Edgar Filing: SI Financial Group, Inc.

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended September 30, 2006

¨	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: 0-50801

SI FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

United States

84-1655232

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)


803 Main Street, Willimantic, Connecticut		06226
(Address of principal executive offices)		(Zip Code)

(860) 423-4581

(Registrant’s telephone number, including area code)

Not Applicable

(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 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 ¨

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 ¨ Accelerated filer ¨ Non-accelerated filer x

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

As of October 27, 2006, there were 12,421,920 shares of the registrant’s common stock outstanding.

SI FINANCIAL GROUP, INC.

TABLE OF CONTENTS



		Page No.
PART I.	FINANCIAL INFORMATION

Item 1.	Consolidated Financial Statements of SI Financial Group, Inc. and Subsidiaries (unaudited):

	Consolidated Balance Sheets at September 30, 2006 and December 31, 2005	1

	Consolidated Statements of Income for the three months and nine months ended September 30, 2006 and 2005	2

	Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2006 and 2005	4

	Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005	5

	Notes to Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27

Item 4.	Controls and Procedures	29

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	29

Item 1A.	Risk Factors	29

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30

Item 3.	Defaults Upon Senior Securities	30

Item 4.	Submission of Matters to a Vote of Security Holders	30

Item 5.	Other Information	30

Item 6.	Exhibits	30

SIGNATURES		31

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, Except Share Amounts)


	September 30, 2006			December 31, 2005
	*(Unaudited)*
ASSETS:
Cash and due from banks:
Noninterest-bearing	$	13,022		$	16,317
Interest-bearing		6,762			6,829
Federal funds sold		—			2,800

Total cash and cash equivalents		19,784			25,946

Available for sale securities, at fair value		122,413			120,019
Loans held for sale		—			107
Loans receivable (net of allowance for loan losses of $4.2 million at September 30, 2006 and $3.7 million at December 31, 2005)		566,859			513,775
Accrued interest receivable		3,572			3,299
Federal Home Loan Bank stock, at cost		6,207			5,638
Cash surrender value of bank-owned life insurance		8,042			7,837
Other real estate owned		—			325
Premises and equipment, net		10,246			8,838
Goodwill and other intangibles		765			817
Deferred tax asset, net		2,529			2,804
Other assets		3,508			2,463

TOTAL ASSETS	$	743,925		$	691,868

LIABILITIES AND STOCKHOLDERS’ EQUITY:
Liabilities:
Deposits:
Noninterest-bearing	$	54,017		$	51,996
Interest-bearing		480,872			457,301

Total deposits		534,889			509,297

Mortgagors’ and investors’ escrow accounts		1,456			2,985
Federal Home Loan Bank advances		105,835			87,929
Junior subordinated debt owed to unconsolidated trust		15,465			7,217
Accrued expenses and other liabilities		4,750			4,397

TOTAL LIABILITIES		662,395			611,825

Commitments and contingencies		—			—

Stockholders’ Equity:
Preferred stock ($.01 par value; 1,000,000 shares authorized; none issued or outstanding)		—			—
Common stock ($.01 par value; 75,000,000 shares authorized; 12,563,750 shares issued; 12,421,920 outstanding at September 30, 2006 and 12,551,186 shares outstanding at December 31, 2005)		126			126
Additional paid-in capital		51,397			51,155
Unallocated common shares held by ESOP		(4,279	)		(4,521	)
Unearned restricted shares		(1,803	)		(2,176	)
Retained earnings		38,775			37,216
Accumulated other comprehensive loss		(1,100	)		(1,609	)
Treasury stock, at cost (141,830 shares at September 30, 2006 and 12,564 shares at December 31, 2005)		(1,586	)		(148	)

TOTAL STOCKHOLDERS’ EQUITY		81,530			80,043

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	743,925		$	691,868

See accompanying notes to unaudited interim consolidated financial statements.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Thousands, Except Share Amounts / Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
Interest and dividend income:
Loans, including fees	$	8,807		$	7,382		$	25,874		$	20,808
Investment securities:
Taxable interest		1,359			1,185			3,898			3,567
Tax-exempt interest		7			5			20			16
Dividends		111			62			296			169
Other		24			77			139			235

TOTAL INTEREST AND DIVIDEND INCOME		10,308			8,711			30,227			24,795

Interest expense:
Deposits		3,516			2,237			9,472			6,057
Federal Home Loan Bank advances		1,103			842			3,118			2,211
Subordinated debt		177			127			475			354

TOTAL INTEREST EXPENSE		4,796			3,206			13,065			8,622

NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES		5,512			5,505			17,162			16,173

Provision for loan losses		141			75			546			310

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		5,371			5,430			16,616			15,863

Noninterest income:
Service fees		1,164			1,094			3,488			3,102
Wealth management fees		863			233			2,533			745
Increase in cash surrender value of bank-owned life insurance		67			69			204			206
Net (loss) gain on sale of securities		(172	)		24			(284	)		59
Net gain on sale of loans		37			26			72			173
Other		13			(21	)		88			96

TOTAL NONINTEREST INCOME		1,972			1,425			6,101			4,381

Noninterest expenses:
Salaries and employee benefits		3,491			3,269			10,778			9,142
Occupancy and equipment		1,231			929			3,593			2,726
Computer and electronic banking services		662			436			1,921			1,322
Outside professional services		248			247			784			907
Marketing and advertising		234			202			591			517
Supplies and printing		131			83			395			346
Other		560			472			1,554			1,483

TOTAL NONINTEREST EXPENSES		6,557			5,638			19,616			16,443

INCOME BEFORE INCOME TAX PROVISION		786			1,217			3,101			3,801
Income tax provision		229			405			992			1,242

NET INCOME	$	557		$	812		$	2,109		$	2,559

See accompanying notes to unaudited interim consolidated financial statements.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME – Concluded

(Dollars in Thousands, Except Share Amounts / Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
NET INCOME PER COMMON SHARE:
Basic	$	0.05	$	0.07	$	0.18	$	0.21
Diluted	$	0.05	$	0.07	$	0.18	$	0.21

WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING:
Basic		11,789,022		12,026,119		11,799,255		12,064,016
Diluted		11,820,206		12,146,514		11,840,744		12,101,886

See accompanying notes to unaudited interim consolidated financial statements.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

(Dollars in Thousands, Except Share Amounts / Unaudited)


						Unallocated Common Shares Held by ESOP			Unearned Restricted Shares			Retained Earnings			Accumulated Other Comprehensive Loss			Treasury Stock			Total Stockholders’ Equity
				Additional Paid-in Capital
	Common Stock
	Shares	Dollars
BALANCE AT DECEMBER 31, 2004	12,563,750	$	126	$	50,947	$	(4,844	)	$	-		$	34,870		$	(290	)	$	-		$	80,809

Cash dividends declared ($0.09 per share)	—		—		—		—			—			(475	)		—			—			(475	)

Restricted stock activity	—		—		1,113		—			(2,487	)		(265	)		—			—			(1,639	)

Equity incentive plan shares earned	—		—		99		—			186			—			—			—			285

Comprehensive income:
Net income	—		—		—		—			—			2,559			—			—			2,559
Change in net unrealized losses on available for sale securities, net of reclassification adjustment and tax effects	—		—		—		—			—			—			(1,057	)		—			(1,057	)

Total comprehensive income																						1,502

BALANCE AT SEPTEMBER 30, 2005	12,563,750	$	126	$	52,159	$	(4,844	)	$	(2,301	)	$	36,689		$	(1,347	)	$	—		$	80,482

BALANCE AT DECEMBER 31, 2005	12,563,750	$	126	$	51,155	$	(4,521	)	$	(2,176	)	$	37,216		$	(1,609	)	$	(148	)	$	80,043

Cash dividends declared ($0.12 per share)	—		—		—		—			—			(550	)		—			—			(550	)

Equity incentive plan shares earned	—		—		201		—			373			—			—			—			574

Allocation of ESOP shares	—		—		28		242			—			—			—			—			270

Vesting of restricted stock	—		—		13		—			—			—			—			—			13

Treasury shares purchased (129,266 shares)	—		—		—		—			—			—			—			(1,438	)		(1,438	)

Comprehensive income:
Net income	—		—		—		—			—			2,109			—			—			2,109
Change in net unrealized gains on available for sale securities, net of reclassification adjustment and tax effects	—		—		—		—			—			—			509			—			509

Total comprehensive income																						2,618

BALANCE AT SEPTEMBER 30, 2006	12,563,750	$	126	$	51,397	$	(4,279	)	$	(1,803	)	$	38,775		$	(1,100	)	$	(1,586	)	$	81,530

See accompanying notes to unaudited interim consolidated financial statements.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands / Unaudited)


