
                      
                      
                      
                      10,294Provision
      for loan losses
                      
                      
                      568
                      
                      
                      
                      426Net
      interest income, after provision for loan losses
                      
                      
                      11,488
                      
                      
                      
                      9,868Non-interest
      income:Customer
      service fees
                      
                      
                      1,801
                      
                      
                      
                      1,839Impairment
      loss on available-for-sale securities
                      
                      
                      (706
                      )
                      
                      
                      -Bank-owned
      life insurance
                      
                      
                      409
                      
                      
                      
                      392Miscellaneous
                      
                      
                      72
                      
                      
                      
                      88Total
      non-interest income
                      
                      
                      1,576
                      
                      
                      
                      2,319Non-interest
      expenses:Salaries
      and employee benefits
                      
                      
                      7,836
                      
                      
                      
                      6,171Occupancy
      and equipment
                      
                      
                      1,372
                      
                      
                      
                      1,282Data
      processing
                      
                      
                      1,103
                      
                      
                      
                      1,004Professional
      fees
                      
                      
                      490
                      
                      
                      
                      563Marketing
                      
                      
                      1,245
                      
                      
                      
                      1,085Other
      general and administrative
                      
                      
                      870
                      
                      
                      
                      729Total
      non-interest expenses
                      
                      
                      12,916
                      
                      
                      
                      10,834Income
      before income taxes
                      
                      
                      148
                      
                      
                      
                      1,353Provision
      for income taxes
                      
                      
                      996
                      
                      
                      
                      596Net
      income (loss)
                      
                      $
                      (848
                      )
                      
                      $
                      757Weighted
      average shares outstanding:Basic
                      
                      
                      4,128,677
                      
                      
                      
                      4,481,203Diluted
                      
                      
                      4,128,677
                      
                      
                      
                      4,481,203Earnings
      (loss) per share:Basic
                      
                      $
                      (0.21
                      )
                      
                      $
                      0.17Diluted
                      
                      $
                      (0.21
                      )
                      
                      
                      0.17
 
 See
accompanying notes to consolidated financial statements.
  F-4
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
  Years
Ended December 31, 2008 and 2007
  AccumulatedAdditional
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      OtherCommon
      Stock
                      
                      
                      Paid-in
                      
                      
                      Retained
                      
                      
                      Unearned
                      
                      
                      Treasury
                      
                      
                      ComprehensiveShares
                      
                      
                      Amount
                      
                      
                      Capital
                      
                      
                      Earnings
                      
                      
                      Compensation
                      
                      
                      Stock
                      
                      
                      Loss
                      
                      
                      Total(Dollars
      in thousands)Balance
      at December 31, 2006
                      
                      
                      4,878,349
                      
                      
                      $
                      49
                      
                      
                      $
                      47,258
                      
                      
                      $
                      16,477
                      
                      
                      $
                      (3,643
                      )
                      
                      $
                      -
                      
                      
                      $
                      (161
                      )
                      
                      $
                      59,980Comprehensive
      income:Net
      income
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      757
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      757Net
      unrealized gain on securities available for sale
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      10
                      
                      
                      
                      10Total
      comprehensive income
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      767Restricted
      stock granted in connection with equity incentive plan (195,133
      shares)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,445
                      
                      
                      
                      -
                      
                      
                      
                      (2,445
                      )
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Stock-based
      compensation - restricted stock
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      279
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      279Stock-based
      compensation - options
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      241
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      241Release
      of ESOP shares (26,018 shares)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      79
                      
                      
                      
                      -
                      
                      
                      
                      261
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      340Purchase
      of treasury shares (213,660 shares)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (2,655
                      )
                      
                      
                      -
                      
                      
                      
                      (2,655
                      )Balance
      at December 31, 2007
                      
                      
                      4,878,349
                      
                      
                      
                      49
                      
                      
                      
                      50,023
                      
                      
                      
                      17,234
                      
                      
                      
                      (5,548
                      )
                      
                      
                      (2,655
                      )
                      
                      
                      (151
                      )
                      
                      
                      58,952Comprehensive
      loss:Net
      loss
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (848
                      )
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (848
                      )Net
      unrealized loss on securities available for sale, net of reclassification
      adjustment of $706,000 for impaired loss on available-for-sale
      securities
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (110
                      )
                      
                      
                      (110
                      )Total
      comprehensive loss
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (958
                      )Impact
      of adoption of EITF 06-04 for split dollar insurance plan
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (62
                      )
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (62
                      )Stock-based
      compensation - restricted stock
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      994
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      994Stock-based
      compensation - options
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      858
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      858Release
      of ESOP shares (26,018 shares)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      49
                      
                      
                      
                      -
                      
                      
                      
                      260
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      309Issuance
      of treasury stock in connection with restricted stock plan (39,027
      shares)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (492
                      )
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      492
                      
                      
                      
                      -
                      
                      
                      
                      -Purchase
      of treasury shares (481,302 shares)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (5,780
                      )
                      
                      
                      -
                      
                      
                      
                      (5,780
                      )Balance
      at December 31, 2008
                      
                      
                      4,878,349
                      
                      
                      $
                      49
                      
                      
                      $
                      50,438
                      
                      
                      $
                      16,324
                      
                      
                      $
                      (4,294
                      )
                      
                      $
                      (7,943
                      )
                      
                      $
                      (261
                      )
                      
                      $
                      54,313
 
  See
accompanying notes to consolidated financial statements.
  F-5
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  CONSOLIDATED
STATEMENTS OF CASH FLOWS
  Years
Ended December 31, 2008 and 2007
  
 2008
                  
                  
                  2007(In
      thousands)Cash
      flows from operating activities:Net
      income (loss)
                  
                  $
                  (848
                  )
                  
                  $
                  757Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Provision
      for loan losses
                  
                  
                  568
                  
                  
                  
                  426Accretion
      of securities held to maturity
                  
                  
                  (106
                  )
                  
                  
                  (23
                  )Impairment
      loss on available-for-sale securities
                  
                  
                  706
                  
                  
                  
                  -Amortization
      of net deferred loan fees
                  
                  
                  (249
                  )
                  
                  
                  (159
                  )Depreciation
      and amortization of premises and equipment
                  
                  
                  608
                  
                  
                  
                  619Stock-based
      compensation and ESOP allocation
                  
                  
                  2,161
                  
                  
                  
                  860Deferred
      income tax benefit
                  
                  
                  (29
                  )
                  
                  
                  (462
                  )Income
      from bank-owned life insurance
                  
                  
                  (409
                  )
                  
                  
                  (392
                  )Net
      change in:Accrued
      interest receivable
                  
                  
                  (160
                  )
                  
                  
                  (242
                  )Other
      assets
                  
                  
                  (607
                  )
                  
                  
                  371Accrued
      expenses and other liabilities
                  
                  
                  (267
                  )
                  
                  
                  626Net
      cash provided by operating activities
                  
                  
                  1,368
                  
                  
                  
                  2,381Cash
      flows from investing activities:Purchase
      of held-to-maturity securities
                  
                  
                  (24,253
                  )
                  
                  
                  (29,421
                  )Reinvested
      dividends on mutual funds
                  
                  
                  (240
                  )
                  
                  
                  (342
                  )Principal
      payments received on securities held to maturity
                  
                  
                  3,083
                  
                  
                  
                  480Purchase
      of bank-owned life insurance
                  
                  
                  -
                  
                  
                  
                  (3,500
                  )Purchase
      of Federal Home Loan Bank stock
                  
                  
                  (1,393
                  )
                  
                  
                  (1,773
                  )Loan
      originations, net of principal payments
                  
                  
                  (40,264
                  )
                  
                  
                  (36,585
                  )Additions
      to premises and equipment
                  
                  
                  (5,481
                  )
                  
                  
                  (369
                  )Net
      cash used by investing activities
                  
                  
                  (68,548
                  )
                  
                  
                  (71,510
                  )
 
  (continued)
   See
accompanying notes to consolidated financial statements.
  F-6
 Index
 
 NEWPORT
BANCORP, INC. AND SUBSIDIARY
  CONSOLIDATED
STATEMENTS OF CASH FLOWS (Concluded)
  Years
Ended December 31, 2008 and 2007
  
 2008
                  
                  
                  2007(In
      thousands)Cash
      flows from financing activities:Net
      increase in deposits
                  
                  
                  35,838
                  
                  
                  
                  311Net
      (decrease) increase in borrowings with maturities of three months or
      less
                  
                  
                  (1,809
                  )
                  
                  
                  3,309Proceeds
      from borrowings with maturities in excess of three months
                  
                  
                  49,500
                  
                  
                  
                  70,500Repayment
      of borrowings with maturities in excess of three months
                  
                  
                  (7,609
                  )
                  
                  
                  (2,903
                  )Purchase
      of treasury stock
                  
                  
                  (5,780
                  )
                  
                  
                  (2,655
                  )Net
      cash provided by financing activities
                  
                  
                  70,140
                  
                  
                  
                  68,562Net
      change in cash and cash equivalents
                  
                  
                  2,960
                  
                  
                  
                  (567
                  )Cash
      and cash equivalents at beginning of year
                  
                  
                  6,705
                  
                  
                  
                  7,272Cash
      and cash equivalents at end of year
                  
                  $
                  9,665
                  
                  
                  $
                  6,705Cash
      paid during the year for:Interest
      on deposit accounts
                  
                  $
                  5,594
                  
                  
                  $
                  4,943Interest
      on borrowings
                  
                  
                  4,682
                  
                  
                  
                  2,554Income
      taxes, net of refunds
                  
                  
                  1,258
                  
                  
                  
