Form 10-Q

10-Q 1 d10q.htm FORM 10-Q 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 March 31, 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 00-50347

JEFFERSON BANCSHARES, INC.

(Exact name of registrant as specified in its charter)


Tennessee		45-0508261
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

120 Evans Avenue, Morristown, Tennessee		37814
(Address of principal executive offices)		(Zip code)

(423) 586-8421

(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 x Non-accelerated filer ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

At May 10, 2006, the registrant had 6,693,317 shares of common stock, $0.01 par value per share, outstanding.

INDEX


		Page
	Part I. FINANCIAL INFORMATION
Item 1.	Financial Statements

	Consolidated Statements of Condition - Unaudited Nine months ended March 31, 2006 and year ended June 30, 2005	3

	Consolidated Statements of Earnings - Unaudited Three and nine months ended March 31, 2006 and 2005	4

	Consolidated Statements of Changes in Stockholders’ Equity - Unaudited Nine months ended March 31, 2006 and 2005	5

	Consolidated Statements of Cash Flows - Unaudited Nine months ended March 31, 2006 and 2005	6

	Notes to Consolidated Financial Statements - Unaudited	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27

Item 4.	Controls and Procedures	27

	Part II. OTHER INFORMATION

Item 1.	Legal Proceedings	28
Item 1A.	Risk Factors	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29
Item 3.	Defaults Upon Senior Securities	29
Item 4.	Submission of Matters to a Vote of Security Holders	29
Item 5.	Other Information	30
Item 6.	Exhibits	30

SIGNATURES

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Condition

(Dollars in thousands)


	March 31, 2006			June 30, 2005
	(Unaudited)
Assets

Cash and cash equivalents	$	3,228		$	3,799
Interest-earning deposits		5,531			7,228
Investment securities classified as available-for-sale, net		39,902			53,366
Federal Home Loan Bank stock		1,720			1,652
Bank owned life insurance		5,440			5,285
Loans receivable, net of allowance for loan losses of $2,191 and $2,293		240,860			208,438
Loans held-for-sale		1,105			3,137
Premises and equipment, net		10,280			7,073
Foreclosed real estate, net		161			914
Accrued interest receivable:
Investments		267			489
Loans receivable		1,287			1,059
Deferred tax asset		1,898			1,878
Other assets		682			723

Total assets	$	312,361		$	295,041

Liabilities and Stockholders’ Equity

Deposits
Noninterest-bearing	$	10,340		$	9,973
Interest-bearing		186,539			184,733
Federal Home Loan Bank advances		39,000			17,000
Other liabilities		988			1,307

Total liabilities		236,867			213,013

Commitments and contingent liabilities		—			—

Stockholders’ equity:
Preferred stock, $.01 par value; 10,000,000 shares authorized; no shares issued or outstanding		—			—
Common stock, $.01 par value; 30,000,000 shares authorized; 8,385,517 shares issued and 6,694,917 and 7,289,284 outstanding		84			84
Additional paid-in capital		72,071			71,694
Unearned ESOP shares		(5,509	)		(5,833	)
Unearned compensation		(2,873	)		(3,232	)
Accumulated other comprehensive income		(558	)		(155	)
Retained earnings		34,952			34,069
Treasury stock, at cost; 1,711,731 and 1,105,832 shares		(22,673	)		(14,599	)

Total stockholders’ equity		75,494			82,028

Total liabilities and stockholders’ equity	$	312,361		$	295,041

See accompanying notes to financial statements

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Earnings (Unaudited)

(Dollars in Thousands, Except Net Earnings Per Share)


	Three Months Ended March 31,						Nine Months Ended March 31,
	2006			2005			2006			2005
Interest income:
Interest on loans receivable	$	4,155		$	3,330		$	11,669		$	9,655
Interest on investment securities		373			594			1,272			1,938
Other interest		77			76			250			193

Total interest income		4,605			4,000			13,191			11,786

Interest expense:
Deposits		1,470			1,064			3,964			3,080
Advances from FHLB		396			101			833			292