	Nine Months Ended September 30,
	2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	2,109		$	2,559
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		546			310
Employee stock ownership plan expense		270			270
Equity incentive plan expense		574			285
Excess tax benefit from share-based payment arrangements		(13	)		—
Amortization (accretion) of investment premiums and discounts, net		(83	)		49
Amortization of loan premiums and discounts, net		704			181
Depreciation and amortization of premises and equipment		1,293			972
Amortization of core deposit intangible		73			73
Amortization of deferred debt issuance costs		44			26
Amortization of mortgage servicing rights		57			46
Net loss (gain) on sale of securities		284			(59	)
Deferred income tax provision (benefit)		12			(73	)
Loans originated for sale		(7,391	)		(6,186	)
Proceeds from sale of loans held for sale		7,570			6,247
Net gain on sale of loans		(72	)		(173	)
Net loss (gain) on sale of bank premises and equipment		20			(31	)
Loss on sale of other real estate owned		11			—
Increase in cash surrender value of bank-owned life insurance		(205	)		(206	)
Change in operating assets and liabilities:
Accrued interest receivable		(273	)		(399	)
Other assets		(1,077	)		(795	)
Accrued expenses and other liabilities		319			289

NET CASH PROVIDED BY OPERATING ACTIVITIES		4,772			3,385

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available for sale securities		(26,175	)		(18,819	)
Proceeds from sales of available for sale securities		12,284			159
Proceeds from maturities of and principal repayments on available for sale securities		12,068			20,427
Net increase in loans		(54,334	)		(74,068	)
Purchases of Federal Home Loan Bank stock		(569	)		(1,325	)
Proceeds from the sale of loans held for investment		—			27,660
Proceeds from sale of other real estate owned		314			—
Proceeds from sale of bank premises and equipment		242			485
Purchases of premises and equipment		(2,963	)		(3,234	)
Other		(21	)		—

NET CASH USED IN INVESTING ACTIVITIES		(59,154	)		(48,715	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		25,592			28,546
Net decrease in mortgagors’ and investors’ escrow accounts		(1,529	)		(1,323	)
Proceeds from Federal Home Loan Bank advances		152,240			42,827
Repayments of Federal Home Loan Bank advances		(134,334	)		(24,373	)
Proceeds from subordinated debt borrowings		8,248			—
Cash dividends paid on common stock		(572	)		(317	)
Purchase of common stock for equity incentive plan		—			(1,639	)

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands / Unaudited)


	Nine Months Ended September 30,
	2006			2005
Excess tax benefit from share-based payment arrangements		13			—
Treasury stock purchased		(1,438	)		—

NET CASH PROVIDED BY FINANCING ACTIVITIES		48,220			43,721

NET CHANGE IN CASH AND CASH EQUIVALENTS		(6,162	)		(1,609	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		25,946			30,775

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	19,784		$	29,166

SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid	$	12,720		$	8,467
Income taxes paid, net	$	1,102		$	1,402
Transfer of loans to other real estate owned	$	—		$	350
Dividends declared	$	550		$	475

See accompanying notes to unaudited interim consolidated financial statements.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 AND 2005 AND DECEMBER 31, 2005

NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

SI Financial Group, Inc. (the “Company”) is the holding company for Savings Institute Bank and Trust Company (the “Bank”). Established in 1842, the Bank is a community-oriented financial institution headquartered in Willimantic, Connecticut. The Bank provides a variety of financial services to individuals, businesses and municipalities through its nineteen offices in eastern Connecticut. The primary products include savings, checking and certificate of deposit accounts, residential and commercial mortgage loans, commercial business loans and consumer loans. In addition, wealth management services, which include trust, financial planning, life insurance and investment services, are offered to individuals and businesses through the Bank’s Connecticut offices. Trust operations in Vermont provide third-party trust outsourcing services to other community banks located throughout the country. SI Bancorp, MHC, the Company’s mutual holding company parent, does not conduct any business other than owning a majority of the common stock of SI Financial Group, Inc.

On November 15, 2005, the Company acquired certain assets of two trust services businesses, Private Trust Services and Bank Trust Services (“SI Trust Servicing”), from the former Circle Trust Company headquartered in Darien, Connecticut. SI Trust Servicing, located in Rutland, Vermont, is a third-party provider of trust outsourcing services for other financial institutions. The acquisition was accounted for as an asset purchase transaction with total cash consideration funded through internal sources. The purchase price was allocated to the net assets acquired with the excess purchase price resulting in goodwill.

On August 31, 2006, the Company formed a new subsidiary, SI Capital Trust II (the “Trust”), and issued $8.0 million of trust-preferred securities through a pooled trust-preferred securities offering. The Company owns all of the common securities of the Trust, which has no independent assets or operations. The Trust was formed for the sole purpose of issuing trust-preferred securities and investing the proceeds in an equivalent amount of junior subordinated debentures issued by the Company.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Savings Institute Bank and Trust Company, and the Bank’s wholly-owned subsidiaries, 803 Financial Corp., SI Mortgage Company and SI Realty Company, Inc. All significant intercompany accounts and transactions have been eliminated.

Basis of Financial Statement Presentation

The interim consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Securities and Exchange Commission and generally accepted practices within the banking industry. Accordingly, certain information and footnote disclosures required by accounting principles generally accepted in the United States of America for complete financial statements have been omitted. Information in the accompanying interim consolidated financial statements and notes to the financial statements of the Company as of September 30, 2006 and for the three months and nine months ended September 30, 2006 and 2005 is unaudited. These unaudited interim consolidated financial statements and related notes should be read in conjunction with the audited financial statements of the Company and the accompanying notes for the year ended December 31, 2005 contained in the Company’s Form 10-K.

Interim financial statements are subject to possible adjustment in connection with the annual audit of the Company for the year ending December 31, 2006. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all of the adjustments (consisting only of normal and recurring in nature) necessary for a fair presentation of the financial condition, results of operations and cash flows as of and for the period covered herein. The results of operations for the three months and nine months ended September 30, 2006 are not necessarily indicative of the operating results for the twelve months ending December 31, 2006.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 AND 2005 AND DECEMBER 31, 2005

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, as of the date of the statement of financial condition and reported amounts of revenues and expenses for the periods presented. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses and the impairment of long-lived assets.

Recent Accounting Pronouncements

In March 2006, the Financial Accounting Standards Board (“FASB”) issued Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets,” which amends Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for servicing of financial assets. This Statement requires that all separately recognized servicing rights be initially measured at fair value, if practicable. For each class of separately recognized servicing assets and liabilities, this Statement permits an entity to choose either of the following subsequent measurement methods: (1) amortize servicing assets or liabilities in proportion to and over the period of estimated net servicing income or net servicing loss; or (2) report servicing assets or liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur. This Statement also requires additional disclosures for all separately recognized servicing rights and is effective for new transactions occurring and for subsequent measurement at the beginning of an entity’s first fiscal year that begins after September 15, 2006. This Statement is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” which is an interpretation of FASB Statement No. 109, “Accounting for Income Taxes.” This Interpretation clarifies the accounting for uncertainty in income taxes recognized in a Company’s financial statements, prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position in the tax return and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transition. The effective date of this Interpretation is for fiscal years beginning after December 15, 2006. The Company does not expect this Interpretation to have a material impact on the Company’s consolidated financial statements.

In September 2006, the FASB issued Financial Accounting Standards No. 157, “Fair Value Measurement,” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands the disclosures about fair value measurement. This Statement was developed to provide guidance for consistency and comparability in fair value measurements and disclosures and applies under other accounting pronouncements that require or permit fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years.

In September 2006, the FASB issued Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R).” This Statement improves financial reporting by requiring employers to recognize the overfunded or underfunded status of a defined benefit postretirement plan as a asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income or a business entity or changes in unrestricted net assets of a not-for-profit organization. An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. The Company is currently in the process of determining the impact this Statement will have on the Company’s consolidated financial statements.

In September 2006, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). This Bulletin provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 AND 2005 AND DECEMBER 31, 2005

and qualitative factors are considered, is material. SAB 108 is effective for years ending on or after November 15, 2006. The Company does not anticipate that the application of SAB 108 will have a material impact on the Company’s consolidated financial statements.

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. The Company had anti-dilutive common shares outstanding of 467,653 and 468,092 for the three months and nine months ended September 30, 2006, respectively. Treasury shares and unallocated common shares held by the ESOP are not included in the weighted-average number of common shares outstanding for purposes of calculating both basic and diluted net income per common share. Unvested restricted shares are only included in dilutive net income per common share computations.