                  954
 
  See
accompanying notes to consolidated financial statements.
  F-7
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
  Years
Ended December 31, 2008 and 2007
  1.
              SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
  Principles
of Consolidation
  The
consolidated financial statements include the accounts of Newport Bancorp, Inc.
(the “Company”) and its wholly-owned subsidiary, Newport Federal Savings Bank
(the “Bank”).  The Bank has one wholly-owned subsidiary, Newport
Federal Investments, Inc., which was established in December 2008 to hold
certain investments, consisting primarily of commercial mortgages and loans. All
significant intercompany balances and transactions have been eliminated in
consolidation.
  Nature
of Operations
  The
Company provides a variety of financial services to individuals and small
businesses through its offices in Newport and Washington County, Rhode
Island.  Its primary deposit products are savings, checking and term
certificate accounts, and its primary lending products are residential and
commercial mortgage loans.
  Segment
Reporting
  Management
evaluates the Company’s performance and allocates resources based on a single
segment concept.  Accordingly, there are no separately identified
operating segments for which discrete financial information is
available.  The Company does not derive revenues from, or have assets
located in, foreign countries, nor does it derive revenues from any single
customer that represents 10% or more of the Company’s total
revenues.
  Use
of Estimates
  In
preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and reported amounts of revenues
and expenses during the reporting period.  Actual results could differ
from those estimates.  Material estimates that are particularly
susceptible to significant changes in the near term relate to the determination
of the allowance for loan losses, other-than-temporary impairment of securities
and the valuation of deferred tax assets.
  Reclassification
  Certain
amounts in the 2007 consolidated financial statements have been reclassified to
conform to the 2008 presentation.
  F-8
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Cash
and Cash Equivalents
  Cash and
cash equivalents include cash and balances due from banks and short-term
investments consisting of federal funds and interest-bearing deposits, all of
which mature within ninety days.
  Securities
  Securities
available for sale are carried at fair value with unrealized gains and losses
excluded from earnings and reported as a separate component of comprehensive
income/loss.  Securities held to maturity are reflected at amortized
cost.
  Purchase
premiums and discounts are amortized to earnings by the interest method over the
terms of the securities.  Declines in the value of securities that are
deemed to be other than temporary are reflected in earnings when
identified.  Gains and losses on disposition of securities are
recorded on the trade date and are computed by the specific identification
method.
  Management
evaluates securities for other-than-temporary impairment at least on a quarterly
basis, and more frequently when economic or market concerns warrant such
evaluation.  Consideration is given to (1) the length of time and the
extent to which the fair value has been less than cost, (2) the financial
condition of the issuer, and (3) the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value.
  Federal
Home Loan Bank Stock
  The Bank,
as a member of the Federal Home Loan Bank (“FHLB”) system, is required to
maintain an investment in capital stock of the FHLB.  Based on
redemption provisions of the FHLB, the stock has no quoted market value and is
carried at cost.  At its discretion, the FHLB may declare dividends on
the stock.  The Bank reviews for impairment based on the ultimate
recoverability of the cost basis in the FHLB stock.  As of December
31, 2008, no impairment has been recognized.
  Loans
  The Bank
grants mortgage, commercial and consumer loans to customers and a substantial
portion of the loan portfolio consists of mortgage loans in Newport and
Washington County, Rhode Island.  The ability of the Company’s debtors
to honor their contracts is dependent upon the economy in general and the real
estate and construction economic sectors.
  F-9
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Loans
(concluded)
  Loans
that management has the intent and ability to hold for the foreseeable future or
until maturity or pay-off are reported at their outstanding unpaid principal
balances adjusted for charge-offs, the allowance for loan losses, and any
deferred fees or costs on originated loans.  Interest income is
accrued on the unpaid principal balance.  Loan origination fees, net
of certain direct origination costs, are deferred and recognized as an
adjustment of the related loan yield using the interest method over the
contractual terms of the loan.
  The
accrual of interest on mortgage loans is discontinued at the time the loan is 90
days past due unless the credit is well-secured and in process of
collection.  Past due status is based on contractual terms of the
loan.  In all cases, loans are placed on non-accrual or charged-off at
an earlier date if collection of principal or interest is considered
doubtful.
  All
interest accrued but not collected for loans that are placed on non-accrual or
charged off is reversed against interest income.  The interest on
these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual.  Loans are returned to accrual
status when all the principal and interest amounts contractually due are brought
current and future payments are reasonably assured.
  Allowance
for Loan Losses
  The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to
earnings.  Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is
confirmed.  Subsequent recoveries, if any, are credited to the
allowance.
  The
allowance for loan losses is evaluated on a regular basis by management and is
based upon management’s periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower’s ability to repay, estimated
value of any underlying collateral and prevailing economic
conditions.  This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.
  The
allowance consists of allocated and general loss components.  For
loans that are classified as impaired, an allowance is established when the
collateral value of the impaired loan is lower than the carrying value of that
loan.  The general component covers non-classified loans and is based
on historical loss experience adjusted for qualitative factors.
  F-10
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Allowance
for Loan Losses (concluded)
  A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due.  Impairment is
measured on a loan by loan basis by the fair value of the
collateral.
  Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment.  Accordingly, the Company does not separately identify
individual consumer and residential loans for impairment
disclosures.
  Transfers
of Financial Assets
  Transfers
of financial assets are accounted for as sales, when control over the assets has
been surrendered.  Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right to pledge or exchange the transferred assets, and
(3) the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
  Bank-owned
Life Insurance
  Bank-owned
life insurance policies are reflected on the consolidated balance sheets at cash
surrender value.  Changes in cash surrender value are reflected in
non-interest income on the consolidated statements of income.
  Premises
and Equipment
  Land is
carried at cost.  Premises and equipment are stated at cost, less
accumulated depreciation and amortization, computed on a straight-line method
over the estimated useful lives of the assets or the expected terms of the
leases, if shorter.  Expected terms include lease option periods to
the extent that the exercise of such options is reasonably assured.
  Marketing
Costs
  Marketing
costs are expensed as incurred.
  Pension
Plan
  It is the
Company’s policy to fund pension costs in the year of accrual.
  F-11
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Stock
Compensation Plans
  The
Company measures and recognizes compensation cost relating to stock-based
compensation transactions based on the grant-date fair value of the equity
instruments issued.  Stock-based compensation is recognized over the
period the employee is required to provide services for the
award.  The Company uses the Black-Scholes option-pricing model to
determine the fair value of stock options granted.
  Employee
Stock Ownership Plan
  Compensation
expense for the Employee Stock Ownership Plan (“ESOP”) is recorded at an amount
equal to the shares allocated by the ESOP multiplied by the average fair market
value of the shares during the period.  The Company recognizes
compensation expense ratably over the year based upon the Company’s estimate of
the number of shares expected to be allocated by the ESOP.  Unearned
compensation applicable to the ESOP is reflected as a reduction of stockholders’
equity in the consolidated balance sheet.  The difference between the
average fair market value and the cost of the shares allocated by the ESOP is
recorded as an adjustment to additional paid-in capital.
  Treasury
Stock
  Common
stock shares repurchased are recorded as treasury stock at cost.
  Income
Taxes
  Deferred
tax assets and liabilities are reflected at currently enacted income tax rates
applicable to the period in which the deferred tax assets or liabilities are
expected to be realized or settled.  As changes in tax laws or rates
are enacted, deferred tax assets and liabilities are adjusted accordingly
through the provision for income taxes.  The Bank’s base amount of its
federal income tax reserve for loan losses is a permanent difference for which
there is no recognition of a deferred tax liability.  However, the
loan loss allowance maintained for financial reporting purposes is a temporary
difference with allowable recognition of a related deferred tax asset, if it is
deemed realizable.
  A
valuation allowance related to deferred tax assets is established when, in the
judgment of management, it is more likely than not that all or a portion of such
deferred tax assets will not be realized.
  F-12
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Earnings
per Share
  Basic
earnings per share (“EPS”) excludes dilution and is calculated by dividing net
income available to common stockholders by the weighted-average number of shares
of common stock outstanding during the period.  Diluted EPS reflects
additional common shares (computed using the treasury stock method) that would
have been outstanding if all potentially dilutive common stock equivalents
(stock options and unvested restricted stock) were issued during the
period.  Common stock equivalents of 594,006 and 633,033 that could
potentially dilute basic EPS in the future were not included in the computation
of diluted EPS because they were anti-dilutive for the years ended December 31,
2008 and 2007, respectively.  Treasury shares and unallocated ESOP
shares are not deemed outstanding for earnings per share
calculations.
  Comprehensive
Income/Loss
  Accounting
principles generally require that recognized revenue, expenses, gains and losses
be included in net income.  Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the retained earnings
section of the balance sheet, such items, along with net income, are components
of comprehensive income/loss.  There is no tax benefit available on
the unrealized losses on the securities available for sale as the losses
represent capital losses for which the Company has no capital gain history to
offset such losses.
  Recent
Accounting Pronouncements
  In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement No. 157, “Fair Value Measurements.”  This Statement
defines fair value, establishes a framework for measuring fair value in
accordance with generally accepted accounting principles, and expands
disclosures about fair value measurements.  The definition of fair
value retains the exchange price notion in earlier definitions of fair
value.  This Statement clarifies that the exchange price is the price
in an orderly transaction between market participants to sell the asset or
transfer the liability in the market in which the reporting entity would
transact for the asset or liability, that is, the principal or most advantageous
market for the asset or liability.  Emphasis is placed on fair value
being a market-based measurement, not an entity-specific measurement, and
therefore a fair value measurement should be determined based on the assumptions
that market participants would use in pricing the asset or
liability.  As a basis for considering these market participant
assumptions, a fair value hierarchy has been established to distinguish between
(1) market participant assumptions developed based on market data obtained from
sources independent of the reporting entity (observable inputs) and (2) the
reporting entity’s own assumptions about market participant assumptions
developed based on the best information available in the circumstances
(unobservable inputs).
  F-13
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Recent
Accounting Pronouncements (continued)
  In
February 2008, the FASB issued a Staff Position which delays the effective date
of Statement No. 157 for non-financial assets and non-financial
liabilities, except for items that are recognized or disclosed at fair value in
the financial statements on a recurring basis, to fiscal years beginning after
November 15, 2008.  The Company adopted this Statement, except
for items covered by the Staff Position, as of January 1, 2008 and the adoption
did not have a material impact on the consolidated financial
statements.  See Note 13.
  In
October 2008, the FASB issued FASB Staff Position No. FAS 157-3, “Determining
the Fair Value of a Financial Asset When the Market for That Asset Is Not
Active” (“FSP 157-3”).  FSP 157-3 clarifies the application of
Statement No. 157 in a market that is not active and provides an example to
illustrate key considerations in determining the fair value of a financial asset
when the market for that financial asset is not active.  FSP 157-3 was
effective immediately upon issuance, and includes prior periods for which
financial statements have not been issued.  FSP 157-3 did not have an
impact on the consolidated financial statements.
  In
February 2007, the FASB issued Statement No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an amendment of FASB
Statement No. 115.”  This Statement permits entities to choose to
measure many financial instruments and certain other items at fair value, with
the objective of improving financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions, and is expected to expand the use of fair value
measurement.  An entity will report unrealized gains and losses on
items for which the fair value option has been elected in earnings at each
subsequent reporting date.  The fair value option may generally be
applied instrument by instrument and is irrevocable.  This Statement
was adopted by the Company on January 1, 2008 and did not have an impact on the
Company’s consolidated financial statements.
  Effective
January 1, 2008, the Company adopted Emerging Issues Task Force (“EITF”) Issue
No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit
Aspects of Endorsement Split-Dollar Life Insurance Arrangements”, which
addresses accounting for split-dollar life insurance arrangements whereby the
employer purchases a policy to insure the life of an employee, and separately
enters into an agreement to split the policy benefits between the employer and
the employee.  This EITF states that an obligation arises as a result
of a substantive agreement with an employee to provide future postretirement
benefits.  Under EITF 06-4, the obligation is not settled upon
entering into an insurance arrangement.  Since the obligation is not
settled, a liability should be recognized in accordance with applicable
authoritative guidance.  The result of adopting this EITF on January
1, 2008 was a decrease to retained earnings in the amount of
$62,000.
  F-14
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (concluded)
  Recent
Accounting Pronouncements (concluded)
  In
December 2007, the FASB issued Statement No. 141 (revised), “Business
Combinations”, which replaces FASB Statement No. 141, and applies to all
business entities, including mutual entities that previously used the
pooling-of-interests method of accounting for certain business combinations.
This Statement makes significant amendments to other Statements and other
authoritative guidance, and applies prospectively to business combinations for
which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008.  An entity
may not apply it before that date.  This Statement is not expected to
have a material impact on the Company’s consolidated financial
statements.
  In March
2008, the FASB issued Statement No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133”,
which changes the disclosure requirements for derivative instruments and hedging
activities.  This Statement is intended to enhance the current
disclosure framework in Statement 133.  The Statement requires that
objectives for using derivative instruments be disclosed in terms of underlying
risk and accounting designation.  This Statement is effective for the
Company’s consolidated financial statements issued for fiscal years and interim
periods beginning on January 1, 2009 and is not expected to have a material
impact on the Company’s consolidated financial statements.
  2.
                RESTRICTIONS ON CASH
      AND AMOUNTS DUE FROM
BANKS
  The Bank
is required to maintain average balances on hand or with the Federal Reserve
Bank.  At December 31, 2008 and 2007, these reserve balances
amounted to $5,451,000 and $2,904,000, respectively.
  F-15
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  3.
              SECURITIES
  The
amortized cost and estimated fair value of securities, with gross unrealized
gains and losses, follows:
  Gross
                                  