Total interest expense		1,866			1,165			4,797			3,372

Net interest income		2,739			2,835			8,394			8,414
Provision for loan losses		—			—			—			—

Net interest income after provision for loan losses		2,739			2,835			8,394			8,414

Noninterest income:
Dividends from investments		12			20			29			46
Mortgage origination fee income		129			40			446			40
Service charges and fees		131			132			404			416
Loss on sale of investment securities, net		(46	)		—			(90	)		(43	)
Gain on sale of foreclosed real estate, net		8			38			168			71
BOLI increase in cash value		49			45			155			153
Other		30			52			70			106

Total noninterest income		313			327			1,182			789

Noninterest expense:
Compensation and benefits		1,483			1,070			4,063			2,914
Occupancy expense		108			89			305			241
Equipment and data processing expense		276			273			735			710
DIF deposit insurance premiums		6			7			19			22
Advertising		28			47			173			140
REO expense		9			26			46			58
Other		376			403			1,107			994

Total noninterest expense		2,286			1,915			6,448			5,079

Earnings before income taxes		766			1,247			3,128			4,124

Income taxes:
Current		218			389			926			1,339
Deferred		72			(4	)		231			89

Total income taxes		290			385			1,157			1,428

Net earnings	$	476		$	862		$	1,971		$	2,696

Net earnings per share, basic	$	0.08		$	0.12		$	0.31		$	0.36

Net earnings per share, diluted	$	0.08		$	0.12		$	0.31		$	0.36

See accompanying notes to financial statements

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders’ Equity

Nine Months Ended March 31, 2006 and 2005 (Unaudited)

(Dollars in Thousands)


	Common Stock		Additional Paid-in Capital		Unallocated Common Stock in ESOP			Unearned Compensation			Accumulated Other Comprehensive Income			Retained Earnings			Treasury Stock			Total Stockholders’ Equity
Balance at June 30, 2005	$	84	$	71,694	$	(5,833	)	$	(3,232	)	$	(155	)	$	34,069		$	(14,599	)	$	82,028

Comprehensive income:
Net earnings		—		—		—			—			—			1,971			—			1,971
Change in net unrealized gain (loss) on securities available for sale, net of taxes of $(250)		—		—		—			—			(403	)		—			—			(403	)

Total comprehensive income		—		—		—			—			—			—			—			1,568

Dividends		—		—		—			—			—			(1,245	)		—			(1,245	)
Dividends used for ESOP payment		—		—		—			—			—			157			—			157
Shares committed to be released by the employee stock ownership plan		—		104		324			—			—			—			—			428
Stock options expensed		—		199		—			—			—			—			—			199
Tax benefit from exercise of nonqualifying stock options		—		—		—			—			—			—			—			—
Earned portion of stock grants		—		—		—			359			—			—			—			359
Exercise of options		—		49		—			—			—			—			—			49
Tax benefit from exercise of nonqualifying stock options		—		25		—			—			—			—			—			25
Purchase of common stock (605,899 shares)		—		—		—			—			—			—			(8,074	)		(8,074	)

Balance at March 31, 2006	$	84	$	72,071	$	(5,509	)	$	(2,873	)	$	(558	)	$	34,952		$	(22,673	)	$	75,494

Balance at June 30, 2004	$	84	$	71,496	$	(6,265	)	$	(3,488	)	$	(793	)	$	32,349		$	—		$	93,383

Comprehensive income:
Net earnings		—		—		—			—			—			2,696			—			2,696
Change in net unrealized gain (loss) on securities available for sale, net of taxes of $138		—		—		—			—			221			—			—			221