*(Dollars in Thousands, Except Share Amounts)*	Three Months Ended September 30,				Nine Months Ended September 30,
*(Dollars in Thousands, Except Share Amounts)*	2006		2005		2006		2005
Net income	$	557	$	812	$	2,109	$	2,559

Weighted-average common shares outstanding:
Basic		11,789,022		12,026,119		11,799,255		12,064,016
Effect of dilutive stock option and restricted stock awards		31,184		120,395		41,489		37,870

Diluted		11,820,206		12,146,514		11,840,744		12,101,886

Net income per common share:
Basic	$	0.05	$	0.07	$	0.18	$	0.21
Diluted	$	0.05	$	0.07	$	0.18	$	0.21

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 AND 2005 AND DECEMBER 31, 2005

NOTE 3. SECURITIES

The amortized cost and approximate fair values of investment securities at September 30, 2006 and December 31, 2005 are as follows:

September 30, 2006


*(Dollars in Thousands)*	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
AVAILABLE FOR SALE SECURITIES:
Debt securities:
U.S. Government and agency obligations	$	3,787	$	23	$	(29	)	$	3,781
Government-sponsored enterprises		64,750		76		(1,067	)		63,759
Mortgage-backed securities		47,609		123		(853	)		46,879
Corporate debt securities		4,519		7		(21	)		4,505
Obligations of state and political subdivisions		1,499		30		—			1,529
Tax-exempt securities		490		—		—			490
Foreign government securities		100		—		(1	)		99

Total debt securities		122,754		259		(1,971	)		121,042

Equity securities:
Marketable equity securities		1,325		46		—			1,371

TOTAL AVAILABLE FOR SALE SECURITIES	$	124,079	$	305	$	(1,971	)	$	122,413

December 31, 2005


*(Dollars in Thousands)*	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
AVAILABLE FOR SALE SECURITIES:
Debt securities:
U.S. Government and agency obligations	$	4,820	$	58	$	(65	)	$	4,813
Government-sponsored enterprises		73,135		—		(1,645	)		71,490
Mortgage-backed securities		37,346		28		(836	)		36,538
Corporate debt securities		4,537		3		(12	)		4,528
Obligations of state and political subdivisions		1,499		47		—			1,546
Tax-exempt securities		490		—		—			490
Foreign government securities		75		—		(1	)		74

Total debt securities		121,902		136		(2,559	)		119,479

Equity securities:
Marketable equity securities		555		—		(15	)		540

TOTAL AVAILABLE FOR SALE SECURITIES	$	122,457	$	136	$	(2,574	)	$	120,019

NOTE 4. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loan Portfolio. The Company’s loan portfolio consists primarily of one- to four-family residential mortgage loans, multi-family and commercial real estate loans and commercial business loans. To a lesser extent, the Company’s loan portfolio includes construction and consumer loans. The Company historically and currently originates loans primarily for investment purposes. However, the Company sold $7.6 million of fixed-rate residential mortgage loans in the first nine months of 2006. At September 30, 2006 and December 31, 2005, loans held for sale were $0 and $107,000, respectively.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 AND 2005 AND DECEMBER 31, 2005

At September 30, 2006, the Company’s loan portfolio, net, was $566.9 million, or 76.2% of assets. The following table summarizes the composition of the loan portfolio in dollar amounts and as a percentage of the respective portfolio at the dates indicated.


*(Dollars in Thousands)*	September 30, 2006					December 31, 2005
*(Dollars in Thousands)*	Amount			Percent of Total		Amount			Percent of Total
Real estate loans:
Residential – 1 to 4 family	$	302,900		53.16	%	$	266,739		51.66	%
Multi-family and commercial		114,523		20.10			100,926		19.54
Construction		43,734		7.67			47,325		9.16

Total real estate loans		461,157		80.93			414,990		80.36

Consumer loans:
Home equity		19,890		3.49			20,562		3.98
Other		11,618		2.04			3,294		0.64

Total consumer loans		31,508		5.53			23,856		4.62

Commercial business loans		77,172		13.54			77,552		15.02

TOTAL LOANS		569,837		100.00	%		516,398		100.00	%

Deferred loan origination costs, net of fees		1,209					1,048
Allowance for loan losses		(4,187	)				(3,671	)

LOANS RECEIVABLE, NET	$	566,859				$	513,775

Allowance for Loan Losses. The allowance for loan losses, a material estimate which could change significantly in the near-term, is established through a provision for loan losses charged to earnings to account for losses that are inherent in the loan portfolio and estimated to occur, and is maintained at a level that management considers adequate to absorb losses in the loan portfolio. Loans are charged against the allowance for loan losses when management believes that the uncollectibility of the principal balance is confirmed. Subsequent recoveries, if any, are credited to the allowance for loan losses when received. The Company evaluates the allowance for loan losses on a monthly basis.

Management’s judgment in determining the adequacy of the allowance is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for loan losses is evaluated on a monthly basis by management and is based on the evaluation of the known and inherent risk characteristics and size and composition of the loan portfolio, the assessment of current economic and real estate market conditions, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, historical loan loss experience, regulatory examination and evaluations of loans and other relevant factors.

The methodology for assessing the appropriateness of the allowance for loan losses consists of the following key elements:

•

Specific allowances for identified problem loans, including loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.

•

General valuation allowance on certain identified problem loans which include classified loans on the Managed Asset Report that do not have an individual allowance. These loans are segregated by loan category and assigned allowance percentages based on the inherent losses associated with each type of lending.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 AND 2005 AND DECEMBER 31, 2005

•

General valuation allowance on the remainder of the loan portfolio, which covers nonclassified loans and is based on historical loss experience adjusted for qualitative factors.

•

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 specific and general losses in the portfolio.

The following table summarizes the activity in the allowance for loan losses at and for the three months and the nine months ended September 30, 2006 and 2005.


*(Dollars in Thousands)*	At or For the Three Months Ended September 30,						At or For the Nine Months Ended September 30,
*(Dollars in Thousands)*	2006			2005			2006			2005
BALANCE AT BEGINNING OF PERIOD	$	4,075		$	3,510		$	3,671		$	3,200

Provision for loan losses		141			75			546			310
Loans charged-off		(32	)		(24	)		(37	)		(27	)
Recoveries of loans previously charged-off		3			8			7			86

BALANCE AT END OF PERIOD	$	4,187		$	3,569		$	4,187		$	3,569

Allowance for loan losses to total loans								0.73	%		0.72	%
Allowance for loan losses to nonperforming loans								463.68			1,450.81

Nonperforming Assets and Restructured Loans. The following table provides information with respect to nonperforming assets and troubled debt restructurings as of the dates indicated.


*(Dollars in Thousands)*	September 30, 2006			December 31, 2005
Nonaccrual loans:
Real estate loans	$	174		$	224
Consumer loans		729			16

TOTAL NONACCRUAL LOANS		903			240

Real estate owned, net		—			325

TOTAL NONPERFORMING ASSETS		903			565

Troubled debt restructurings		73			74

TOTAL NONPERFORMING ASSETS AND TROUBLED DEBT RESTRUCTURINGS	$	976		$	639

Total nonperforming loans to total loans		0.16	%		0.05	%
Total nonperforming loans to total assets		0.12			0.03
Total nonperforming assets and troubled debt restructurings to total assets		0.13			0.09

In addition to the loans disclosed in the above table, at September 30, 2006, the Company identified loans totaling $6.5 million in which the borrowers had possible credit problems that caused management to have doubts about the ability of the borrowers to comply with the present loan repayment terms and that may result in the future

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 AND 2005 AND DECEMBER 31, 2005

inclusion of such loans in the above table. The aforementioned loans have been classified as substandard based on the Company’s internal asset classification system, which the Company uses to monitor and evaluate the credit risk inherent in its loan portfolio.

NOTE 5. DEPOSITS

The following table sets forth the deposit balances, by type, at the dates indicated.


*(Dollars in Thousands)*	September 30, 2006		December 31, 2005		Change
Noninterest-bearing demand deposits	$	54,017	$	51,996	$	2,021

Interest-bearing accounts:
NOW and money market accounts		121,290		125,156		(3,866	)
Savings accounts		78,897		87,894		(8,997	)
Certificates of deposit ⁽¹⁾		280,685		244,251		36,434

Total interest-bearing accounts		480,872		457,301		23,571

TOTAL DEPOSITS	$	534,889	$	509,297	$	25,592

⁽¹⁾	Includes brokered deposits of $7.0 million and $5.0 million at September 30, 2006 and December 31, 2005, respectively.

NOTE 6. OTHER COMPREHENSIVE INCOME (LOSS)

Other comprehensive income (loss), which is comprised solely of the change in unrealized gains and losses on available for sale securities, net of taxes, for the nine months ended September 30, 2006 and 2005 is as follows:

Nine Months Ended September 30, 2006


*(Dollars in Thousands)*	Before Tax Amount			Tax Effects			Net of Tax Amount
Unrealized holding gains arising during the period	$	488		$	(166	)	$	322
Reclassification adjustment for losses recognized in net income		284			(97	)		187

UNREALIZED HOLDING GAINS ON AVAILABLE FOR SALE SECURITIES, NET OF TAXES	$	772		$	(263	)	$	509


Nine Months Ended September 30, 2005

*(Dollars in Thousands)*	Before Tax Amount			Tax Effects			Net of Tax Amount
Unrealized holding losses arising during the period	$	(1,543	)	$	525		$	(1,018	)
Reclassification adjustment for gains recognized in net income		(59	)		20			(39	)

UNREALIZED HOLDING LOSSES ON AVAILABLE FOR SALE SECURITIES, NET OF TAXES	$	(1,602	)	$	545		$	(1,057	)

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 AND 2005 AND DECEMBER 31, 2005

NOTE 7. EQUITY INCENTIVE PLAN

Under the SI Financial Group, Inc. 2005 Equity Incentive Plan (the “Incentive Plan”), the Company may grant up to 615,623 stock options and 246,249 shares of restricted stock to its employees, officers, directors and directors emeritus. Both incentive stock options and non-statutory stock options may be granted under the plan. Stock option and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of grant. See additional details relating to the Incentive Plan in Note 11 of the consolidated financial statements in the Company’s 2005 Annual Report on Form 10-K.