                                  
                                  GrossAmortized
                                  
                                  
                                  Unrealized
                                  
                                  
                                  Unrealized
                                  
                                  
                                  FairCost
                                  
                                  
                                  Gains
                                  
                                  
                                  Losses
                                  
                                  
                                  Value(In
      thousands)December 31, 2008Securities Available for
    SaleMutual
      funds - bond funds
                                  
                                  $
                                  6,651
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  (261
                                  )
                                  
                                  $
                                  6,390Securities Held to MaturityMortgage-backed
      securities
                                  
                                  $
                                  52,162
                                  
                                  
                                  $
                                  2,040
                                  
                                  
                                  $
                                  (4
                                  )
                                  
                                  $
                                  54,198December 31, 2007Securities Available for
    SaleMutual
      funds - bond funds
                                  
                                  $
                                  7,117
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  (151
                                  )
                                  
                                  $
                                  6,966Securities Held to MaturityMortgage-backed
      securities
                                  
                                  $
                                  30,886
                                  
                                  
                                  $
                                  3
                                  
                                  
                                  $
                                  (138
                                  )
                                  
                                  $
                                  30,751
 
 Mortgage-backed
securities consist primarily of participation certificates guaranteed by the
Federal National Mortgage Association.
  At
December 31, 2008 and 2007, mortgage-backed securities were pledged to secure
repurchase agreements (see Note 7).
  There
were no sales of securities for the years ended December 31, 2008 and
2007.
  F-16
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  SECURITIES
(continued)
  Information
pertaining to securities with gross unrealized losses aggregated by investment
category and length of time that individual securities have been in a continuous
loss position, follows:
  Less
      Than Twelve Months
                                    
                                    
                                    Over
      Twelve MonthsGross
                                    
                                    
                                    
                                    
                                    
                                    GrossUnrealized
                                    
                                    
                                    Fair
                                    
                                    
                                    Unrealized
                                    
                                    
                                    FairLosses
                                    
                                    
                                    Value
                                    
                                    
                                    Losses
                                    
                                    
                                    Value(In
      thousands)December 31, 2008Securities Available for
    SaleMutual
      funds - bond funds
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    261
                                    
                                    
                                    $
                                    4,404Securities Held to MaturityMortgage-backed
      securities
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    4
                                    
                                    
                                    
                                    1,293Total
      temporarily impaired securities
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    265
                                    
                                    
                                    $
                                    5,697December 31, 2007Securities Available for
    SaleMutual
      funds - bond funds
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    151
                                    
                                    
                                    $
                                    6,966Securities Held to MaturityMortgage-backed
      securities
                                    
                                    
                                    105
                                    
                                    
                                    
                                    29,124
                                    
                                    
                                    
                                    33
                                    
                                    
                                    
                                    1,571Total
      temporarily impaired securities
                                    
                                    $
                                    105
                                    
                                    
                                    $
                                    29,124
                                    
                                    
                                    $
                                    184
                                    
                                    
                                    $
                                    8,537
  At
December 31, 2008, two mutual funds have unrealized losses with aggregate
depreciation of 5.6% from the Company’s cost basis.  Neither of the
funds have reduced or eliminated their dividend payments.  The Company
has determined that these unrealized losses relate primarily to illiquidity in
the market for the securities underlying these funds and not to credit
issues.  The Company has the intent and ability to hold the securities
for a period of time sufficient to allow for an anticipated recovery of the fair
value.  The effective duration of these funds range from 1.5 years to
2.7 years.  The Company has reviewed the financial condition of the
issuers and has determined that none of the declines are other than
temporary.
  At
December 31, 2008, one mortgage-backed security is in an unrealized loss
position which relates primarily to changes in interest rates and as the Company
has the intent and ability to hold this security until maturity, the decline is
deemed not to be other than temporary.
  F-17
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  SECURITIES
(concluded)
  At
December 31, 2008, the Company recognized a $706,000 impairment charge for the
Bank’s holding in the AMF Ultra Short Mortgage Fund.  This fund has
invested in private-label mortgage-backed securities and U.S. Government agency
and government-sponsored enterprise securities.  Although management
believes it is possible that all principal and interest payments will be
received, general market concerns over these and similar types of securities has
caused the fair value to decline severely enough to warrant an
other-than-temporary impairment charge.  Given the significant
uncertainty and illiquidity in the markets for such securities, the Bank cannot
be certain that future impairment charges will not be required against this
investment, which had a remaining book value of $2.0 million at December 31,
2008 (net of impairment charges).
  In
February 2008, the redemption-in-kind provisions of two of the Company’s mutual
fund investments, with an aggregate carrying value of $4,074,000 at December 31,
2008, were activated as a result of current market conditions.  In
addition, cash redemptions for these funds have been restricted to $250,000 over
any ninety day period.  Redemptions in excess of this amount may be
done in-kind.  Management does not intend to redeem these
funds.
  4.
              LOANS
  A summary
of the balances of loans follows:
  December
      31,2008
                    
                    
                    2007(In
      thousands)Mortgage
      loans:One-to-four
      family residential
                    
                    $
                    183,767
                    
                    
                    $
                    169,179Multi-family
      residential
                    
                    
                    17,379
                    
                    
                    
                    9,494Commercial
                    
                    
                    93,632
                    
                    
                    
                    76,919Equity
      loans and lines of credit
                    
                    
                    30,425
                    
                    
                    
                    30,934Construction
                    
                    
                    11,204
                    
                    
                    
                    9,427336,407
                    
                    
                    
                    295,953Personal
      installment
                    
                    
                    601
                    
                    
                    
                    442Total
      loans
                    
                    
                    337,008
                    
                    
                    
                    296,395Less:  Allowance
      for loan losses
                    
                    
                    (2,924
                    )
                    
                    
                    (2,399
                    )Net
      deferred loan fees
                    
                    
                    (1,055
                    )
                    
                    
                    (912
                    )Loans,
      net
                    
                    $
                    333,029
                    
                    
                    $
                    293,084
 
 Loans
sold and serviced for others amounted to $13,775,000 and $15,231,000 at
December 31, 2008 and 2007, respectively, which are primarily sold without
recourse.
  F-18
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  LOANS
(concluded)
  An
analysis of the allowance for loan losses follows:
  Years
      Ended December 31,2008
                      
                      
                      2007(In
      thousands)Balance
      at beginning of year
                      
                      $
                      2,399
                      
                      
                      $
                      1,973Provision
      for loan losses
                      
                      
                      568
                      
                      
                      
                      426Loans
      charged-off
                      
                      
                      (47
                      )
                      
                      
                      -Recoveries
      of loans previously charged-off
                      
                      
                      4
                      
                      
                      
                      -Balance
      at end of year
                      
                      $
                      2,924
                      
                      
                      $
                      2,399
 
 There
were no non-accrual or impaired loans at December 31, 2008.  At
December 31, 2007, non-accrual and impaired loans amounted to $908,000,
with no related valuation allowance.  There were no additional funds
committed to be advanced in connection with impaired loans.  For the
years ended December 31, 2008 and 2007, the average recorded investment in
impaired loans amounted to $378,000 and $326,000, respectively.  There
was $19,000 of interest income recognized on impaired loans during 2008, on the
cash basis.  The Bank recognized no interest income on impaired loans
during 2007.  At December 31, 2008 and 2007, there were no loans
greater than ninety days past due and still accruing interest.
  5.
              PREMISES
      AND EQUIPMENT
  A summary
of the cost and accumulated depreciation and amortization and estimated useful
lives of premises and equipment follows:
  December
      31,
                          