Total comprehensive income		—		—		—			—			—			—			—			2,917

Dividends		—		—		—			—			—			(1,173	)		—			(1,173	)
Dividends used for ESOP payment		—		—		—			—			—			143			—			143
Shares committed to be released by the employee stock ownership plan		—		97		324			—			—			—			—			421
Stock options expensed		—		—		—			—			—			—			—			—
Earned portion of stock grants		—		—		—			330			—			—			—			330
Exercise of options		—		44		—			—			—			—			—			44
Purchase of stock for the 2004 Stock Incentive Plan		—		—		—			(184	)		—			—			—			(184	)
Tax benefit from exercise of nonqualifying stock options		—		25		—			—			—			—			—			25
Purchase of common stock (828,552 shares)		—		—		—			—			—			—			(10,948	)		(10,948	)

Balance at March 31, 2005	$	84	$	71,662	$	(5,941	)	$	(3,342	)	$	(572	)	$	34,015		$	(10,948	)	$	84,958

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)


	Nine Months ended March 31,
	2006			2005
Cash flows from operating activities:
Net earnings	$	1,971		$	2,696
Adjustments to reconcile net earnings to net cash provided by (used for) operating activities
Allocated ESOP shares		428			422
Depreciation and amortization expense		202			196
Amortization of premiums (discounts), net on investment securities		23			11
(Gain) loss on sale of investment securities and mortgage-backed securities, net		106			43
(Gain) on sale of equity investments		(16	)		—
FHLB stock dividends		(68	)		(52	)
Amortization of deferred loan fees, net		(95	)		(97	)
Loss (gain) on sale of foreclosed real estate, net		(168	)		(70	)
Deferred tax benefit		231			296
Tax benefit from stock options and MRP		25			—
Originations of mortgage loans held for sale		(41,998	)		(5,279	)
Proceeds from sales of mortgage loans		44,030			3,900
Increase in cash value of life insurance		(155	)		(153	)
Earned portion of MRP		359			330
Stock options expensed		199			—
Decrease (increase) in:
Accrued interest receivable		(6	)		376
Other assets		41			66
Increase (decrease) in other liabilities and accrued income taxes		8			117

Net cash provided by (used for) operating activities		5,117			2,802

Cash flows used for investing activities:
Loan originations, net of principal collections		(31,579	)		(7,954	)
Investment securities classified as available for sale:
Purchased		(1,246	)		—
Proceeds from sale		11,527			20,378
Proceeds from maturity		200			1,700
Return of principal on mortgage-backed securities		2,201			3,152
Purchase of premises and equipment		(3,410	)		(255	)
Proceeds from sale of (additions to) foreclosed real estate, net		345			430

Net cash provided by (used for) investing activities		(21,962	)		17,451

Cash flows from financing activities:
Net increase (decrease) in deposits		2,173			(8,292	)
Proceeds from advances from FHLB		40,000			15,000
Repayment of FHLB advances		(18,000	)		(9,000	)
Purchase of company stock for the 2004 Stock Based Incentive Plan		—			(14	)
Purchase of treasury stock		(8,074	)		(10,948	)
Cash dividend paid on common stock		(1,572	)		(1,550	)
Proceeds from exercise of stock options		50			44

Net cash provided by (used for) financing activities		14,577			(14,760	)

Net increase (decrease) in cash, cash equivalents and interest-earning deposits		(2,268	)		5,493
Cash, cash equivalents and interest-earning deposits at beginning of period		11,027			6,411

Cash, cash equivalents and interest-earning deposits at end of period	$	8,759		$	11,904

Supplemental disclosures of cash flow information:
Cash paid during period for:
Interest on deposits	$	3,964		$	3,080
Interest on FHLB advances		833			292
Income taxes		1,135			1,390
Real estate acquired in settlement of loans		454			1,282

See accompanying notes to financial statements

Notes To Consolidated Financial Statements

(1)

Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of Jefferson Bancshares, Inc. (the “Company” or “Jefferson Bancshares”) and its wholly-owned subsidiary, Jefferson Federal Bank (the “Bank” or “Jefferson Federal”). The unaudited financial statements of the Company were prepared with generally accepted accounting principles and with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations and cash flows. In the opinion of management, the accompanying unaudited financial statements contain all adjustments, which are normal and recurring in nature, necessary for a fair presentation of the interim financial statements. The results of operations for the period ended March 31, 2006 are not necessarily indicative of the results which may be expected for the entire fiscal year. These unaudited consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2005.

