Naugatuck Valley Financial 10-Q 2006 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

____________

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2006

OR

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

For the transition period from ______________ to _____________

Commission file number: 0-50876

NAUGATUCK VALLEY FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

UNITED STATES	65-1233977
(State or other jurisdiction of incorporation or	(I.R.S. Employer Identification No.
organization)

333 CHURCH STREET, NAUGATUCK, CONNECTICUT	06770
(Address of principal executive offices)	(Zip Code)

(203) 720-5000

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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 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 ýNo o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. (See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.)

Large accelerated filer o Accelerated filer o Non-accelerated filer ý

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

Yes oNo ý

As of May 1, 2006, there were 7,604,375 shares of the registrant’s common stock outstanding.

NAUGATUCK VALLEY FINANCIAL CORPORATION

Table of Contents

Part I. Financial Information			Page No.
	Item 1.	Financial Statements (Unaudited)
		Consolidated Statements of Financial Condition at March 31, 2006 and
		December 31, 2005	3
		Consolidated Statements of Income for the three months ended
		March 31, 2006 and 2005	4
		Consolidated Statements of Cash Flows for the three months ended
		March 31, 2006 and 2005	5
		Notes to Unaudited Consolidated Financial Statements	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results
		of Operations	9
		Liquidity and Capital Resources	12
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	14
	Item 4.	Controls and Procedures	15
Part II. Other Information
	Item 1.	Legal Proceedings	16
	Item 1A.	Risk Factors	16
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	16
	Item 3.	Defaults Upon Senior Securities	16
	Item 4.	Submission of Matters to a Vote of Security Holders	16
	Item 5.	Other Information	16
	Item 6.	Exhibits	16
Signatures
Exhibits

Item 1. Financial Statements.

2

Condensed Consolidated Statements of Financial Condition

(In thousands, except share data)

	March 31,			December 31,
	2006			2005
	(Unaudited)
ASSETS
Cash and due from depository institutions	$	7,935		$	8,922
Investment in federal funds		3,450			29
Investment securities		66,937			63,049
Loans receivable, net		263,237			259,427
Deferred income taxes		1,513			1,331
Other assets		23,081			22,588
Total assets	$	366,153		$	355,346
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits	$	255,154		$	240,846
Advances from Federal Home Loan Bank of Boston		56,506			57,059
Other liabilities		3,326			6,477
Total liabilities		314,986			304,382
Commitments and contingencies
Stockholders' Equity
Common stock, $.01 par value; 25,000,000 shares authorized;
7,604,375 shares issued and outstanding		76			76
Preferred stock, $.01 par value; 1,000,000 shares authorized;
no shares issued or outstanding		-			-
Paid-in capital		33,189			33,157
Retained earnings		22,897			22,588
Unearned ESOP shares		(2,733	)		(2,733	)
Unearned stock awards		(1,567	)		(1,551	)
Treasury stock		(102	)		(122	)
Accumulated other comprehensive loss		(593	)		(451	)
Total stockholders' equity		51,167			50,964
Total liabilities and stockholders' equity	$	366,153		$	355,346

3

Consolidated Statements of Income

(In thousands, except share data)

	Three Months Ended
	March 31,
	2006			2005
	(Unaudited)
Interest and dividend income
Interest on loans	$	4,030		$	3,029
Interest and dividends on investments and deposits		757			403
Total interest income		4,787			3,432
Interest expense
Interest on deposits		1,273			588
Interest on borrowed funds		643			225
Total interest expense		1,916			813
Net interest income		2,871			2,619
Provision for loan losses		62			15
Net interest income after provision for loan losses		2,809			2,604
Noninterest income
Fees for services		311			209
Income from bank owned life insurance		76			48
Income from investment advisory services, net		34			63
Other income		29			20
Total noninterest income		450			340
Noninterest expense
Compensation, taxes and benefits		1,633			1,390
Office occupancy		400			397
Computer processing		142			144
Advertising		125			131
Gain on foreclosed real estate, net		(2	)		(37	)
Other expenses		357			355
Total noninterest expense		2,655			2,380
Income before provision
for income taxes		604			564
Provision for income taxes		134			161
Net Income	$	470		$	403
Earnings per common share - Basic and Diluted	$	0.06		$	0.06