                          
                          Estimated2008
                          
                          
                          2007
                          
                          
                          Useful
      Life(In
      thousands)Land
                          
                          $
                          538
                          
                          
                          $
                          538
                          
                          
                          N/ABuilding
      and improvements
                          
                          
                          5,180
                          
                          
                          
                          5,180
                          
                          
                          20-40
      yearsLeasehold
      improvements
                          
                          
                          1,285
                          
                          
                          
                          1,272
                          
                          
                          10-20
      yearsFurniture,
      fixtures and equipment
                          
                          
                          3,140
                          
                          
                          
                          2,977
                          
                          
                          3-10
      yearsConstruction
      in progress
                          
                          
                          5,555
                          
                          
                          
                          348
                          
                          
                          N/A15,698
                          
                          
                          
                          10,315Less
      accumulated depreciation and amortization
                          
                          
                          (4,976
                          )
                          
                          
                          (4,466
                          )$
                          10,722
                          
                          
                          $
                          5,849
  F-19
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  PREMISES
AND EQUIPMENT (concluded)
  Depreciation
and amortization expense for each of the years ended December 31, 2008 and
2007 amounted to $608,000 and $619,000, respectively.
  Construction
in progress primarily represents costs incurred to date in connection with
proposed new branches in Portsmouth, RI, and Stonington, CT, and renovations to
the main office in Newport, RI.  At December 31, 2008, total
commitments related to the construction in progress total
$5,085,000.  The Portsmouth, RI branch was completed in January 2009
at a total cost of $7,760,000.
  6.
              DEPOSITS
  A summary
of deposit balances, by type, is as follows:
  December
      31,2008
                    
                    
                    2007(In
      thousands)NOW
      and demand
                    
                    $
                    90,758
                    
                    
                    $
                    59,223Money
      market
                    
                    
                    39,540
                    
                    
                    
                    28,763Regular
                    
                    
                    25,591
                    
                    
                    
                    25,963Total
      non-certificate accounts
                    
                    
                    155,889
                    
                    
                    
                    113,949Term
      deposit certificates
                    
                    
                    73,234
                    
                    
                    
                    79,336Total
      deposits
                    
                    $
                    229,123
                    
                    
                    $
                    193,285
 
 The
aggregate amount of time deposit accounts with balances over $100,000 amounted
to $21,966,000 and $23,916,000 at December 31, 2008 and 2007,
respectively.
  A summary
of certificate accounts is as follows:
  December
      31, 2008
                      
                      
                      December
      31, 2007Weighted
                      
                      
                      
                      
                      
                      WeightedAverage
                      
                      
                      
                      
                      
                      AverageAmount
                      
                      
                      Rate
                      
                      
                      Amount
                      
                      
                      Rate(Dollars
      in thousands)Maturing
      in:2008
                      
                      $
                      -
                      
                      
                      
                      -
                      %
                      
                      $
                      76,058
                      
                      
                      
                      4.41
                      %2009
                      
                      
                      66,777
                      
                      
                      
                      3.01
                      
                      
                      
                      1,707
                      
                      
                      
                      3.082010
                      
                      
                      1,858
                      
                      
                      
                      3.48
                      
                      
                      
                      1,189
                      
                      
                      
                      4.172011
                      
                      
                      3,178
                      
                      
                      
                      3.53
                      
                      
                      
                      183
                      
                      
                      
                      3.732012
                      
                      
                      941
                      
                      
                      
                      4.02
                      
                      
                      
                      199
                      
                      
                      
                      3.20Thereafter
                      
                      
                      480
                      
                      
                      
                      3.66
                      
                      
                      
                      -
                      
                      
                      
                      -$
                      73,234
                      
                      
                      
                      3.06
                      %
                      
                      $
                      79,336
                      
                      
                      
                      4.37
                      %
  F-20
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  7.
                BORROWINGS
  Short-term
Borrowings
  Short-term
borrowings consist of Federal Home Loan Bank of Boston (“FHLB”) advances, which
mature within one year at a weighted average rate of 0.46% and 4.41% at
December 31, 2008 and 2007, respectively.
  The Bank
also has an available line of credit with the FHLB at an interest rate that
adjusts daily.  Borrowings under the line are limited to 2% of the
Bank’s total assets.  At December 31, 2008 and 2007, this line of
credit amounted to $3,000,000. There were no amounts outstanding at December 31,
2008.  At December 31, 2007, $1,809,000 was outstanding and is
included in short-term borrowings.
  Long-term
Borrowings
  FHLB
Advances
  Long-term
borrowings include the following FHLB advances:
  December
      31, 2008
                            
                            
                            December
      31, 2007Weighted
                            
                            
                            
                            
                            
                            WeightedAverage
                            
                            
                            
                            
                            
                            AverageAmount
                            
                            
                            Rate
                            
                            
                            Amount
                            
                            
                            Rate(Dollars
      in thousands)Fixed-rate
      advances maturing:2008
                            
                            
                            $
                            -
                            
                            
                            
                            -
                            %
                            
                            $
                            7,000
                            
                            
                            
                            5.78
                            %2009
                            
                            
                            
                            11,248
                            
                            
                            
                            4.98
                            
                            
                            
                            11,642
                            
                            
                            
                            4.962010*
                            
                            
                            
                            17,000
                            
                            
                            
                            4.44
                            
                            
                            
                            9,500
                            
                            
                            
                            5.162011
                            
                            
                            
                            14,218
                            
                            
                            
                            4.18
                            
                            
                            
                            4,290
                            
                            
                            
                            5.532012
                            
                            
                            
                            14,472
                            
                            
                            
                            4.76
                            
                            
                            
                            14,615
                            
                            
                            
                            4.752013*
                            
                            
                            
                            23,500
                            
                            
                            
                            3.22
                            
                            
                            
                            5,000
                            
                            
                            
                            4.28Thereafter*
                            
                            
                            
                            21,000
                            
                            
                            
                            3.92
                            
                            
                            
                            22,500
                            
                            
                            
                            4.02$
                            101,438
                            
                            
                            
                            4.12
                            %
                            
                            $
                            74,547
                            
                            
                            
                            4.72
                            %
 
 *
                Includes
      advances callable within one year aggregating $36,500,000 with a weighted
      average rate of 3.47% at December 31,
2008.
  All FHLB
borrowings are secured by a blanket lien on certain qualified collateral,
defined principally as 75% of the carrying value of first mortgage loans on
owner-occupied residential property, 50% of the carrying value of certain
pledged commercial mortgages and 65% of the carrying value of certain pledged
multi-family real estate loans.  At December 31, 2008 and 2007, the
carrying amount of assets qualifying as collateral for FHLB advances amounted to
$194,185,000 and $143,520,000, respectively.
  F-21
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  BORROWINGS
(concluded)
  Long-term
Borrowings (concluded)
  Repurchase
Agreements
  During
2008, the Company entered into a repurchase agreement for $15,000,000 at a rate
of 2.58%.  This agreement matures on November 21, 2013, and is
callable on November 21, 2010 and each quarter thereafter.
  During
2007, the Company entered into a repurchase agreement for $25,000,000 at a rate
of 3.36%, subject to adjustment if 3-month LIBOR exceeds 5.05%.  On
November 29, 2009 the rate becomes fixed at 3.36%.  This
agreement matures on November 29, 2012, and is callable on November 29, 2009 and
each quarter thereafter.
  The
amount of securities collateralizing these agreements to repurchase remains in
securities and the obligation to repurchase securities sold is reflected as a
liability in the consolidated balance sheets.  Mortgage-backed
securities pledged to secure these agreements have a carrying value of
$52,121,000 and $29,804,000 and a fair value of $54,154,000 and $29,124,000 at
December 31, 2008 and 2007, respectively.
  8.
                INCOME
      TAXES
  Allocation
of federal and state income taxes between current and deferred portions is as
follows:
  Years
      Ended December 31,2008
                    
                    
                    2007(In
      thousands)Current
      tax provision:Federal
                    
                    $
                    823
                    
                    
                    $
                    821State
                    
                    
                    202
                    
                    
                    
                    2371,025
                    
                    
                    
                    1,058Deferred
      tax benefit (provision):Federal
                    
                    
                    (880
                    )
                    
                    
                    (389
                    )State
                    
                    
                    361
                    
                    
                    
                    (101
                    )(519
                    )
                    
                    
                    (490
                    )Change
      in valuation allowance
                    
                    
                    490
                    
                    
                    
                    28(29
                    )
                    
                    
                    (462
                    )Total
      tax provision
                    
                    $
                    996
                    
                    
                    $
                    596
  F-22
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  INCOME
TAXES (continued)
  The
reasons for the differences between the statutory federal income tax provision
and the actual income tax provision are summarized as follows:
  Years
      Ended December 31,2008
                    
                    
                    2007(In
      thousands)Statutory
      tax provision at 34%
                    
                    $
                    50
                    
                    
                    $
                    460Increase
      (decrease) resulting from:State
      taxes, net of federal tax benefit
                    
                    
                    72
                    
                    
                    
                    90Impact
      of establishment of RI passive investment corporation
                    
                    
                    300
                    
                    
                    
                    -Change
      in valuation allowance
                    
                    
                    490
                    
                    
                    
                    28Bank-owned
      life insurance
                    
                    
                    (139
                    )
                    
                    
                    (131
                    )Stock-based
      compensation and ESOP Plan
                    
                    
                    227
                    
                    
                    
                    125Other
                    
                    
                    (4
                    )
                    
                    
                    24Total
      tax provision
                    
                    $
                    996
                    
                    
                    $
                    596
 
 The
components of the net deferred tax asset are as follows:
  December
      31,2008
                        
                        
                        2007(In
      thousands)Deferred
      tax asset:Federal
                        
                        $
                        3,183
                        
                        
                        $
                        2,336State
                        
                        
                        271
                        
                        
                        
                        6793,454
                        
                        
                        
                        3,015Valuation
      allowance
                        
                        
                        (982
                        )
                        
                        
                        (492
                        )2,472
                        
                        
                        
                        2,523Deferred
      tax liability:Federal
                        
                        
                        (130
                        )
                        