Effective for the quarter ended June 30, 2005, the Company adopted the provisions of FASB’s Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123(R)”) for recognizing the cost of employee services received in share-based payment arrangements. In accordance with SFAS 123(R), the Company records 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 the restricted stock awards, which is equal to the market price at the date of grant, was recorded as unearned restricted shares. The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model, which included several assumptions such as volatility, expected dividends, expected term and risk-free rate for each stock option award. For the three months and nine months ended September 30, 2006, the Company recorded share-based compensation expense of $192,000 and $574,000, respectively, and $189,000 and $285,000, respectively, for the three months and nine months ended September 30, 2005.

For the nine months ended September 30, 2006, the Company granted 10,000 stock options at a fair value of $3.64 per share. Using the Black-Scholes option pricing model, the following assumptions were used to determine the weighted-average fair value of stock options granted:


Dividend yield:	1.50	%
Expected volatility:	20.02	%
Risk-free rate:	4.57	%
Expected life in years:	10 years

The following table summarizes the total aggregate stock option activity for the period January 1, 2006 through September 30, 2006:


	Shares		Weighted- Average Exercise Price		Weighted- Average Grant Date Fair Value
OUTSTANDING AT JANUARY 1, 2006	463,500		$	10.10	$	2.89
Granted	10,000			11.39		3.64
Forfeited	(6,000	)		10.10		2.89

OUTSTANDING AT SEPTEMBER 30, 2006	467,500			10.13		2.91

NOTE 8. REGULATORY CAPITAL

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. As a savings and loan holding company regulated by the Office of Thrift Supervision, the Company is not subject to any separate regulatory capital requirements.

At September 30, 2006 and December 31, 2005, the Bank met all capital adequacy requirements to which it was subject and the Bank is considered “well capitalized” under regulatory guidelines.

SI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 AND 2005 AND DECEMBER 31, 2005

The following is a summary of the Bank’s regulatory capital amounts and ratios as of September 30, 2006 and December 31, 2005.

September 30, 2006


*(Dollars in Thousands)*	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total Capital to Risk Weighted Assets	$	69,213	15.92	%	$	34,780	8.00	%	$	43,476	10.00	%
Tier I Capital to Risk Weighted Assets		65,102	14.98			17,384	4.00			26,076	6.00
Tier I Capital to Total Assets		65,102	9.00			28,934	4.00			36,168	5.00

December 31, 2005


*(Dollars in Thousands)*	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total Capital to Risk Weighted Assets	$	66,274	16.79	%	$	31,578	8.00	%	$	39,472	10.00	%
Tier I Capital to Risk Weighted Assets		62,612	15.87			15,781	4.00			23,672	6.00
Tier I Capital to Total Assets		62,612	9.31			26,901	4.00			33,626	5.00

NOTE 9. DEFINITIVE AGREEMENT SIGNED TO BUY MORTGAGE COMPANY

On September 5, 2006, the Company announced that the Bank had signed a definitive agreement to purchase Fairfield Financial Mortgage Group, Inc. (“FFMG”). FFMG has branch offices in Texas, Massachusetts, New Hampshire, New Jersey, New York and Pennsylvania and is also a licensed mortgage banker in South Carolina, Florida, Georgia, Michigan, Rhode Island, Maryland, Delaware and California. The transaction is expected to be completed in the first quarter of 2007, subject to all necessary regulatory approvals.

NOTE 10. TRUST-PREFERRED SECURITIES OFFERING

On August 31, 2006, the Company formed a new subsidiary, SI Capital Trust II, a statutory trust formed under the laws of Delaware and issued $8.0 million of trust-preferred securities through a pooled trust-preferred securities offering. The Company owns all of the common securities of the Trust, which has no independent assets or operations. The Trust was formed for the sole purpose of issuing trust-preferred securities and investing the proceeds in an equivalent amount of junior subordinated debentures issued by the Company. The junior subordinated debentures are unsecured obligations of the Company and are subordinate and junior in right of payment to all present and future senior indebtedness of the Company. The junior subordinated debentures, which bear interest at three-month LIBOR plus 1.70%, mature in 30 years and can be redeemed at the Company’s option on or after September 15, 2011, subject to regulatory approval.

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

The following analysis discusses changes in financial condition at September 30, 2006 and December 31, 2005 and results of operations for the three months and nine months ended September 30, 2006 and 2005 and should be read in conjunction with the Company’s consolidated financial statements and notes thereto, appearing in Part I, Item I of this document, as well as with Management’s Discussion and Analysis included in the Company’s 2005 Annual Report on Form 10-K.

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 the 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 that 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 United States government, including policies of the United States 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 that may affect the Company’s results are discussed in this document under Item 1A – Risk Factors and in the Company’s 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.

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 allowance for loan losses and the impairment of long-lived assets to be its critical accounting policies. Additional information about the Company’s accounting policies is included in Notes 1 and 4 of the consolidated financial statements in Part I, Item 1 of this document and Items 1 and 8 in the Company’s 2005 Annual Report on Form 10-K.

Allowance for Loan Losses. Determining the amount of allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a monthly basis and establishes the provision for loan losses based on the size and the composition of the loan portfolio, delinquency levels, loss experience, economic conditions, and other factors related to the collectibility of the loan portfolio. The level of the allowance for loan losses fluctuates primarily due to changes in the size and composition of the loan portfolio and in the level of nonperforming loans, classified assets and charge-offs. A portion of the allowance is established by segregating the loans by loan category and assigning allocation percentages based on historical loss experience and delinquency trends. The applied loss factors are re-evaluated at least annually to ensure their relevance in the current real estate environment. Accordingly, increases in the size of the loan portfolio and the increased emphasis on commercial real estate and commercial business loans, which carry a higher degree of risk of default and, thus, a higher allocation percentage, increases the allowance. To a lesser extent, the purchase of indirect automobile loans during 2006 increased the allowance for loan losses due to the higher risk of loss associated with this type of consumer lending. An unallocated component is maintained in the allowance to cover uncertainties that could affect management’s estimate of probable losses.

Impairment of Long-Lived Assets. The Company is required to record certain assets it has acquired, including identifiable intangible assets such as core deposit intangibles, goodwill and certain liabilities that it assumed at fair value, which may involve making estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. Further, long-lived assets, including intangible assets and premises and equipment, that are held and used by the Company, are presumed to have a useful life. The determination of the useful lives of intangible assets is subjective, as is the appropriate amortization period for such intangible and long-lived assets. Additionally, long-lived assets are reviewed for impairment annually at a minimum or whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If impairment is indicated by that review, the asset is written down to its estimated fair value through a charge to noninterest expenses. Testing for impairment is a subjective process, the application of which could result in different evaluations of impairment.

Impact of New Accounting Standards

Refer to Note 1 to the consolidated financial statements in this report for a detailed discussion of new accounting pronouncements.

Recent Developments and Initiatives

•

The Bank opened its 19^th branch office in Gales Ferry, Connecticut on August 14, 2006.

•

The Bank signed a definitive agreement to purchase a mortgage company based in Danbury, Connecticut, and with branch offices in Texas, Massachusetts, New Hampshire, New Jersey, New York and Pennsylvania.

•

The Savings Institute Bank and Trust Company Employees’ Caring and Giving Program awarded grants to ten local charitable organizations. The Caring and Giving Program continues to make quarterly grants since its inception in 1998.

•

The Company’s Board of Directors declared a quarterly cash dividend of $0.04 per share, paid on October 27, 2006, to stockholders of record at the close of business on October 6, 2006.

•

The Company raised $8.0 million through a pooled trust-preferred securities offering. The trust-preferred securities were issued by a newly-established subsidiary, SI Capital Trust II.

•

Bauer Financial, the nation’s leading independent bank rating firm, announced that Savings Institute Bank & Trust Company achieved its highest 5-Star superior rating for its financial strength and stability for seven consecutive quarters.

Comparison of Financial Condition at September 30, 2006 and December 31, 2005

Assets:

Summary. The Company’s total assets increased $52.1 million, or 7.5%, to $743.9 million at September 30, 2006, as compared to $691.9 million at December 31, 2005, primarily due to increases in net loans receivable of $53.1 million, available for sale securities of $2.4 million, premises and equipment of $1.4 million, other assets of $1.0 million and Federal Home Loan Bank stock of $569,000, offset by a $6.2 million decrease in cash and cash equivalents. Other assets increased primarily due to other investments and receivables. Federal Home Loan Bank stock increased to $6.2 million at September 30, 2006 to support a higher level of Federal Home Loan Bank borrowings. The decrease in cash and cash equivalents resulted as excess funds were used to fund loans and purchase investment securities.

Loans Receivable, Net. The Company’s net loan portfolio increased 10.3% to $566.9 million as a result of strong loan originations and the purchase of $10.3 million in consumer loans, offset by loan sales of $7.6 million of fixed-rate residential mortgage loans during the first nine months of 2006. The sale of loans is expected to mitigate the Company’s exposure to interest rate risk while improving liquidity. Loan originations increased 1.2% for the nine months ended September 30, 2006, compared to the same period in 2005. The level of loan closings were impacted by several factors, including promotional and sales activities, competitive pricing initiatives and a relatively stable housing market and local economy. Changes in the loan portfolio consisted of the following:

•

Residential Mortgage Loans. Despite mortgage loan sales, residential mortgage loans increased $36.2 million, or 13.6%. Loan originations for residential mortgage loans increased 6.1% to $81.4 million for the first nine months of 2006 compared to the same period in 2005.