4

Consolidated Statements of Cash Flows

(In thousands)

	Three Months Ended
	March 31,
	2006			2005
Cash flows from operating activities	(Unaudited)
Net income	$	470		$	403
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses		62			15
Depreciation and amortization expense		155			168
Stock based compensation		162			-
Provision for deferred taxes		-			(69	)
Net gain on sale of real estate owned		(4	)		(46	)
Increase in accrued income receivable		(11	)		(158	)
Decrease in deferred loan fees		(12	)		(10	)
Increase in bank owned life insurance asset		(76	)		(48	)
Decrease in other assets		28			62
Decrease in other liabilities		(1,867	)		(288	)
Net cash (used) provided by operating activities		(1,093	)		29
Cash flows from investing activities
Proceeds from maturities and repayments of available-for-sale securities		4,861			740
Proceeds from maturities of held-to-maturity securities		285			190
Purchase of available-for-sale securities		(9,247	)		(9,855	)
Purchase of Federal Home Loan Bank stock		(282	)		-
Loan originations net of principal payments		(3,860	)		(6,801	)
Proceeds from the sale of foreclosed real estate		51			113
Proceeds from sale of property and equipment		2			-
Purchase of property and equipment		(467	)		(875	)
Net cash used by investing activities		(8,657	)		(16,488	)
Cash flows from financing activities
Net change in time deposits		9,804			3,770
Net change in other deposit accounts		4,504			(2,628	)
Advances from Federal Home Loan Bank		18,650			39,545
Repayment of advances from Federal Home Loan Bank		(19,203	)		(21,447	)
Net change in mortgagors' escrow accounts		(1,414	)		(1,330	)
Dividends paid to stockholders		(157	)		(125	)
Net cash provided by financing activities		12,184			17,785
Increase in cash and cash equivalents		2,434			1,326
Cash and cash equivalents at beginning of period		8,951			7,575
Cash and cash equivalents at end of period	$	11,385		$	8,901
Cash paid during the period for:
Interest	$	1,923		$	818
Income taxes		-			68

5

NOTE 1 - BASIS OF PRESENTATION

The accompanying condensed consolidated interim financial statements are unaudited and include the accounts of Naugatuck Valley Financial Corporation (the “Company”), Naugatuck Valley Savings and Loan (the “Bank”), and those of Naugatuck Valley Mortgage Servicing Corporation, a wholly owned subsidiary of the Bank. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to SEC Form 10-Q. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements. All significant intercompany accounts and transactions have been eliminated in the consolidation. These financial statements reflect, in the opinion of Management, all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the Company’s financial position and the results of its operations and its cash flows for the periods presented. Operating results for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2005 Annual Report to Stockholders.

The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

NOTE 2 - EARNINGS PER SHARE

Basic net income per common share is calculated by dividing the net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per common share is computed in a manner similar to basic net income per common share except that the weighted-average number of common shares outstanding is increased to include the incremental common shares (as computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents were issued during the period. The Company's common stock equivalents relate solely to stock option and restricted stock awards. Anti-dilutive shares are common stock equivalents with weighted-average exercise prices in excess of the weighted-average market value for the periods presented. For the three months ended March 31, 2006, anti-dilutive options excluded from the calculations totaled 361,080 options (with an exercise price of $11.10). There were no options issued as of March 31, 2005. Unallocated common shares held by the ESOP are not included in the weighted-average number of common shares outstanding for purposes of calculating either basic or diluted net income per common share.

	Three Months Ended
	March 31,
	2006		2005
Net income	$	470	$	403
Weighted-average common shares outstanding:
Basic		7,331,084		7,311,195
Effect of dilutive stock options
and restrictive stock awards		-		-
Diluted		7,331,084		7,311,195
Net income per common share:
Basic	$	0.06	$	0.06
Diluted	$	0.06	$	0.06

6

NOTE 3 - COMPREHENSIVE INCOME

Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," establishes standards for disclosure of comprehensive income, which includes net income and any changes in equity from non-owner sources that are not recorded in the income statement (such as changes in the net unrealized gain/loss on available-for-sale securities). The purpose of reporting comprehensive income is to report a measure of all changes in equity that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. The Company’s one source of other comprehensive income is the net unrealized gain (loss) on its available-for-sale securities.