                        
                        (164
                        )State
                        
                        
                        -
                        
                        
                        
                        (46
                        )(130
                        )
                        
                        
                        (210
                        )Net
      deferred tax asset
                        
                        $
                        2,342
                        
                        
                        $
                        2,313
  F-23
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  INCOME
TAXES (concluded)
  The tax
effects of each item that gives rise to deferred taxes are as
follows:
  December
      31,2008
                        
                        
                        2007(In
      thousands)Allowance
      for loan losses
                        
                        $
                        863
                        
                        
                        $
                        804Depreciation
      and amortization
                        
                        
                        54
                        
                        
                        
                        (57
                        )Net
      deferred loan fees
                        
                        
                        349
                        
                        
                        
                        351Charitable
      contribution carryover
                        
                        
                        1,171
                        
                        
                        
                        1,268Stock
      options and awards
                        
                        
                        345
                        
                        
                        
                        177Employee
      benefit plans
                        
                        
                        280
                        
                        
                        
                        246Impairment
      loss on available for sale securities
                        
                        
                        240
                        
                        
                        
                        -Other,
      net
                        
                        
                        22
                        
                        
                        
                        163,324
                        
                        
                        
                        2,805Valuation
      allowance
                        
                        
                        (982
                        )
                        
                        
                        (492
                        )Net
      deferred tax asset
                        
                        $
                        2,342
                        
                        
                        $
                        2,313
 
 At
December 31, 2008, the Company has a charitable contribution carryforward in the
amount of $2,935,000, which will expire in 2011, if not fully
utilized.  The Company reduces deferred tax assets by a valuation
allowance if, based on the weight of available evidence, it is more likely than
not that some portion or all of the deferred tax assets will not be
realized.  The Company assesses the realizability of its deferred tax
assets by (1) reviewing taxable income in allowable federal carry-back periods,
and (2) assessing the likelihood of the Company generating federal and state
taxable income, as applicable, in future periods in amounts sufficient to offset
the deferred tax charges in the periods they are expected to
reverse.  Based on this assessment, management concluded that a
valuation allowance of $742,000 and $492,000 was required for the years ended
December 31, 2008 and 2007, respectively, due to the possible limitation of the
charitable contribution deduction.
  In
addition, as a result of an impairment loss recognized during 2008 and no
history of capital gains, an additional valuation reserve of $240,000 was
established.
  The
federal income tax reserve for loan losses at the Bank’s base year amounted to
$1,032,000.  If any portion of the reserve is used for purposes other
than to absorb loan losses, approximately 150% of the amount actually used,
limited to the amount of the reserve, would be subject to taxation in the year
in which used.  As the Bank intends to use the reserve only to absorb
loan losses, a deferred income tax liability of $412,000 has not been
provided.
  F-24
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  9.
                STOCKHOLDERS’
      EQUITY
  Minimum
Regulatory Capital Requirement
  The Bank
is subject to various regulatory capital requirements administered by the Office
of Thrift Supervision.  Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank’s consolidated financial statements.  Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of
assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices.  The capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.  Federal Savings and
Loan Holding Companies are not subject to any regulatory capital requirements by
the Office of Thrift Supervision.
  Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios of Tier 1 and tangible capital (as
defined) to adjusted total assets (as defined) and of total and Tier 1
capital to risk-weighted assets (as defined).  Management believes, as
of December 31, 2008 and 2007, that the Bank met all capital adequacy
requirements to which it was subject.
  F-25
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  STOCKHOLDERS’
EQUITY (continued)
  Minimum
Regulatory Capital Requirement (concluded)
  As of
December 31, 2008, the most recent notification from the Office of Thrift
Supervision categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action.  To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based,
Tier 1 leverage and tangible ratios as set forth in the following
table.  There are no conditions or events since that notification that
management believes have changed the Bank’s category.  The Bank’s
actual capital amounts and ratios as of December 31, 2008 and 2007 are also
presented in the table.
  MinimumTo
      Be WellMinimum
                        
                        
                        Capitalized
      UnderCapital
                        
                        
                        Prompt
      CorrectiveActual
                        
                        
                        Requirement
                        
                        
                        Action
      ProvisionsAmount
                        
                        
                        Ratio
                        
                        
                        Amount
                        
                        
                        Ratio
                        
                        
                        Amount
                        
                        
                        Ratio(Dollars
      in thousands)December 31, 2008Total
      capital to risk weighted assets
                        
                        $
                        41,128
                        
                        
                        
                        14.3
                        %
                        
                        $
                        22,973
                        
                        
                        
                        8.0
                        %
                        
                        $
                        28,717
                        
                        
                        
                        10.0
                        %Tier
      1 capital to risk weighted assets
                        
                        
                        38,265
                        
                        
                        
                        13.3
                        
                        
                        
                        11,487
                        
                        
                        
                        4.0
                        
                        
                        
                        17,230
                        
                        
                        
                        6.0Tier
      1 capital to adjusted total assets
                        
                        
                        38,265
                        
                        
                        
                        8.9
                        
                        
                        
                        12,947
                        
                        
                        
                        3.0
                        
                        
                        
                        21,578
                        
                        
                        
                        5.0Tangible
      capital to adjusted total assets
                        
                        
                        38,265
                        
                        
                        
                        8.9
                        
                        
                        
                        6,474
                        
                        
                        
                        1.5
                        
                        
                        
                        N/A
                        
                        
                        
                        N/ADecember 31, 2007Total
      capital to risk weighted assets
                        
                        $
                        41,152
                        
                        
                        
                        16.9
                        %
                        
                        $
                        19,476
                        
                        
                        
                        8.0
                        %
                        
                        $
                        24,345
                        
                        
                        
                        10.0
                        %Tier
      1 capital to risk weighted assets
                        
                        
                        38,814
                        
                        
                        
                        15.9
                        
                        
                        
                        9,738
                        
                        
                        
                        4.0
                        
                        
                        
                        14,607
                        
                        
                        
                        6.0Tier
      1 capital to adjusted total assets
                        
                        
                        38,814
                        
                        
                        
                        10.8
                        
                        
                        
                        10,814
                        
                        
                        
                        3.0
                        
                        
                        
                        18,023
                        
                        
                        
                        5.0Tangible
      capital to adjusted total assets
                        
                        
                        38,814
                        
                        
                        
                        10.8
                        
                        
                        
                        5,407
                        
                        
                        
                        1.5
                        
                        
                        
                        N/A
                        
                        
                        
                        N/A
 
 Other
Capital Restrictions
  Federal
banking regulations place certain restrictions on dividends paid, stock
repurchases and other transactions charged to the capital accounts of the
Bank.  Capital distributions in the form of dividends paid to the
Bank’s stockholder for any one year may not exceed the Bank’s net income for the
year to date plus the Bank’s retained earnings for the preceding two years,
without regulatory approval.  Loans or advances are limited to 10
percent of the Bank’s capital stock and surplus on a secured
basis.
  F-26
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  STOCKHOLDERS’
EQUITY (concluded)
  Other
Capital Restrictions (concluded)
  At
December 31, 2008 and 2007, the Bank’s retained net income available for the
payment of dividends was $1,354,000 and $2,039,000,
respectively.  Accordingly, $36,911,000 and $36,774,000 of the
Company’s equity in the net assets of the Bank was restricted at December 31,
2008 and 2007, respectively.  At December 31, 2008 and 2007, funds
available for loans or advances by the Bank to the Company amounted to
$1,947,000 and $2,022,000, respectively.  In addition, dividends paid
would be prohibited if the effect thereof would cause the Bank’s capital to be
reduced below applicable minimum capital requirements.
  Liquidation
Account
  As part
of the Conversion, the Bank established a liquidation account which was equal to
the net worth of the Bank as of the date of the latest consolidated balance
sheet appearing in the final prospectus distributed in connection with the
Conversion.  The liquidation account will be maintained for the
benefit of eligible account holders and supplemental eligible account holders
who maintain their accounts at the Bank after the Conversion.  The
liquidation account will be reduced annually to the extent that such account
holders have reduced their qualifying deposits as of each anniversary
date.  Subsequent increases will not restore an account holder’s
interest in the liquidation account.  In the event of a complete
liquidation, each eligible account holder will be entitled to receive balances
for accounts then held.  At December 31, 2008, the balance remaining
in the liquidation account amounted to $11,588,000.
  Share
Repurchase Plan
  In 2007,
the Board of Directors approved a stock repurchase program to acquire up to
243,917 shares, or 5%, of its outstanding common stock.  This
repurchase program was completed on January 31, 2008.  In addition, in
February 2008, the Board of Directors approved a second stock repurchase program
to acquire up to 5% of the Company’s outstanding common stock.  This
stock repurchase program was completed in July 2008 upon acquiring 231,721
shares at an average cost of $12.45 per share.  In July 2008, the
Board of Directors approved a third stock repurchase program to acquire up to
440,270 shares, or 10%, of its outstanding common stock. As of December 31, 2008,
214,900 shares have been purchased under this program at an average cost of
$11.56, leaving 225,370 shares available for possible future
repurchases.  Repurchases, which will be conducted through open market
purchases or privately negotiated transactions, will be made from time to time
depending on market conditions and other factors.
  F-27
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  10.
              EMPLOYEE
      BENEFIT PLANS
  Defined
Benefit Plan
  The Bank
is a participant in the defined benefit plan of the Financial Institutions
Retirement Fund.  The Plan is a multi-employer plan whereas the
contributions by each bank are not restricted to provide benefits to the
employees of the contributing bank.  Each employee reaching the age of
21 and having completed at least 1,000 hours of service in one consecutive
twelve-month period, beginning with such employee’s date of employment,
automatically becomes a participant in the Plan.  Participants become
vested after completion of five years of service measured from their date of
hire.  Pension expense under this Plan amounted to $296,000 and
$318,000 for the years ended December 31, 2008 and 2007,
respectively.
  401(k)
Plan
  The Bank
offers a 401(k) plan for eligible employees that provides for voluntary
contributions by participating employees up to fifty percent of their annual
compensation subject to certain limits based on federal tax
laws.  Each employee reaching the age of 21 and having completed at
least 500 hours of service in one six-month period beginning with such
employee’s date of employment, or anniversary thereof, becomes eligible to be a
participant in the plan.  The Bank matches the employees’ voluntary
contribution up to 3% of their compensation and will match one-half of the next
2%.  The Bank’s total contribution for the years ended
December 31, 2008 and 2007 amounted to $206,000 and $222,000,
respectively.
  Incentive
Plan
  The
Company has an Incentive Plan (the “Plan”) whereby officers and employees are
eligible to receive cash bonuses based upon Company performance against annual
established performance targets, including financial measures and other factors,
including individual performance.  The structure of the Plan is to be
reviewed on an annual basis by the Board of Directors and individual awards are
adjusted based on recommendations from the Compensation
Committee.  Incentive compensation expense for the years ended
December 31, 2008 and 2007 amounted to $211,000 and $322,000,
respectively.
  Supplemental
Executive and Director Retirement Plans
  The Bank
has a Supplemental Executive Retirement Plan, which provides for certain
executives of the Bank to receive monthly benefits upon retirement, subject to
certain limitations as set forth in the Plan.  The present value of
these future benefits is accrued over the executive’s term of service, taking
into consideration vesting provisions in these agreements.  The
related expense for the years ended December 31, 2008 and 2007 amounted to
$168,000 and $180,000, respectively.
  F-28
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  EMPLOYEE BENEFIT PLANS
(continued)
  Supplemental
Executive and Director Retirement Plans (concluded)
  In
addition, the Bank has a Supplemental Director Retirement Plan, which provides
for certain directors to receive annual benefits upon retirement, subject to
certain limitations set forth in the Plan.  The present value of these
benefits is accrued over the directors’ required service periods, and the
expense for the years ended December 31, 2008 and 2007 amounted to $41,000
and $45,000, respectively.
  The
accrued liability for these Plans is included in accrued expenses and other
liabilities on the consolidated balance sheets and amounted to $822,000 and
$613,000 at December 31, 2008 and 2007, respectively.
  Endorsement
Split-Dollar Life Insurance Arrangements
  The
Company is the sole owner of life insurance policies pertaining to certain
executives and directors of the Company.  The Company has entered into
agreements with these executives whereby the Company will pay to the executives’
estates or beneficiaries a portion of the death benefit that the Company will
receive as beneficiary of such policies.  Prior to January 1, 2008, no
liability had been recognized on the consolidated balance sheet for such death
benefits.  On January 1, 2008, the Company adopted EITF 06-4 (see
Note 1).  As a result, the Company recognized a liability for
future death benefits in the amount of $62,000 by cumulatively adjusting
retained earnings as of January 1, 2008 and recognized related expense of
$31,000 for the year ended December 31, 2008.
  Employee
Stock Ownership Plan
  The
Company maintains an Employee Stock Ownership Plan (“ESOP”) to provide eligible
employees the opportunity to own Company stock.  The Company provided
a loan to the Newport Federal Savings Bank Employee Stock Ownership Trust of
$3,903,000, which was used to purchase 390,268 shares of the Company’s common
stock at a price of $10.00 per share.  The loan bears interest equal
to 8.25% and provides for annual payments of interest and principal over the
15-year term of the loan.
  F-29
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  EMPLOYEE BENEFIT PLANS
(continued)
  Employee Stock Ownership Plan
(continued)
  At
December 31, 2008, the remaining principal balance on the ESOP debt is payable
as follows:
  