•

Commercial Loans. Multi-family and commercial real estate and commercial business loans increased $13.2 million, or 7.4%. Despite the Company’s continued emphasis on the commercial loan market, commercial mortgage and business loan originations were relatively flat for 2006 compared to 2005.

•

Consumer Loans. The increase of $7.7 million, or 32.1%, reflects the purchase of $10.3 million of indirect automobile loans during the first quarter of 2006. Although automobile loans typically involve a higher degree of credit risk, they generally provide a higher rate of return and were therefore, purchased with the intention of supplementing the Company’s interest income during this period of lower net interest margins. Consumer loan originations were down 23.3% in 2006 partly due to a decrease in home equity lines of credit as a result of the variable-rate nature of the product and rising market interest rates.

The allowance for losses totaled $4.2 million, representing 0.73% of total loans, at September 30, 2006, compared to $3.7 million, or 0.71% of total loans, at December 31, 2005. The increase in the allowance reflects increases in the commercial and consumer loan portfolios, which carry a higher risk of default compared to residential mortgage loans. Centrix Financial, LLC (“Centrix”), the organization with which the Company contracted to service the Company’s indirect automobile loan portfolio, filed Chapter 11 bankruptcy during the third quarter of 2006. As a result, the Company increased its provision for loan losses 0.5% for anticipated loan charge-offs on its indirect automobile loan portfolio. Although Centrix continues to operate, their ability to service the remaining $7.4 million loan portfolio is currently being assessed by the Company’s management.

Investment Activities. At September 30, 2006, the Company’s investment portfolio, excluding Federal Home Loan Bank stock, consisted solely of available for sale securities of $122.4 million, or 16.5% of assets. At December 31, 2005, the Company’s available for sale securities totaled $120.0 million, or 17.3% of assets. The increase in available for sale securities of $2.4 million, or 2.0%, was primarily due to net purchases of mortgage-backed securities. Proceeds from the sale of primarily government-sponsored enterprise securities, which were in an unrealized loss position, were reinvested into higher yielding mortgage-backed securities during the second and third quarters of 2006.

Liabilities:

Summary. Total liabilities increased $50.6 million, or 8.3%, from December 31, 2005 to September 30, 2006 primarily as a result of net increases in deposits of $25.6 million, increases in Federal Home Loan Bank advances of $17.9 million and proceeds from subordinated debt of $8.2 million.

Borrowings. Increases in Federal Home Loan Bank advances of 20.4% to $105.8 million at September 30, 2006 represented short-term fixed-rate advances with terms of three months to three years used to fund loan growth and to manage interest rate risk. In September 2006, a newly-formed subsidiary of the company, SI Capital Trust II, issued $8.0 million of trust-preferred securities through a pooled trust-preferred securities offering. The proceeds were invested in an equivalent amount of junior subordinated debentures issued by the Company that mature in 30 years or may be redeemed in whole or in part on or after September 15, 2011.

Deposits. Deposits, including mortgagors’ and investors’ escrow accounts, increased $24.1 million, or 4.7%, to $536.3 million at September 30, 2006. Noninterest-bearing accounts increased $2.0 million related to higher balances in primarily business checking accounts. Interest-bearing deposits increased $23.6 million, or 5.2%, primarily due to increases in certificates of deposits. Certificates of deposit increased $36.4 million, or 14.9%, as a result of branch expansion, promotional rates, competitive pricing and marketing efforts to capitalize on the consolidation of financial institutions within the Bank’s market area. Savings accounts decreased $9.0 million

mainly due to a reduction in passbook savings and money market accounts. Additionally, brokered deposits increased $2.0 million in 2006.

Equity:

Summary. Total stockholders’ equity increased $1.5 million to $81.5 million at September 30, 2006. The increase in equity was primarily attributable to retained earnings of $2.1 million, a decrease in net unrealized holding losses on available for sale securities aggregating $509,000 (net of taxes), offset by stock repurchases of 129,266 shares at a cost of $1.4 million and dividends declared of $550,000.

Net Unrealized Losses on Available for Sale Securities. Unrealized holding losses on available for sale securities, net of taxes, decreased $509,000 to $1.1 million for the nine months ended September 30, 2006. Unrealized holding losses resulted primarily from a decline in the market value of the debt securities portfolio, which was recognized in accumulated other comprehensive income (loss) on the consolidated balance sheet and the consolidated statement of changes in stockholders’ equity. Management believes that none of the unrealized losses on these securities are other than temporary because substantially all of the unrealized losses relate to government-sponsored enterprises and mortgage-backed securities issued by the U.S. Treasury, government-sponsored enterprises or private issuers that maintain investment grade ratings, which the Company has both the intent and the ability to hold until maturity or until the fair value fully recovers. In addition, management considers the issuers of the securities to be financially sound and believes the Company will receive all contractual principal and interest related to these investments.

Average Balance Sheet and Analysis of Net Interest and Dividend Income

Average Balance Sheet. The following table presents information regarding the average balances of assets and liabilities, the total dollar amounts of interest and dividend income from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities and the resulting 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 average daily balances.


	At or For the Three Months Ended September 30,
(Dollars in Thousands)	2006							2005
(Dollars in Thousands)	Average Balance		Interest & Dividends			Average Yield/ Rate		Average Balance		Interest & Dividends			Average Yield/ Rate
ASSETS:
Interest-earning assets:
Loans ⁽¹⁾⁽²⁾	$	562,706	$	8,807		6.21	%	$	483,944	$	7,382		6.05	%
Investment securities ⁽³⁾		131,484		1,479		4.46			127,894		1,254		3.89
Other interest-earning assets		3,730		24		2.55			11,324		77		2.70

Total interest-earning assets		697,920		10,310		5.86			623,162		8,713		5.55

Noninterest-earning assets		37,218							39,644

Total assets	$	735,138						$	662,806

LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Deposits:
NOW and money market	$	122,973		251		0.81		$	124,692		212		0.67
Savings ⁽⁴⁾		82,043		242		1.17			92,098		221		0.95
Certificates of deposit ⁽⁵⁾		280,121		3,023		4.28			217,373		1,804		3.29

Total interest-bearing deposits		485,137		3,516		2.88			434,163		2,237		2.04

FHLB advances		101,548		1,103		4.31			85,223		842		3.92
Subordinated debt		8,114		177		8.65			7,217		127		6.98

Total interest-bearing liabilities		594,799		4,796		3.20			526,603		3,206		2.42

Noninterest-bearing liabilities		59,797							54,713

Total liabilities		654,596							581,316

Total stockholders’ equity		80,542							81,490

Total liabilities and stockholders’ equity	$	735,138						$	662,806

Net interest-earning assets	$	103,121						$	96,559

Tax equivalent net interest income ⁽³⁾				5,514							5,507

Tax equivalent interest rate spread ⁽⁶⁾						2.66							3.13

Tax equivalent net interest margin as a percentage of interest-earning assets ⁽⁷⁾						3.13							3.51

Average of interest-earning assets to average interest-bearing liabilities						117.34							118.34

Less: Tax equivalent adjustment ⁽³⁾				(2	)						(2	)

NET INTEREST INCOME PER STATEMENTS OF INCOME			$	5,512						$	5,505

⁽¹⁾	Amount is net of deferred loan origination fees and costs. Average balances include nonaccrual loans and loans held for sale.

⁽²⁾	Loan fees are included in interest income and are insignificant.

⁽³⁾	Investment securities income and net interest income are presented on a tax equivalent basis using a tax rate of 34%. The tax equivalent adjustment is deducted from tax equivalent net interest income to agree to the amount reported in the statements of income.

⁽⁴⁾	Includes mortgagors’ and investors’ escrow accounts.

⁽⁵⁾	Includes brokered deposits.

⁽⁶⁾	Tax equivalent net interest rate spread represents the difference between the weighted-average tax equivalent yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities.

⁽⁷⁾	Tax equivalent net interest margin represents tax equivalent net interest income divided by average interest-earning assets.