	Three Months Ended
	March 31,
	2006			2005
	(In thousands)
Net income	$	470		$	403
Net unrealized loss on
securities available for sale
during the period, net of tax		(142	)		(204	)
Total Comprehensive Income	$	328		$	199

NOTE 4 - CRITICAL ACCOUNTING POLICIES

The Company 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 income to be critical accounting policies. The Company considers the following to be critical accounting policies: allowance for loan losses and deferred income taxes.

Allowance for Loan Losses. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a quarterly basis, at a minimum, and establishes the provision for loan losses based on the composition of the loan portfolio, delinquency levels, loss experience, economic conditions, and other factors related to the collectibility of the loan portfolio.

Although the Company believes that it uses the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. The Company engages an independent review of its commercial loan portfolio annually and adjusts its loan ratings based upon this review. In addition, the Company’s regulatory authorities, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such an agency may require the Company to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination.

Deferred Income Taxes. The Company 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. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company exercises significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed continually as regulatory and business factors change.

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NOTE 5 - EQUITY INCENTIVE PLAN

At the annual meeting of stockholders on May 5, 2005, stockholders of the Company approved the Naugatuck Valley Financial Corporation 2005 Equity Incentive Plan (the “Incentive Plan”). Under the Incentive Plan, the Company may grant up to 372,614 stock options and 149,045 shares of restricted stock to its employees, officers and directors for an aggregate amount of up to 521,659 shares of the Company’s common stock for issuance upon the grant or exercise of awards. Both incentive stock options and non-statutory stock options may be granted under the Incentive Plan.

On July 26, 2005, the Company awarded 354,580 options to purchase the Company’s common stock and 139,712 shares of restricted stock. Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($11.10) with maximum term of ten years. On March 21, 2006, the Company awarded an additional 6,500 options to purchase the Company’s common stock and 1,500 additional shares of restricted stock. The additional stock option awards were granted with an exercise price equal to those granted on July 26, 2005 ($11.10) with a maximum term of ten years. Both stock options and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of grant.

Stock options and restricted stock awards are considered common stock equivalents for the purpose of computing earnings per share on a diluted basis.

The Company adopted Financial Accounting Standards Board’s SFAS No.123(R), “Share Based Payment”, beginning with the period ended September 30, 2005. In accordance with Statement No.123 (R), the Company has recorded share-based compensation expense related to outstanding stock option and restricted stock awards based upon the fair value at the date of grant over the vesting period of such awards on a straight-line basis. The fair value of each restricted stock allocation, based on the market price at the date of grant, is recorded to unearned stock awards. Compensation expenses related to unearned restricted shares are amortized to compensation, taxes and benefits expense over the vesting period of the restricted stock awards. The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing method which includes several assumptions such as volatility, expected dividends, expected term and risk-free rate for each stock option award. The Company recorded share-based compensation expense of $109,376 for the three months ended March 31, 2006 in connection with the stock option and restricted stock awards.

The weighted-average fair value of stock options granted and the assumptions used in the Black-Scholes option pricing method are shown in the following table.

	March 21,			July 26,
Grant date	2006			2005
Dividend yield		1.89	%		1.44	%
Expected volatility		11.20	%		11.47	%
Risk-free rate		4.61	%		4.18	%
Expected life in years		6.5			6.5
Weighted average fair value of options at grant date	$	2.25		$	2.47

NOTE 6 - DIVIDENDS

On January 17, 2006, the Company's Board of Directors declared a cash dividend of $0.05 per outstanding common share, which was paid on March 1, 2006, to stockholders of record as of the close of business on February 6, 2006. Naugatuck Valley Mutual Holding Company, the Company's mutual holding company parent, waived receipt of its dividend upon non-objection from the Office of Thrift Supervision ("OTS").

8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This discussion should be read in conjunction with the Company’s Consolidated Financial Statements for the year ended December 31, 2005 included in the Company’s 2005 Annual Report to Stockholders.