 Years
      EndingDecember
      31,
                      
                      Amount(In
      thousands)2009
                      
                      $
                      1722010
                      
                      
                      1862011
                      
                      
                      2012012
                      
                      
                      2182013
                      
                      
                      236Thereafter
                      
                      
                      2,296$
                      3,309
  The Bank
has committed to make contributions to the ESOP sufficient to support the debt
service of the loan.  The loan is secured by the shares purchased,
which are held in a suspense account until released for allocation to
participants, as principal and interest payments are made by the ESOP to the
Company.
  Shares
released are allocated to each eligible participant based on the ratio of each
such participant’s compensation, as defined in the ESOP, to the total
compensation of all eligible plan participants.  Cash dividends paid
on allocated shares will be distributed, at the direction of the Bank, to
participants’ accounts or used to repay the principal and interest on the ESOP
loan used to acquire Company stock on which dividends were paid.  Cash
dividends on unallocated shares will be used to repay the outstanding debt of
the ESOP.
  Shares
held by the ESOP include the following:
  December
      31,2008
                    
                    
                    2007Allocated
                    
                    
                    52,036
                    
                    
                    
                    26,018Committed
      to be allocated
                    
                    
                    26,018
                    
                    
                    
                    26,018Unallocated
                    
                    
                    312,214
                    
                    
                    
                    338,232390,268
                    
                    
                    
                    390,268
  F-30
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  EMPLOYEE
BENEFIT PLANS (continued)
  Employee
Stock Ownership Plan (concluded)
  The fair
value of unallocated ESOP shares was $3,587,000 and $3,991,000 at December 31,
2008 and 2007, respectively.
  As ESOP
shares are earned by the participants, the Company recognizes compensation
expense equal to the fair value of the earned ESOP shares during the periods in
which they become committed to be released.  Total compensation
expense recognized in connection with the ESOP was $309,000 and $340,000 for the
years ended December 31, 2008 and 2007, respectively.
  Stock
Compensation Plans
  In
accordance with the Company’s 2007 Equity Incentive Plan (the “2007 Plan”), the
Company awarded 437,900 stock options and 195,133 shares of restricted stock to
eligible participants on October 1, 2007.  The 2007 Plan provides for
total awards of 487,834 stock options and 195,133 shares of restricted stock,
leaving 49,934 stock options available for future awards.  The shares
of common stock underlying any awards that are forfeited, cancelled or otherwise
terminated (other than by exercise), shares that are tendered or withheld in
payment of the exercise price of any award, and shares that are tendered or
withheld for tax withholding obligations will be added back to the shares of
common stock with respect to which new awards may be granted under the
plan.  The exercise price of options granted under the plan is equal
to the market value of the underlying common stock on the date of
grant.  Stock options and restricted stock granted under the 2007 Plan
vest over five years and options expire no later than ten years from the date of
grant.  Upon a change in control (as defined in the plan) or the death
or disability of the individual to whom options or shares were awarded, all
options and restricted shares awarded immediately vest.
  The fair
value of the stock options granted in 2007 were estimated on the date of grant
using a Black-Scholes option valuation model with the following weighted-average
assumptions:
  Expected
      volatility
                      
                      
                      28
                      %Expected
      option term
                      
                      6.5
      yearsInterest
      rate (risk free)
                      
                      
                      4.31
                      %Expected
      annual dividend yield
                      
                      
                      0
                      %
 
 There
were no stock options granted during 2008.
  F-31
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  EMPLOYEE
BENEFIT PLANS (continued)
  Stock
Compensation Plans (continued)
  The
expected volatility was determined based on the review of the experience of peer
companies who are similar in size.  The volatility is calculated over
the expected term of the grant.  The expected term is determined using
the average of the mathematical mean of the vesting period and the full term of
the option rather than estimating based on historical experience.  The
risk-free interest rate for a period equal to the expected term of the option is
based on the U.S. Treasury yield curve in effect at the time of
grant.  The dividend yield assumption is based on the Company’s
history and expectation of dividend payouts.
  The
following table presents the activity for the 2007 Plan as of and for the year
ended December 31, 2008:
  Non-vestedStock
      Options
                            
                            
                            Restricted
      StockWeightedAverageWeighted
                            
                            
                            Remaining
                            
                            
                            
                            
                            
                            
                            
                            
                            WeightedAverage
                            
                            
                            Contractual
                            
                            
                            Aggregate
                            
                            
                            
                            
                            
                            AverageNumber
                            
                            
                            Exercise
                            
                            
                            Term
                            
                            
                            Intrinsic
                            
                            
                            Number
                            
                            
                            Grant Dateof
      Shares
                            
                            
                            Price
                            
                            
                            (Years)
                            
                            
                            Value
                            
                            
                            of
      Shares
                            
                            
                            Fair
      ValueOutstanding
      at beginning of year
                            
                            
                            437,900
                            
                            
                            $
                            12.53
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            195,133
                            
                            
                            $
                            12.53Granted
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -
                            
                            
                            
                            -Vesting
      of restricted stock
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (39,027
                            )
                            
                            
                            12.53Cancelled
      (forfeited and expired)
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -
                            
                            
                            
                            -Outstanding
      at end of year
                            
                            
                            437,900
                            
                            
                            $
                            12.53
                            
                            
                            
                            8.75
                            
                            
                            $
                            -
                            
                            
                            
                            156,106
                            
                            
                            $
                            12.53Options
      exercisable at end of year
                            
                            
                            87,580
                            
                            
                            $
                            12.53
                            
                            
                            
                            8.75
                            
                            
                            $
                            -
  The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value, based on the Company’s closing stock price of $11.49 as of
December 31, 2008 which would have been received by the option holders had all
option holders exercised their options as of that date.  There were no
in-the-money options exercisable as of December 31, 2008, therefore the
options have no intrinsic value.  The weighted-average grant-date fair
values of options granted during the year ended December 31, 2007 was
$4.82.
  F-32
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  EMPLOYEE
BENEFIT PLANS (concluded)
  Stock
Compensation Plans (concluded)
  For the
years ended December 31, 2008 and 2007, the Company recognized compensation
cost for stock options of $858,000 and $241,000, respectively, with a related
tax benefit of $82,000 and $27,000, respectively.  For the years ended
December 31, 2008 and 2007, the Company recognized compensation cost for
restricted stock awards of $994,000 and $279,000, respectively, with a related
tax benefit of $338,000 and $111,000, respectively.  The Company is
employing an accelerated method of expense recognition for options and
restricted stock awards.  The estimated amount and timing of future
compensation cost (pre-tax) to be recognized for awards to date under the plan
is as follows:
  2009
                    
                    
                    2010
                    
                    
                    2011
                    
                    
                    2012
                    
                    
                    Total(In
      thousands)Stock
      options
                    
                    $
                    489
                    
                    
                    $
                    295
                    
                    
                    $
                    164
                    
                    
                    $
                    63
                    
                    
                    $
                    1,011Restricted
      stock
                    
                    
                    566
                    
                    
                    
                    342
                    
                    
                    
                    189
                    
                    
                    
                    73
                    
                    
                    
                    1,170$
                    1,055
                    
                    
                    $
                    637
                    
                    
                    $
                    353
                    
                    
                    $
                    136
                    
                    
                    $
                    2,181
 
 11.         OTHER
COMMITMENTS AND CONTINGENCIES
  In the
normal course of business there are outstanding commitments and contingencies
which are not reflected in the accompanying financial statements.
  Loan
Commitments
  The Bank
is a party to financial instruments with off-balance-sheet risk in the normal
course of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit.  Such commitments
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amount recognized in the accompanying balance sheets.
 