	At or For the Nine Months Ended September 30,
*(Dollars in Thousands)*	2006							2005
*(Dollars in Thousands)*	Average Balance		Interest & Dividends			Average Yield/ Rate		Average Balance		Interest & Dividends			Average Yield/ Rate
ASSETS:
Interest-earning assets:
Loans ⁽¹⁾⁽²⁾	$	546,256	$	25,874		6.33	%	$	461,508	$	20,808		6.03	%
Investment securities ⁽³⁾		130,575		4,221		4.32			128,520		3,758		3.91
Other interest-earning assets		7,480		139		2.48			11,975		235		2.62

Total interest-earning assets		684,311		30,234		5.91			602,003		24,801		5.51

Noninterest-earning assets		37,819							39,707

Total assets	$	722,130						$	641,710

LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Deposits:
NOW and money market		123,708		697		0.75			117,147		459		0.52
Savings ⁽⁴⁾		84,921		705		1.11			93,320		622		0.89
Certificates of deposit ⁽⁵⁾		268,581		8,070		4.02			213,690		4,976		3.11

Total interest-bearing deposits		477,210		9,472		2.65			424,157		6,057		1.91

FHLB advances		99,213		3,118		4.20			76,579		2,211		3.86
Subordinated debt		7,519		475		8.45			7,217		354		6.56

Total interest-bearing liabilities		583,942		13,065		2.99			507,953		8,622		2.27

Noninterest-bearing liabilities		57,912							52,405

Total liabilities		641,854							560,358

Total stockholders’ equity		80,276							81,352

Total liabilities and stockholders’ equity	$	722,130						$	641,710

Net interest-earning assets	$	100,369						$	94,050

Tax equivalent net interest income ⁽³⁾				17,169							16,179

Tax equivalent interest rate spread ⁽⁶⁾						2.92							3.24

Tax equivalent net interest margin as a percentage of interest-earning assets ⁽⁷⁾						3.35							3.59

Average of interest-earning assets to average interest-bearing liabilities						117.19							118.52

Less: Tax equivalent adjustment ⁽³⁾				(7	)						(6	)

NET INTEREST INCOME PER STATEMENTS OF INCOME			$	17,162						$	16,173

⁽¹⁾	Amount is net of deferred loan origination fees and costs. Average balances include nonaccrual loans and loans held for sale.

⁽²⁾	Loan fees are included in interest income and are insignificant.

⁽³⁾	Investment securities income and net interest income are presented on a tax equivalent basis using a tax rate of 34%. The tax equivalent adjustment is deducted from tax equivalent net interest income to agree to the amount reported in the statements of income.

⁽⁴⁾	Includes mortgagors’ and investors’ escrow accounts.

⁽⁵⁾	Includes brokered deposits.

⁽⁶⁾	Tax equivalent net interest rate spread represents the difference between the weighted-average tax equivalent yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities.

⁽⁷⁾	Tax equivalent net interest margin represents tax equivalent net interest income divided by average interest-earning assets.

Rate/Volume Analysis. The following table sets forth the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have on the Company’s interest income and interest expense for the periods presented. 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 rate and volume columns. For purposes of this table, changes attributable to both changes in rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.


*(Dollars in Thousands)*	Three Months Ended September 30, 2006 and 2005									Nine Months Ended September 30, 2006 and 2005
	Increase (Decrease) Due To									Increase (Decrease) Due To
	Rate			Volume			Net			Rate			Volume			Net
INTEREST-EARNING ASSETS:
Interest and Dividend Income:
Loans ⁽¹⁾⁽²⁾	$	197		$	1,228		$	1,425		$	1,093		$	3,973		$	5,066
Investment securities ⁽³⁾		189			36			225			402			61			463
Other interest-earning assets		(4	)		(49	)		(53	)		(12	)		(84	)		(96	)

Total interest-earning assets		382			1,215			1,597			1,483			3,950			5,433

INTEREST-BEARING LIABILITIES:
Interest Expense:
Deposits ⁽⁴⁾		755			524			1,279			1,999			1,416			3,415
Federal Home Loan Bank advances		89			172			261			209			698			907
Subordinated debt		33			17			50			105			16			121

Total interest-bearing liabilities		877			713			1,590			2,313			2,130			4,443

CHANGE IN NET INTEREST INCOME ⁽³⁾	$	(495	)	$	502		$	7		$	(830	)	$	1,820		$	990

⁽¹⁾	Amount is net of deferred loan origination fees and costs. Average balances include nonaccrual loans and loans held for sale.

⁽²⁾	Loans fees are included in interest income and are insignificant.

⁽³⁾	Investment securities income and net interest income are presented on a tax equivalent basis using a tax rate of 34%. The tax equivalent adjustment is deducted from tax equivalent net interest income to agree to the amount reported in the statements of income.

⁽⁴⁾	Includes mortgagors’ and investors’ escrow accounts and brokered deposits.

Results of Operations for the Three Months and Nine Months Ended September 30, 2006 and 2005

General. The Company’s results of operations depend primarily on net interest and dividend income, which is the difference between the interest and dividend income earned on the Company’s interest-earning assets, such as loans and investments, and the interest expense on its interest-bearing liabilities, such as deposits and borrowings. The Company also generates noninterest income such as gains on securities and loan sales, fees from deposit and trust and investment management services, insurance commissions, increases in cash surrender value of bank-owned life insurance and other fees. The Company’s noninterest expenses consist of salaries and employee benefits, occupancy and equipment, computer and electronic banking services, outside professional services, marketing and other general and administrative expenses. The Company’s results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, governmental policies and actions of regulatory agencies.

Summary. The Company recorded net income of $557,000 for the three months ended September 30, 2006, a decrease of $255,000 compared to $812,000 for the three months ended September 30, 2005. The decrease was primarily attributable to increases in noninterest expenses of $919,000 and provision for loan losses of $66,000, offset by increases of $547,000 in noninterest income and $7,000 in net interest income and a decrease of $176,000 in the provision for income taxes.

Net income decreased $450,000, or 17.6%, to $2.1 million for the nine months ended September 30, 2006 due to increases of $3.2 million in noninterest expenses and $236,000 in the provision for loan losses, offset by increases of $1.7 million in noninterest income and $989,000 in net interest income and a decrease of $250,000 in the provision for income taxes.

For both the three months and the nine months ended September 30, 2006, net interest income rose in response to an increase in average interest-earning assets and higher average yields for investment securities and loans, offset by an increase in the cost of funds as a result of both the average volume and average cost of deposits and borrowings. Despite increases in net interest income for the three months and nine months ended September 30, 2006, the net interest margin decreased 38 basis points and 24 basis points, respectively, from the same periods in 2005. The continual flattening of the yield curve and compression of the margins provides challenges for management in an effort to minimize the impact on net interest income.

Interest and Dividend Income. Total interest and dividend income increased $1.6 million, or 18.3%, for the third quarter of 2006. Average interest-earning assets increased $74.8 million, or 12.0%, to $697.9 million, primarily due to higher loan volume, offset by a decrease in federal funds and other interest-earnings assets. Average loans increased $78.8 million and the rate earned on loans increased 16 basis points to 6.21% for the third quarter of 2006 from 6.05% for the same period in 2005. Increased volume on higher yielding commercial loans contributed to the rise in interest earnings on loans. Additionally, rising interest rates on the Company’s variable-rate loans had a favorable impact on interest income. Average securities rose $3.6 million, with an increase in yield from 3.89% to 4.46%.

For the nine months ended September 30, 2006, interest and dividend income increased $5.4 million to $30.2 million due to a higher average balance of loans and an increase in the average yield on interest-earning assets from 5.51% to 5.91%. Average yields on loans and investment securities increased 30 basis points and 41 basis points, respectively.

Interest Expense. Interest expense increased $1.6 million, or 49.6%, to $4.8 million for the third quarter of 2006 compared to $3.2 million for the third quarter of 2005, primarily as a result of the rate paid on certificates of deposit and increases in the average balance of deposits and Federal Home Loan Bank advances. The yield on deposit accounts increased 84 basis points due to rising market interest rates, promotional rates and aggressive pricing. Average deposits rose $51.0 million. The average balance on certificates of deposit increased $62.7 million and the average yield increased 99 basis points. The rate paid on subordinated debt borrowings increased 167 basis points from 6.98% to 8.65%. Average Federal Home Loan Bank advances increased $16.3 million and the yield on Federal Home Loan Bank borrowings increased 39 basis points to 4.31%.

For the nine months ended September 30, 2006, interest expense increased $4.4 million as a result of increases in both the average balance of interest-bearing liabilities from $508.0 million to $583.9 million and the average yield from 2.27% to 2.99%. Certificates of deposit contributed $3.1 million to the increase in interest expense for the period.

Provision for Loan Losses. The Company’s provision for loan losses increased $66,000 to $141,000 in the third quarter of 2006, in part due to an increase in residential and commercial loan volume, higher anticipated loan loss charge-offs for the indirect automobile loan portfolio and an increase in the Company’s classified and nonperforming loans compared to the same quarter in 2005. Higher commercial loan volume contributed to the increase as commercial loans tend to carry a higher risk of default than residential mortgage loans.

For the nine months ended September 30, 2006, the provision for loan losses increased $236,000 to $546,000 from $310,000 for the same period in 2005. This increase was primarily the result of the Bank’s residential and commercial mortgage loan growth which increased 13.6% and 13.5%, respectively, and an increase in the Bank’s classified and nonperforming loan portfolios from the prior year-end. Additionally, the purchase of $10.3 million of indirect automobile loans contributed to the provision for loan losses due to the increased risk of loss associated with consumer lending.

Centrix Financial, LLC (“Centrix”), the organization with which the Company contracted to service the Company’s indirect automobile loan portfolio, filed Chapter 11 bankruptcy during the third quarter of 2006. As a result, the Company increased its provision for loan losses 0.5% for anticipated loan charge-offs on its indirect automobile loan portfolio. Although Centrix continues to operate, their ability to service the remaining $7.4 million loan portfolio is currently being assessed by the Company’s management.