Forward-Looking Statements

This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words “believe”, “expect”, “intend”, “anticipate”, “estimate”, “project” or similar expressions. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area, changes in real estate market values in the Company’s market area, and changes in relevant accounting principles and guidelines. Additional factors are discussed in the Company’s 2005 Annual Report to Stockholders on Form 10-K under “Item 1A - Risk Factors”. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

Comparison of Financial Condition at March 31, 2006 and December 31, 2005

Total assets increased by $10.8 million, or 3.0% to $366.2 million during the period from December 31, 2005 to March 31, 2006, primarily due to an increase in loans of $3.8 million, an increase in investments of $3.9 million and an increase in cash and cash equivalents of $2.4 million. The increases in loans and investments were primarily funded by increases in deposits. The increase in loans primarily reflects an increase in our one-to-four family mortgages and home equity loans.

Total liabilities were $315.0 million at March 31, 2006 compared to $304.4 million at December 31, 2005. Deposits at March 31, 2006 increased $14.3 million, or 5.9%, over December 31, 2005 due to increased advertising and more aggressive pricing. Advances from the Federal Home Loan Bank of Boston decreased from $57.1 million to $56.5 million. The increases in deposits were used primarily to fund loans and investments and, to a lesser extent, repay advances and fund disbursements from mortgage tax escrow accounts.

Total stockholders’ equity increased from $51.0 million at December 31, 2005 to $51.2 million at March 31, 2006. The increase in equity was due to net income of $470,000 for the three month period, partially offset by dividends of $157,000 paid to stockholders, a net increase to the unrealized loss on available-for-sale securities of $142,000 and $32,000 in capital adjustments related to the Company’s 2005 Equity Incentive Plan.

Comparison of Operating Results For the Three Months Ended March 31, 2006 and 2005

General. For the three months ended March 31, 2006, the Company had net income of $470,000 compared to $403,000 for the three months ended March 31, 2005. The increase was primarily due to an increase in net interest income and an increase in noninterest income which was partially offset by an increase in noninterest expense.

Net Interest Income.Net interest income increased $252,000, or 9.6%, to $2.9 million for the three months ended March 31, 2006. The increase in net interest income during the three month period was the result of a 34.0% increase in the average balance of interest earning assets, along with an increase in the average rate earned on these assets of 23 basis points over the 2005 rates. The increases in interest income were partially offset by an increase in interest expense. Interest expense increased by 135.7% due to rising rates on deposits and borrowings along with increases in the average balances of deposits and borrowings.

9

The following table summarizes changes in interest income and interest expense for the three months ended March 31, 2006 and 2005.

	Three months
	Ended March 31,
	2006		2005		% change
	(Dollars in thousands)
Interest income:
Loans	$	4,030	$	3,029		33.05	%
Fed Funds sold		10		7		42.86	%
Investment securities		704		375		87.73	%
Federal Home Loan Bank stock		43		21		104.76	%
Total interest income		4,787		3,432		39.48	%
Interest expense:
Certificate accounts		1,075		457		135.23	%
Regular savings accounts		116		45		157.78	%
Checking and NOW accounts		41		11		272.73	%
Money market savings accounts		41		75		-45.33	%
Total interest-bearing deposits		1,273		588		116.50	%
FHLB advances		641		224		186.16	%
Other borrowings		2		1		100.00	%
Total interest expense		1,916		813		135.67	%
Net interest income	$	2,871	$	2,619		9.62	%

The following table summarizes average balances and average yields and costs for the three months ended March 31, 2006 and 2005.