 The
Bank’s exposure to credit loss is represented by the contractual amount of these
commitments.  The Bank uses the same credit policies in making
commitments as it does for on-balance-sheet instruments.
  F-33
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  OTHER
COMMITMENTS AND CONTINGENCIES (continued)
  Loan
Commitments (concluded)
  At
December 31, 2008 and 2007, the following financial instruments were
outstanding whose contract amounts represent credit risk:
  2008
                    
                    
                    2007(In
      thousands)Commitments
      to grant loans
                    
                    $
                    8,853
                    
                    
                    $
                    4,778Unadvanced
      funds on equity lines of credit
                    
                    
                    14,890
                    
                    
                    
                    14,934Unadvanced
      funds on construction loans
                    
                    
                    9,023
                    
                    
                    
                    4,482Unadvanced
      funds on commercial lines of credit
                    
                    
                    3,533
                    
                    
                    
                    2,771
 
 Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  The commitments for lines of credit may
expire without being drawn upon.  Therefore, the total commitment
amounts do not necessarily represent future cash requirements.  The
Bank evaluates each customer’s credit worthiness on a case-by-case basis and the
commitments are collateralized by real estate.
  Operating
Lease Commitments
  Pursuant
to the terms of noncancelable lease agreements in effect pertaining to banking
premises, future minimum rent commitments are as follows:
  Years
      EndingDecember
      31,
                        
                        Amount(In
      thousands)2009
                        
                        $
                        2022010
                        
                        
                        2022011
                        
                        
                        1632012
                        
                        
                        1372013
                        
                        
                        137Thereafter
                        
                        
                        2,265$
                        3,106
 
 The
leases contain options to extend for periods from five to fifty
years.  The cost of such rentals is not included
above.  Total rent expense for the years ended December 31, 2008
and 2007 amounted to $104,000 and $97,000, respectively.
  F-34
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  OTHER
COMMITMENTS AND CONTINGENCIES (concluded)
  Employment
and Change in Control Agreements
  The
Company and the Bank have entered into employment agreements with certain
executive officers which provide for a specific salary and continuation of
benefits in the event the executive is terminated without
cause.  However, such employment may be terminated for cause, as
defined, without incurring any continuing obligations.  The agreements
also provide for a lump sum severance payment, subject to certain conditions,
following a “change in control” as defined in the agreement.  In
addition, the Bank has entered into change in control agreements with certain
other executive officers which provide for a lump sum severance payment, subject
to certain conditions.
  Other
Contingencies
  Various
legal claims also arise from time to time in the normal course of business
which, in the opinion of management, will have no material effect on the
Company’s financial position.
  12.
              RELATED
      PARTY TRANSACTIONS
  In the
ordinary course of business, the Bank has granted loans to its directors and
officers and affiliates.  Activity is as follows:
  Years
      Ended December 31,2008
                      
                      
                      2007(In
      thousands)Balance
      at beginning of year
                      
                      $
                      5,807
                      
                      
                      $
                      5,608Originations
                      
                      
                      216
                      
                      
                      
                      1,013Principal
      payments
                      
                      
                      (818
                      )
                      
                      
                      (814
                      )Balance
      at end of year
                      
                      $
                      5,205
                      
                      
                      $
                      5,807
  F-35
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  13.
              FAIR
      VALUE OF FINANCIAL INSTRUMENTS
  The
Company uses fair value measurements to record fair value adjustments to certain
assets and liabilities and to determine fair value disclosures.  In
accordance with FASB Statement No. 157, the fair value of a financial instrument
is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.  Fair value is best determined based upon quoted
market prices.  However, in many instances, there are no quoted market
prices for the Company’s various financial instruments.  In cases
where quoted market prices are not available, fair values are based on estimates
using present value or other valuation techniques.  Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows.  Accordingly, the fair value
estimates may not be realized in an immediate settlement of the
instrument.
  Fair
Value Hierarchy
  In
accordance with Statement No. 157, the Company groups its financial assets and
financial liabilities generally measured at fair value in three levels, based on
the markets in which the assets and liabilities are traded and the reliability
of the assumptions used to determine fair value.
  Level 1 –
Valuation is based on quoted prices in active markets for identical assets or
liabilities. Level 1 assets and liabilities generally include debt and equity
securities that are traded in an active exchange market. Valuations are obtained
from readily available pricing sources for market transactions involving
identical assets or liabilities.
  Level 2 –
Valuation is based on observable inputs other than Level 1 prices, such as
quoted prices for similar assets or liabilities; quoted prices in markets that
are not active; or other inputs that are observable or can be corroborated by
observable market data for substantially the full term of the assets or
liabilities.  For example, Level 2 assets and liabilities may include
debt securities with quoted prices that are traded less frequently than
exchange-traded instruments or mortgage loans held for sale, for which the fair
value is based on what the securitization market is currently offering for
mortgage loans with similar characteristics.
  Level 3 –
Valuation is based on unobservable inputs that are supported by little or no
market activity and that are significant to the fair value of the assets or
liabilities.  Level 3 assets and liabilities include financial
instruments whose value is determined using pricing models, discounted cash flow
methodologies, or similar techniques, as well as instruments for which the
determination of fair value requires significant management judgment or
estimation.  This category generally includes certain asset-backed
securities, certain private equity investments, residential mortgage servicing
rights, and long-term derivative contracts.
  F-36
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  FAIR
VALUE OF FINANCIAL INSTRUMENTS (continued)
  Fair
Value Hierarchy (continued)
  The
following methods and assumptions were used by the Company in estimating fair
value disclosures:
  Cash and cash
equivalents:  The carrying amounts of cash and cash equivalents
approximate fair values.
  Securities available for
sale:  Fair values are based on the net asset values (“NAV”) of
the mutual funds.  The NAV is determined based on the fair values of
the individual securities within the fund divided by the number of shares
outstanding.  The funds’ debt securities are valued at market
quotations obtained from independent pricing services, or, for certain
securities, a fixed income pricing methodology using factors such as 1)
information obtained with respect to market transactions in such securities or
comparable securities; (2) the price and extent of public trading in similar
securities of the issuer or comparable securities; (3) the fundamental
analytical data relating to the investment and; (4) quotations from
broker/dealers, yields, maturities, ratings and various relationships between
securities.  The valuation process also takes into consideration
factors such as interest rate changes, movements in credit spreads, default rate
assumptions, prepayment assumptions, type and quality of collateral, and
security seasoning.
  Securities held to
maturity:  Fair values are based on pricing models that
consider standard input factors such as observable market data, benchmark
yields, interest rate volatilities, broker/dealer quotes, credit spreads and new
issue data.
  FHLB
stock:  The carrying value of FHLB stock approximates fair
value based on the redemption provisions of the Federal Home Loan Bank of
Boston.
  Loans:  For
variable rate loans that reprice frequently and with no significant change in
credit risk, fair values are based on carrying values.  Fair values
for other loans are estimated using discounted cash flow analyses, using market
interest rates currently being offered for loans with similar terms, adjusted
for credit risk.
  Accrued
interest:  The carrying amounts of accrued interest approximate
fair values.
  Deposits:  The
fair values for non-certificate accounts are, by definition, equal to the amount
payable on demand at the reporting date which is the carrying
amount.  Fair values for certificates of deposit are estimated using a
discounted cash flow calculation that applies market interest rates currently
being offered on certificates to a schedule of aggregated expected monthly
maturities on time deposits.
  F-37
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  FAIR
VALUE OF FINANCIAL INSTRUMENTS (continued)
  Fair
Value Hierarchy (concluded)
  Short-term
borrowings:  The carrying amounts of short-term borrowings
approximate fair value.
  Long-term
borrowings:  Fair values of long-term debt are estimated using
discounted cash flow analyses based on the current incremental borrowing rates
in the market for similar types of borrowing arrangements.
  Off-balance-sheet
instruments:  Fair values for off-balance-sheet lending
com-mitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties’ credit standing.  The estimated fair values of
off-balance-sheet instruments are immaterial.
  Assets
Measured at Fair Value on a Recurring Basis
  Assets
measured at fair value on a recurring basis are summarized below:
  December
      31, 2008Assets
      atLevel
      1
                    
                    
                    Level
      2
                    
                    
                    Level
      3
                    
                    
                    Fair
      Value(Dollars
      in thousands)Securities
      available for sale
                    
                    $
                    -
                    
                    
                    $
                    6,390
                    
                    
                    $
                    -
                    
                    
                    $
                    6,390
  The
Company’s assets measured at fair value are grouped in the Level 2 category
because the valuation technique used is based on the net asset values of the
funds which use observable inputs that can be corroborated by observable market
data for substantially the full term of the assets.
  The
Company does not measure any liabilities at fair value on a recurring basis and
does not measure any assets or liabilities at fair value on a non-recurring
basis.
  F-38
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  FAIR
VALUE OF FINANCIAL INSTRUMENTS (concluded)
  Summary
of Fair Value of Financial Instruments
  As
required under FASB Statement No. 107, “Disclosures about Fair Value of
Financial Instruments,” the estimated fair values, and related carrying or
notional amounts, of the Company’s financial instruments are as
follows.  Statement No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure
requirements.  Accordingly, the aggregate fair value amounts presented
herein may not necessarily represent the underlying fair value of the
Company.
  2008
                    
                    
                    2007Carrying
                    
                    
                    Fair
                    
                    
                    Carrying
                    
                    
                    FairAmount
                    
                    
                    Value
                    
                    
                    Amount
                    
                    
                    Value(In
      thousands)Financial
      assets:Cash
      and cash equivalents
                    
                    $
                    9,665
                    
                    
                    $
                    9,665
                    
                    
                    $
                    6,705
                    
                    
                    $
                    6,705Securities
      available for sale
                    
                    
                    6,390
                    
                    
                    