The Company believes that its conservative underwriting standards; strong collection efforts as well as a favorable real estate market have contributed to the historical quality of the loan portfolio. At September 30, 2006, nonperforming loans totaled $903,000 compared to $246,000 at September 30, 2005. Net charge-offs from loan losses totaled $30,000 for the nine months ended September 30, 2006 compared to net recoveries of loan losses of $59,000 for the nine months ended September 30, 2005. The Company continues to monitor the impact that rising interest rates will have on variable-rate borrowers’ ability to repay higher monthly interest payments.

Noninterest Income. The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.


*(Dollars in Thousands)*	Three Months Ended September 30,											Nine Months Ended September 30,
*(Dollars in Thousands)*	2006			2005			$ Change			% Change		2006			2005		$ Change			% Change
Service fees	$	1,164		$	1,094		$	70		6.4	%	$	3,488		$	3,102	$	386		12.4	%
Wealth management fees		863			233			630		270.4			2,533			745		1,788		240.0
Increase in cash surrender value of bank-owned life insurance		67			69			(2	)	(2.9	)		204			206		(2	)	(1.0	)
Net gain (loss) on sale of securities		(172	)		24			(196	)	(816.7	)		(284	)		59		(343	)	(581.4	)
Net gain on sale of loans		37			26			11		42.3			72			173		(101	)	(58.4	)
Other		13			(21	)		34		(161.9	)		88			96		(8	)	(8.3	)

TOTAL NONINTEREST INCOME	$	1,972		$	1,425		$	547		38.4	%	$	6,101		$	4,381	$	1,720		39.3	%

Service fees increased principally as a result of branch expansion and increased utilization of deposit-related products and electronic banking for 2006. Wealth management fees, which include trust and investment service fees, rose primarily due to fee income from SI Trust Servicing, the Bank’s third-party trust outsourcing service that was acquired in November 2005. The net loss on the sale of securities in 2006 resulted from the sale of primarily government-sponsored enterprise securities, which were in an unrealized loss position, during the second and third quarters of 2006. The proceeds from the sale of securities during the second and third quarters of 2006 were reinvested into higher yielding mortgage-backed securities. Net gains on the sale of loans reflect the sale of $7.6 million of fixed-rate residential mortgage loans during the first nine months of 2006 compared to $33.9 million of loan losses during the same period in 2005.

Noninterest Expenses. The following table shows the components of noninterest expenses and the dollar and percentage changes for the periods presented.


*(Dollars in Thousands)*	Three Months Ended September 30,								Nine Months Ended September 30,
*(Dollars in Thousands)*	2006		2005		$ Change		% Change		2006		2005		$ Change			% Change
Salaries and employee benefits	$	3,491	$	3,269	$	222	6.8	%	$	10,778	$	9,142	$	1,636		17.9	%
Occupancy and equipment		1,231		929		302	32.5			3,593		2,726		867		31.8
Computer and electronic banking services		662		436		226	51.8			1,921		1,322		599		45.3
Outside professional services		248		247		1	0.4			784		907		(123	)	(13.6	)
Marketing and advertising		234		202		32	15.8			591		517		74		14.3
Supplies and printing		131		83		48	57.8			395		346		49		14.2
Other		560		472		88	18.6			1,554		1,483		71		4.8

TOTAL NONINTEREST EXPENSES	$	6,557	$	5,638	$	919	16.3	%	$	19,616	$	16,443	$	3,173		19.3	%

Noninterest expenses increased for both the three months and the nine months ended September 30, 2006 compared to the same periods in 2005, primarily due to increased operating costs associated with the opening of branch offices and the acquisition of SI Trust Servicing. Increases in salaries and employee benefits reflect higher staffing levels and the amortization of share-based compensation arrangements. The adoption of

SFAS 123(R) during the second quarter of 2005 resulted in share-based compensation expense of $192,000 and $574,000, respectively, for the three months and nine months ended September 30, 2006. For the quarter and the nine months ended September 30, 2005, share-based compensation expense totaled $189,000 and $285,000, respectively. Additional facility and equipment leases, depreciation expense and other occupancy-related expenses resulted in the increase in occupancy and equipment expenses. Computer and electronic banking services continued to rise as a result of the addition of branch offices and the acquisition of SI Trust Servicing. Outside professional services decreased as a result of lower legal and auditing expenditures compared to the prior year. Marketing and advertising expenses increased as a result of various promotional initiatives related to the Company’s products and services and new branch openings.

Income Tax Provision. For the three months and nine months ended September 30, 2006, the Company’s income tax expense decreased $176,000 and $250,000, respectively, as a result of lower taxable income. The effective tax rate for the three months ended September 30, 2006 and 2005 was 29.1% and 33.3%, respectively, and 32.0% and 32.7% for the nine months ended September 30, 2006 and 2005, respectively.

Liquidity and Capital Resources

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

The Company’s most liquid assets are cash and cash equivalents. The levels of these assets depend on the Company’s operating, financing and investing activities during any given period. At September 30, 2006, cash and cash equivalents totaled $19.8 million, which included interest-bearing deposits and federal funds sold of $6.8 million.

Securities classified as available for sale, which provide additional sources of liquidity, totaled $122.4 million at September 30, 2006. In addition, at September 30, 2006, the Company had the ability to borrow $228.1 million from the Federal Home Loan Bank, which included overnight lines of credit of $6.2 million, before deducting outstanding advances. On that date, the Company had advances outstanding of $105.8 million and no overnight lines of credit advances outstanding. The Company believes that its most liquid assets combined with the available line from the Federal Home Loan Bank provide adequate liquidity to meet its current financial obligations.

The Company’s primary investing activities are the origination of loans and the purchase of securities. For the nine months ended September 30, 2006, the Company originated $135.8 million of loans and purchased $26.2 million of securities, excluding Federal Home Loan Bank stock. For the twelve months ended December 31, 2005, the Company originated $183.8 million of loans and purchased $27.0 million of securities.

Financing activities consist primarily of activities in deposit accounts and Federal Home Loan Bank advances. Liquidity needed to fund asset growth has been provided through deposits, Federal Home Loan Bank borrowings, raising capital through the issuance of trust preferred securities and the initial public offering. The Company experienced a net increase in total deposits, including mortgagors’ and investors’ escrow accounts, of $24.1 million, $51.8 million and $43.2 million for the nine months ended September 30, 2006 and for the years ended December 31, 2005 and 2004, respectively. Certificates of deposit due within one year of September 30, 2006 totaled $194.6 million, or 36.3%, of total deposits (including mortgagors’ and investors’ escrow accounts). Deposit flows are affected by the overall level of interest rates, products offered by the Company and its local competitors and other factors. The Company generally manages the pricing of its deposits to be competitive and to increase core deposits and commercial banking relationships. Occasionally, the Company offers promotional rates on certain deposit products to attract deposits. The Company believes, based on past experience, that a significant portion of the certificates of deposit will remain with the Company. The Company experienced a net increase of $17.9 million in Federal Home Loan Bank advances for the nine months

ended September 30, 2006 to fund loan demand and to invest in securities. The Company had net increases of $15.3 million and $15.5 million in Federal Home Loan Bank advances for the years ended December 31, 2005 and 2004, respectively. For the nine months ended September 30, 2006, the Company repurchased 129,266 shares of common stock at a cost of $1.4 million. Additional discussion about the Company’s liquidity and capital resources is contained in Item 7 in the Company’s 2005 Annual Report on Form 10-K. Reference the comparison of financial condition in this report for further details on the Company’s capital resources.

Payments Due Under Contractual Obligations

Information relating to payments due under contractual obligations is presented in the Company’s Form 10-K for the year ended December 31, 2005. There were no material changes in the Company’s payments due under contractual obligations between December 31, 2005 and September 30, 2006.

Off-Balance Sheet Arrangements

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with accounting principles generally accepted in the United States of America, are not recorded in its 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, lines of credit and letters of credit.

The contractual amount of commitments to extend credit represent the amount of potential accounting losses should the contract be fully drawn upon, the customer defaults and the value of any existing collateral becomes worthless. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Financial instruments whose contract amounts represent credit risk at September 30, 2006 and December 31, 2005 are as follows:


(Dollars in Thousands)	September 30, 2006		December 31, 2005
Commitments to extend credit: ⁽¹⁾
Future loan commitments ⁽²⁾	$	16,911	$	31,192
Undisbursed construction loans		28,888		25,572
Undisbursed home equity lines of credit		20,978		21,481
Undisbursed commercial lines of credit		11,593		10,796
Overdraft protection lines		1,402		1,277
Standby letters of credit ⁽³⁾		1,178		812
Loans sold with recourse ⁽⁴⁾		60		66

TOTAL COMMITMENTS	$	81,010	$	91,196

⁽¹⁾	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 may require payment of a fee and generally have fixed expiration dates or other termination clauses.

⁽²⁾	Includes fixed-rate loan commitments of $4.3 million at interest rates ranging from 5.375% to 7.750% and $5.5 million at interest rates ranging from 4.875% to 8.000% at September 30, 2006 and December 31, 2005, respectively.