	Three months ended March 31,
	2006					2005
	Average		Yield/			Average		Yield/
	Balance		Cost			Balance		Cost
	(Dollars in thousands)
Interest-earning assets
Loans	$	261,258		6.17	%	$	206,050		5.88	%
Fed Funds sold		804		4.98	%		1,038		2.70	%
Investment securities		66,139		4.26	%		38,232		3.92	%
Federal Home Loan Bank stock		3,320		5.18	%		2,180		3.85	%
Total interest-earning assets	$	331,521		5.78	%	$	247,500		5.55	%
Interest-bearing liabilities
Certificate accounts	$	127,469		3.37	%	$	82,272		2.22	%
Regular savings accounts & escrow		53,856		0.86	%		45,946		0.39	%
Checking and NOW accounts		47,061		0.35	%		34,919		0.13	%
Money market savings accounts		18,752		0.87	%		29,652		1.01	%
Total interest-bearing deposits		247,138		2.06	%		192,789		1.22	%
FHLB advances		59,067		4.34	%		24,117		3.72	%
Other borrowings		187		4.28	%		90		2.04	%
Total interest-bearing liabilities	$	306,392		2.50	%	$	216,996		1.50	%

10

Interest and dividend income increased $1.4 million, or 39.5%, for the three months ended March 31, 2006 as a result of an increase in the average balance of interest-earning assets to $331.5 million from $247.5 million along with an increase in the average yield on interest-earning assets from 5.55% to 5.78%.

Interest expense increased by $1.1 million for the three months ended March 31, 2006, due to an increase of $54.3 million in the average balance of interest-bearing deposits along with an increase in the average cost of these deposits from 1.22% to 2.06%. The average balance of Federal Home Loan Bank advances also increased by $34.9 million with a 62 basis point increase in the average cost from 3.72% to 4.34%.

Provision for Loan Losses. The following table summarizes the activity in the allowance for loan losses and provision for loan losses for the three months ended March 31, 2006 and 2005.

	Three Months Ended
	March 31,
	2006		2005
	(In thousands)
Allowance at beginning of period	$	1,878	$	1,829
Provision for loan losses		62		15
Charge-offs		-		(3	)
Recoveries		-		1
Net charge-offs		-		(2	)
Allowance at end of period	$	1,940	$	1,842

The Company recorded a provision for loan losses of $62,000 for the three month period ended March 31, 2006, compared to a provision of $15,000 for the three month period ended March 31, 2005. The increased provision in the 2006 period is due to the increasing size of the loan portfolio and a change in the mix of the portfolio towards commercial loans which are riskier than one-to-four family loans.

The following table provides information with respect to the Company’s nonperforming assets at the dates indicated. The Company did not have any troubled debt restructurings or any accruing loans past due 90 days or more at the dates presented.

	At March 31,			At December 31,
	2006			2005			% change
	(Dollars in thousands)
Nonaccrual loans	$	402		$	294			36.73	%
Real estate owned		-			47			-100.00	%
Total nonperforming assets	$	402		$	341			17.89	%
Total nonperforming loans to total loans		0.15	%		0.11	%		36.36	%
Total nonperforming loans to total assets		0.11	%		0.08	%		37.50	%
Total nonperforming assets to total assets		0.11	%		0.10	%		10.00	%

11

Noninterest Income. The following table summarizes noninterest income for the three months ended March 31, 2006 and 2005.

	Three Months
	Ended March 31,
	2006		2005		% Change
	(Dollars in thousands)
Fees for services	$	311	$	209		48.80	%
Income from bank owned life insurance		76		48		58.33	%
Income from investment advisory services		34		63		-46.03	%
Other income		29		20		45.00	%
Total	$	450	$	340		32.35	%

Noninterest income increased 32.4% during the three months ended March 31, 2006 as a result of a $102,000 increase in fees for services, primarily related to checking account fees, combined with an increase in income from investments in Bank Owned Life Insurance of 58.3% over the 2005 period. Checking account fees increased due to new product offerings. These increases were partially offset by a decrease of $29,000 in income from investment advisory services.

Noninterest Expense. The following table summarizes noninterest expense for the three months ended March 31, 2006 and 2005.

	Three Months
	Ended March 31,
	2006			2005			% Change
	(Dollars in thousands)
Compensation, taxes and benefits	$	1,633		$	1,390			17.48	%
Office occupancy		400			397			0.76	%
Computer processing		142			144			-1.39	%
Advertising		125			131			-4.58	%
Gain on foreclosed real estate, net		(2	)		(37	)		-94.59	%
Other expenses		357			355			0.56	%
Total	$	2,655		$	2,380			11.55	%

Noninterest expense increased in the three months ended March 31, 2006 primarily as a result of a $243,000 increase in compensation costs over the 2005 period. The increase in compensation costs were primarily due to additional lending staff and expenses related to the awards made under the equity incentive plan previously approved by shareholders. The increase in compensation related costs were partially offset by small decreases in computer processing costs and advertising.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future short-term financial obligations. The Company’s primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and advances 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.