                    6,390
                    
                    
                    
                    6,966
                    
                    
                    
                    6,966Securities
      held to maturity
                    
                    
                    52,162
                    
                    
                    
                    54,198
                    
                    
                    
                    30,886
                    
                    
                    
                    30,751FHLB
      stock
                    
                    
                    5,556
                    
                    
                    
                    5,556
                    
                    
                    
                    4,163
                    
                    
                    
                    4,163Loans,
      net
                    
                    
                    333,029
                    
                    
                    
                    350,965
                    
                    
                    
                    293,084
                    
                    
                    
                    292,229Accrued
      interest receivable
                    
                    
                    1,429
                    
                    
                    
                    1,429
                    
                    
                    
                    1,269
                    
                    
                    
                    1,269Financial
      liabilities:Deposits
                    
                    
                    229,123
                    
                    
                    
                    229,640
                    
                    
                    
                    193,285
                    
                    
                    
                    194,078Short-term
      borrowings
                    
                    
                    4,000
                    
                    
                    
                    4,000
                    
                    
                    
                    5,809
                    
                    
                    
                    5,809Long-term
      borrowings
                    
                    
                    141,438
                    
                    
                    
                    142,966
                    
                    
                    
                    99,547
                    
                    
                    
                    99,896Accrued
      interest payable
                    
                    
                    661
                    
                    
                    
                    661
                    
                    
                    
                    1,350
                    
                    
                    
                    1,350
  F-39
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  14.
              CONDENSED
      FINANCIAL STATEMENTS OF PARENT
COMPANY
  Financial
information pertaining only to Newport Bancorp, Inc. is as follows:
  December
      31,BALANCE SHEETS
                                      
                                      2008
                                      
                                      
                                      2007(In
      thousands)ASSETSCash
      and cash equivalents due from subsidiary
                                      
                                      $
                                      11,929
                                      
                                      
                                      $
                                      15,554Investment
      in common stock of subsidiary
                                      
                                      
                                      38,265
                                      
                                      
                                      
                                      38,813Loan
      to Newport Federal Savings Bank ESOP
                                      
                                      
                                      3,309
                                      
                                      
                                      
                                      3,468Net
      deferred tax asset
                                      
                                      
                                      455
                                      
                                      
                                      
                                      776Other
      assets
                                      
                                      
                                      446
                                      
                                      
                                      
                                      429Total
      assets
                                      
                                      $
                                      54,404
                                      
                                      
                                      $
                                      59,040LIABILITIES
      AND STOCKHOLDERS' EQUITYAccrued
      expenses and other liabilities
                                      
                                      $
                                      91
                                      
                                      
                                      $
                                      88Stockholders'
      equity
                                      
                                      
                                      54,313
                                      
                                      
                                      
                                      58,952Total
      liabilities and stockholders' equity
                                      
                                      $
                                      54,404
                                      
                                      
                                      $
                                      59,040
  Years
      Ended December 31,STATEMENTS OF OPERATIONS
                      
                      2008
                      
                      
                      2007(In
      thousands)Income:Interest
      and fees on loans
                      
                      $
                      286
                      
                      
                      $
                      298Interest
      on cash and cash equivalents
                      
                      
                      317
                      
                      
                      
                      50Total
      income
                      
                      
                      603
                      
                      
                      
                      348Total
      non-interest expenses
                      
                      
                      430
                      
                      
                      
                      646Income
      (loss) before income taxes and equity in undistributed net income (loss)
      of subsidiary
                      
                      
                      173
                      
                      
                      
                      (298
                      )Applicable
      income tax provision (benefit)
                      
                      
                      336
                      
                      
                      
                      (69
                      )(163
                      )
                      
                      
                      (229
                      )Equity
      in undistributed net income (loss) of subsidiary
                      
                      
                      (685
                      )
                      
                      
                      986Net
      income (loss)
                      
                      $
                      (848
                      )
                      
                      $
                      757
  F-40
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  CONDENSED
FINANCIAL STATEMENTS OF PARENT COMPANY (Concluded)
  Years
      Ended December 31,STATEMENT OF CASH FLOWS
                    
                    2008
                    
                    
                    2007(In
      thousands)Cash
      flows from operating activities:Net
      income (loss)
                    
                    $
                    (848
                    )
                    
                    $
                    757Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Equity
      in undistributed net income (loss) of subsidiary
                    
                    
                    685
                    
                    
                    
                    (986
                    )Repayment
      of ESOP loan
                    
                    
                    159
                    
                    
                    
                    146Stock-based
      compensation
                    
                    
                    96
                    
                    
                    
                    28Repayment
      of stock-based compensation by subsidiary
                    
                    
                    1,756
                    
                    
                    
                    493Deferred
      income tax provision
                    
                    
                    321
                    
                    
                    
                    124Increase
      in other assets
                    
                    
                    (17
                    )
                    
                    
                    (295
                    )Increase
      in other liabilities
                    
                    
                    3
                    
                    
                    
                    83Net
      cash provided by operating activities
                    
                    
                    2,155
                    
                    
                    
                    350Cash
      flows from financing activities:Treasury
      stock purchased
                    
                    
                    (5,780
                    )
                    
                    
                    (2,655
                    )Net
      cash used by financing activities
                    
                    
                    (5,780
                    )
                    
                    
                    (2,655
                    )Net
      change in cash and cash equivalents
                    
                    
                    (3,625
                    )
                    
                    
                    (2,305
                    )Cash
      and cash equivalents at beginning of period
                    
                    
                    15,554
                    
                    
                    
                    17,859Cash
      and cash equivalents at end of period
                    
                    $
                    11,929
                    
                    
                    $
                    15,554
  F-41
 Index
  NEWPORT
BANCORP, INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded)
  15.
                QUARTERLY
      DATA (UNAUDITED)
  Years
      Ended December 31,2008
                          
                          
                          2007Fourth
                          
                          
                          Third
                          
                          
                          Second
                          
                          
                          First
                          
                          
                          Fourth
                          
                          
                          Third
                          
                          
                          Second
                          
                          
                          FirstQuarter
                          
                          
                          Quarter
                          
                          
                          Quarter
                          
                          
                          Quarter
                          
                          
                          Quarter
                          
                          
                          Quarter
                          
                          
                          Quarter
                          
                          
                          Quarter(In
      thousands, except per share data)Interest
      and dividend income
                          
                          $
                          5,647
                          
                          
                          $
                          5,374
                          
                          
                          $
                          5,402
                          
                          
                          $
                          5,221
                          
                          
                          $
                          4,864
                          
                          
                          $
                          4,536
                          
                          
                          $
                          4,367
                          
                          
                          $
                          4,221Interest
      expense
                          
                          
                          2,506
                          
                          
                          
                          2,395
                          
                          
                          
                          2,318
                          
                          
                          
                          2,369
                          
                          
                          
                          2,203
                          
                          
                          
                          1,930
                          
                          
                          
                          1,896
                          
                          
                          
                          1,665Net
      interest income
                          
                          
                          3,141
                          
                          
                          
                          2,979
                          
                          
                          
                          3,084
                          
                          
                          
                          2,852
                          
                          
                          
                          2,661
                          
                          
                          
                          2,606
                          
                          
                          
                          2,471
                          
                          
                          
                          2,556Provision
      for loan losses
                          
                          
                          223
                          
                          
                          
                          119
                          
                          
                          
                          115
                          
                          
                          
                          111
                          
                          
                          
                          140
                          
                          
                          
                          126
                          
                          
                          
                          47
                          
                          
                          
                          113Net
      interest income, after provision for loan losses
                          
                          
                          2,918
                          
                          
                          
                          2,860
                          
                          
                          
                          2,969
                          
                          
                          
                          2,741
                          
                          
                          
                          2,521
                          
                          
                          
                          2,480
                          
                          
                          
                          2,424
                          
                          
                          
                          2,443Impairment
      loss on available-for-sale securities
                          
                          
                          (226
                          )
                          
                          
                          (480
                          )
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Other
      non-interest income
                          
                          
                          528
                          
                          
                          
                          599
                          
                          
                          
                          596
                          
                          
                          
                          559
                          
                          
                          
                          582
                          
                          
                          
                          584
                          
                          
                          
                          598
                          
                          
                          
                          555Non-interest
      expenses
                          
                          
                          3,165
                          
                          
                          
                          3,396
                          
                          
                          
                          3,235
                          
                          
                          
                          3,120
                          
                          
                          
                          3,096
                          
                          
                          
                          2,627
                          
                          
                          
                          2,524
                          
                          
                          
                          2,587Income
      (loss) before income taxes
                          
                          
                          55
                          
                          
                          
                          (417
                          )
                          
                          
                          330
                          
                          
                          
                          180
                          
                          
                          
                          7
                          
                          
                          
                          437
                          
                          
                          
                          498
                          
                          
                          
                          411Provision
      for income taxes (1)
                          
                          
                          664
                          
                          
                          
                          58
                          
                          
                          
                          168
                          
                          
                          
                          106
                          
                          
                          
                          54
                          
                          
                          
                          176
                          
                          
                          
                          214
                          
                          
                          
                          152Net
      income (loss)
                          
                          $
                          (609
                          )
                          
                          $
                          (475
                          )
                          
                          $
                          162
                          
                          
                          $
                          74
                          
                          
                          $
                          (47
                          )
                          
                          $
                          261
                          
                          
                          $
                          284
                          
                          
                          $
                          259Earnings
      (loss) per common share:Basic
      and diluted
                          
                          $
                          (0.15
                          )
                          
                          $
                          (0.12
                          )
                          
                          $
                          0.04
                          
                          
                          $
                          0.02
                          
                          
                          $
                          (0.01
                          )
                          
                          $
                          0.06
                          
                          
                          $
                          0.06
                          
                          
                          $
                          0.06
 
 (1)
                The
      increase in the fourth quarter of 2008 is due to a $250,000 increase in
      the valuation reserve against deferred tax assets for a change in
      projected profitability and a $300,000 write-down of the net deferred
      state tax asset in connection with the formation of a passive investment
      company subsidiary.
   F-42