⁽³⁾	Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.

⁽⁴⁾	Loan repurchase commitments are agreements to repurchase loans previously sold upon the occurrence of conditions established in the contract including default by the underlying borrower.

Outstanding commitments for the construction of new branch facilities in the aggregate totaled approximately $480,000 and $870,000 at September 30, 2006 and December 31, 2005, respectively.

For the nine months ended September 30, 2006, with the exception of the aforementioned commitments, the Company did not engage in any additional off-balance sheet transactions reasonably likely to have a material effect on the Company’s financial condition, results of operations or cash flows. See Note 12 to the consolidated financial statements contained in the Company’s 2005 Annual Report on Form 10-K.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Qualitative Aspects of Market Risk

The primary market risk factor affecting the financial condition and operating results of the Company is interest rate risk. Interest rate risk is the exposure of current and future earnings and capital arising from movements in interest rates. This risk is managed by periodic evaluation of the interest rate risk inherent in interest-earning assets and interest-bearing liabilities 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 decrease earnings while decreases in interest rates may increase earnings. To reduce the potential volatility of earnings, the Company has sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Pursuant to this strategy, the Company originates adjustable-rate mortgage loans for retention in its loan portfolio. However, the ability to originate adjustable-rate loans depends, to a great extent, on market interest rates and borrowers’ preferences. As an alternative to adjustable-rate mortgage loans, the Company offers fixed-rate mortgage loans with maturities of fifteen years. This product enables the Company to compete in the fixed-rate mortgage market while maintaining a shorter maturity. Fixed-rate mortgage loans typically have an adverse effect on interest rate sensitivity compared to adjustable-rate loans. Accordingly, the Company has sold more long-term fixed-rate mortgage loans in the secondary market in recent periods to manage interest rate risk. In recent years, the Company also has used investment securities with terms of three years or less, longer-term borrowings from the Federal Home Loan Bank and brokered deposits to help manage interest rate risk. The Company currently does not participate in hedging programs, interest rate swaps or other activities involving the use of derivative financial instruments.

The Company has an Asset/Liability 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 analyzes its interest rate sensitivity position to manage the risk associated with interest rate movements through the use of interest income simulation. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The Company’s goal is to manage asset and liability positions to moderate the effect of interest rate fluctuations on net interest income.

Income Simulation Analysis. Interest income simulations are completed quarterly and presented to the Company’s Asset/Liability Committee. The simulations provide an estimate of the impact of changes in interest rates on net interest income under a range of assumptions. The numerous assumptions used in the simulation process are reviewed by the Asset/Liability Committee on a quarterly basis. Changes to these assumptions can significantly affect the results of the simulation. The simulation incorporates assumptions regarding the potential timing in the repricing of certain assets and liabilities when market rates change and the changes in spreads between different market rates. The simulation analysis incorporates management’s current assessment of the risk that pricing margins will change adversely over time due to competition or other factors.

Simulation analysis is only an estimate of the Company’s interest rate risk exposure at a particular point in time. The Company continually reviews the potential effect that changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities.

The tables below set forth an approximation of the Company’s exposure as a percentage of estimated net interest income for the next twelve and twenty-four-month periods using interest income simulation. The simulation uses projected repricing of assets and liabilities at September 30, 2006 and December 31, 2005 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rates can have a significant impact on interest income simulation. Because of the Company’s large percentage of loans and mortgage-backed securities, rising or falling interest rates have a significant impact on the prepayment speeds of its earning assets that in turn affect the rate sensitivity position. The prepayment rates on investment securities are assumed to fluctuate between 8% and 12% in a flat interest rate environment, between 6% and 12% in an increasing interest rate environment and between 18% and 40% in a decreasing interest rate environment, depending on the type of security. Loan prepayment rates are assumed to fluctuate between 6% and 18% in a flat interest rate environment, between 6% and 15% in a rising rate environment and between 6% and 36% in a falling rate environment, depending on the type of loan. As evidenced by these assumptions, when interest rates rise, prepayments tend to slow and when interest rates fall, prepayments tend to increase. The Company’s asset sensitivity would be reduced if prepayments slow and vice versa. Because prospective effects of hypothetical interest rate changes are based on a number of assumptions, these computations should not be relied upon as indicative of actual results. While the Company believes such assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed securities, collateralized mortgage obligations and loan repayment activity. Further, the computations do not reflect any actions that management may undertake in response to changes in interest rates. Management periodically reviews its rate assumptions based on existing and projected economic conditions.

The Company’s management generally simulates changes to net interest income using three different interest rate scenarios. The first scenario anticipates the maximum foreseeable increase in rates over the next twelve months; management assumes this to be 200 basis points at September 30, 2006 and 300 basis points at December 31, 2005. The second scenario anticipates management’s view of the most likely change in interest rates over the next twelve months; management’s current assumption is a 100 basis point increase in rates. The third scenario anticipates the maximum foreseeable decrease in rates over the next twelve months; management’s assumption is 200 basis points. The basis point change in each of the three scenarios is assumed to occur evenly over both the twelve and twenty-four months presented. As of September 30, 2006 and December 31, 2005, the Company’s estimated exposure as a percentage of estimated net interest income for the twelve-month and twenty-four-month periods are as follows:

September 30, 2006:


	Percent Change in Estimated Net Interest Income Over
	12 Months		24 Months
200 basis point increase in rates	(6.32	)%	(8.88	)%
100 basis point increase in rates	(2.15	)	(2.91	)
200 basis point decrease in rates	(2.95	)	(8.13	)

December 31, 2005:


	Percent Change in Estimated Net Interest Income Over
	12 Months		24 Months
300 basis point increase in rates	(3.36	)%	(5.56	)%
100 basis point increase in rates	0.44		1.54
200 basis point decrease in rates	(4.28	)	(7.55	)

As of September 30, 2006, based on the scenarios above, net interest income would be adversely affected in both the twelve and twenty-four-month periods if interest rates rose by 100 and 200 basis points or if interest rates decreased 200 basis points. Using net interest income for the quarter ended September 30, 2006, for each percentage point change in net interest income, the effect on the Company’s annual net income would be $146,000, assuming a 34% marginal income tax rate.

As of December 31, 2005, based on the scenarios above, net interest income would be adversely affected in both the twelve and twenty-four-month periods if interest rates rose by 300 basis points or if interest rates decreased 200 basis points and favorably impacted by a 100 basis point increase in rates. Using net interest income for the quarter ended December 31, 2005, for each percentage point change in net interest income, the effect on the Company’s annual net income would be $148,000, assuming a 34% marginal income tax rate.

For both the twelve and twenty-four-month periods, the effect on net interest income has declined in the event of a sudden and sustained increase in prevailing market interest rates of 100 and 200 basis points at September 30, 2006 compared to December 31, 2005. Net interest income has improved as rates decrease 200 basis points for the twelve-month period, but net interest income declined for the twenty-four-month period. As a result, the Company’s strategy is to better position the balance sheet for the anticipated economic slowdown by shortening the maturities on borrowings and certificates of deposit, while lengthening the durations of investment securities.

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 (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 officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

Periodically, there have been various claims and lawsuits against the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds a security interest, claims involving the making and servicing of real property loans and other issues incident to the Bank’s business. The Company is not a party to any pending legal proceedings that it believes would have a material adverse effect on its financial condition, results of operations or cash flows.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, which could materially and adversely affect the Company’s business, financial condition or future results. The risks described in the Company’s Annual Report on Form 10-K are not the only risks that the Company faces. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

The following table provides certain information with regard to shares repurchased by the Company in the third quarter of 2006.


Period	Total Number of Shares Purchased ⁽¹⁾	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs
July 1, 2006 through July 31, 2006	—	$	—	—	486,170
August 1, 2006 through August 31, 2006	—		—	—	486,170
September 1, 2006 through September 30, 2006	—		—	—	486,170

Total	—	$	—	—	486,170

⁽¹⁾

On November 23, 2005, the Company announced that the Board of Directors had approved a stock repurchase program authorizing the Company to repurchase up to 628,000 shares of the Company’s common stock. The repurchase program will continue until it is completed or terminated by the Board of Directors.

Item 3. Defaults Upon Senior Securities.

None.

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

None.

Item 5. Other Information.

None.

Item 6. Exhibits.


3.1		Charter of SI Financial Group, Inc. ⁽¹⁾

3.2		Bylaws of SI Financial Group, Inc. ⁽¹⁾

4.0		Specimen Stock Certificate of SI Financial Group, Inc. ⁽¹⁾

31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

32.0		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

⁽¹⁾	Incorporated by reference into this document from the Exhibits filed with the Securities and Exchange Commission on the Registration Statement on Form S-1, and any amendments thereto, Registration No. 333- 116381.

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.


		SI FINANCIAL GROUP, INC.

November 10, 2006		/s/ Rheo A. Brouillard
		Rheo A. Brouillard
		President and Chief Executive Officer
		(principal executive officer)

November 10, 2006		/s/ Brian J. Hull
		Brian J. Hull
		Executive Vice President, Treasurer and
		Chief Financial Officer
		(principal financial and accounting officer)

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