Each quarter the Company projects liquidity availability and demands on this liquidity for the next 90 days. The Company regularly adjusts its 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

12

our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits, federal funds, short- and intermediate-term U.S. Government agency obligations and to a lesser extent, municipal securities.

The Company’s most liquid assets are cash and cash equivalents and interest-bearing deposits. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At March 31, 2006, cash and cash equivalents totaled $11.4 million, including federal funds of $3.4 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $62.2 million at March 31, 2006. At March 31, 2006, the Company had the ability to borrow a total of $115.4 million from the Federal Home Loan Bank of Boston, of which $56.5 million was outstanding. At March 31, 2006, the Company had arranged overnight lines of credit of $2.5 million with the Federal Home Loan Bank of Boston. The Company had no overnight advances outstanding with the Federal Home Loan Bank of Boston. In addition, at March 31, 2006, the Company had the ability to borrow $2.5 million from a correspondent bank. The Company had no advances outstanding on these lines at March 31, 2006.

At March 31, 2006, the Company had commitments of $19.4 million in unused home equity lines of credit, $4.0 million in unadvanced commercial lines, $2.9 million in mortgage commitments, $6.3 million in commercial loan commitments, $15.4 million in unadvanced construction mortgage commitments, $2.4 million in letters of credit and $94,000 in overdraft line of credit availability. Certificates of deposit due within one year of March 31, 2006 totaled $88.0 million, or 34.5% of total deposits. If these deposits do not remain with us, the Company will be required to seek other sources of funds, including other certificates of deposit and our available lines of credit. Depending on market conditions, the Company may be required to pay higher rates on such deposits or other borrowings than are currently paid on the certificates of deposit due on or before March 31, 2007. Based on past experience, however, the Company believes that a significant portion of our certificates of deposit will remain with us. The Company has the ability to attract and retain deposits by adjusting the interest rates offered.

Historically, the Company has remained highly liquid, with our liquidity position increasing substantially over the past two fiscal years. The Company is not aware of any trends and/or demands, commitments, events or uncertainties that could result in a material decrease in liquidity. The Company expects that all of our liquidity needs, including the contractual commitments stated above, the estimated costs of our branch expansion plans and increases in loan demand can be met by our currently available liquid assets and cash flows. In the event loan demand was to increase at a pace greater than expected, or any unforeseen demand or commitment were to occur, we could access our borrowing capacity with the Federal Home Loan Bank of Boston. The Company expects that our currently available liquid assets and our ability to borrow from the Federal Home Loan Bank of Boston would be sufficient to satisfy our liquidity needs without any material adverse effect on our liquidity.

The Company’s primary investing activities are the origination of loans and the purchase of securities. For the three months ended March 31, 2006 the Company originated $14.1 million of loans, including renewals and refinances, and purchased $9.2 million of securities. These activities were funded primarily by the proceeds from sales and maturities of available-for-sale and held-to-maturity securities of $5.1 million and an increase of deposits of $14.3 million.

Financing activities consist primarily of activity in deposit accounts and in Federal Home Loan Bank advances. The Company experienced a net increase in total deposits of $14.3 million for the three months ended March 31, 2006. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. The Company generally manages the pricing of our deposits to be competitive and to increase core deposit relationships. Occasionally, the Company offers promotional rates on certain deposit products in order to attract deposits. The Company experienced a net decrease in Federal Home Loan Bank advances of $553,000 for the three months ended March 31, 2006. The increases in deposit accounts primarily funded our investing and lending activities and, to a lesser extent, repayment of Federal Home Loan Bank advances.

The Company is not subject to separate regulatory capital requirements. At March 31, 2006, the Bank was subject to the regulatory capital requirements of 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 March 31, 2006, the Bank exceeded all of its regulatory capital requirements. The Bank is considered “well capitalized” under regulatory guidelines.

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Off-Balance Sheet Arrangements

In the normal course of operations, the Company 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, unused lines of credit, amounts due on construction loans, amounts due on commercial loans, commercial letters of credit and commitments to sell loans.

For the three months ended March 31, 2006, the Company did not engage in any off-balance-sheet transactions reasonably likely to have a material effect on its financial condition, results of operations or cash flows.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Qualitative Aspects of Market Risk.The Company’s most significant form of market risk is interest rate risk. The Company 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 the Company’s earnings while decreases in interest rates may beneficially affect the Company’s earnings. To reduce the potential volatility of the Company’s earnings, the Company has sought to improve the match between assets and liability maturities (or rate adjustment periods), while maintaining an acceptable interest rate spread, by originating adjustable-rate mortgage loans for retention in the loan portfolio, variable-rate home equity lines and variable-rate commercial loans and by purchasing variable-rate investments and investments with expected maturities of less than 10 years. The Company currently does not participate in hedging programs, interest rate swaps or other activities involving the use of off-balance sheet derivative financial instruments.

The Bank’s Asset/Liability Committee communicates, coordinates and controls all aspects of asset/liability management. The committee establishes and monitors the volume and mix of assets and funding sources with the objective of managing assets and funding sources.

Quantitative Aspects of Market Risk. The Bank uses an interest rate sensitivity analysis prepared by the Office of Thrift Supervision to review its level of interest rate risk. This analysis measures interest rate risk by computing changes in net portfolio value of the Bank’s 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 to 200 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. The Bank measures interest rate risk by modeling the changes in net portfolio value over a variety of interest rate scenarios. The following table, which is based on information that the Bank provides to the Office of Thrift Supervision, presents the change in the Bank’s net portfolio value at December 31, 2005 (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 the Bank might take to counteract that change. The Bank expects that its net portfolio value at March 31, 2006 is consistent with the table below.

									Net Portfolio Value as % of
Basis Point ("bp")	Net Portfolio Value								Present Value of Assets
Change in Rates	$ Amount		$ Change			% Change			NPV Ratio			Change
	(Dollars in thousands)
300 bp		34,847		(17,063	)		-33	%		10.39	%		-4.07	%
200		40,579		(11,331	)		-22	%		11.83	%		-2.63	%
100		46,417		(5,493	)		-11	%		13.22	%		-1.24	%
0		51,910		-			-			14.46	%		-
(100)		55,471		3,561			7	%		15.20	%		0.74	%
(200)		54,958		3,048			6	%		14.98	%		0.52	%

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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.

Item 4. Controls and Procedures.

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

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Part II - OTHER INFORMATION

Item 1. - Legal Proceedings.

The Company is not involved in any pending legal proceedings. The Bank is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to its financial condition and results of operations.

Item 1A. - Risk Factors. There have been no material changes with respect to the Risk Factors disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds. Not applicable

Item 3. - Defaults Upon Senior Securities. Not applicable

Item 4. - Submission of Matters to a Vote of Security Holders. Not applicable

Item 5. - Other Information. Not applicable

Item 6. - Exhibits.

Exhibits -

3.1 Charter of Naugatuck Valley Financial Corporation (1)

3.2 Bylaws of Naugatuck Valley Financial Corporation (1)

4.1 Specimen Stock Certificate of Naugatuck Valley Financial Corporation (2)

31.1           Rule 13a-14(a)/15d-14(a) Certification.

31.2          Rule 13a-14(a)/15d-14(a) Certification.

32              Section 1350 Certifications.

____________________

(1) Incorporated by reference to the Company’s Form 10-Q for the three months ended September 30, 2004.

(2) Incorporated herein by reference to the Exhibits to the Company’s Registration Statement on Form S-1, as amended, initially filed on June 18, 2004.

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SIGNATURES

Pursuant to the requirements 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.

Naugatuck Valley Financial Corporation

Date:	May 8, 2006	by:	/s/ John C. Roman
			John C. Roman
			President and Chief Executive Officer
Date:	May 8, 2006	by:	/s/ Lee R. Schlesinger
			Lee R. Schlesinger
			Vice President and Treasurer
			(Principal Financial Officer)

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