(2)

Principles of Consolidation

The consolidated financial statements include the accounts of Jefferson Bancshares, Inc. and its wholly-owned subsidiary, Jefferson Federal Bank. All significant intercompany balances and transactions have been eliminated in consolidation.

(3)

Use of Estimates

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the statement of condition dates and revenues and expenses for the periods shown. Actual results could differ from the estimates and assumptions used in the consolidated financial statements. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate and deferred tax assets.

(4)

Limitation on Capital Distributions

Office of Thrift Supervision regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and the prior approval of the Office of Thrift Supervision is required prior to any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under Office of Thrift Supervision regulations (i.e., generally, examination ratings in the top two categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with, or condition imposed by, the Office of Thrift Supervision. If an application is not required, the institution must still provide prior notice to the Office of Thrift Supervision of the capital distribution if, like Jefferson Federal, it is a subsidiary of a holding company. In addition, the Office of Thrift Supervision could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Office of Thrift Supervision determined that such

distribution would constitute an unsafe or unsound practice. In the event Jefferson Federal’s capital falls below its regulatory requirements or the Office of Thrift Supervision notifies it that it is in need of more than normal supervision, Jefferson Federal’s ability to make capital distributions could be restricted. Jefferson Federal also may not make a capital distribution if the distribution would reduce its regulatory capital below the amount needed for the liquidation account established in connection with its conversion from the mutual holding company form of organization.

(5)

Earnings Per Common Share

Earnings per common share and earnings per common share-assuming dilution have been computed on the basis of dividing net earnings by the weighted-average number of shares of common stock outstanding, exclusive of unearned ESOP shares. Diluted earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. The following table illustrates the number of weighted-average shares of common stock used in each corresponding earnings per common share calculation:


	Weighted-Average Shares Outstanding for the Three Months Ended March 31,		Weighted-Average Shares Outstanding for the Nine Months Ended March 31,
	2006	2005	2006	2005
Weighted average number of common shares used in computing basic earnings per common share	6,227,668	7,171,692	6,422,164	7,443,856
Effect of dilutive stock options	20,436	16,865	18,193	18,459

Weighted average number of common shares and dilutive potential common shares used in computing earnings per common share assuming dilution	6,248,104	7,188,557	6,440,357	7,462,315

(6)

Statements of Cash Flows

Dividends declared but not paid have been recorded in other liabilities; however, their non-effect on cash and operations dictates their exclusion from the cash flows until actually paid.

(7)

Accounting by Creditors for Impairment of a Loan

Impairment of loans having an average recorded investment of $62,000 during the nine-month period ended March 31, 2006 has been recognized in conformity with the Financial Accounting Standards Board (“FASB”) Statement No. 118. There was no allowance for loan losses related to impaired loans at March 31, 2006. Other nonaccrual loans at March 31, 2006 were approximately $62,000. For the nine months ended March 31, 2006, gross income which would have been recognized had impaired and nonaccrual loans been current in accordance with their original terms amounted to approximately $4,000. Interest income from impaired and non-accrual loans included in the Company’s interest income amounted to $2,000 for the nine months ended March 31, 2006.

The following table summarizes the activity in the allowance for loan losses for the three months ended March 31, 2006:


	Allowance for Loan Losses (Dollars in thousands)
Balance at June 30, 2005				$	2,293
Provision for loan losses					—
Charge-offs	$	(227	)
Recoveries		125

Net (charge-offs)/recoveries					(102	)

Balance at March 31, 2006				$	2,191

(8)

Financial Instruments With Off-Balance Sheet Risk

Jefferson Bancshares is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount and related accrued interest receivable of those instruments. The Company minimizes this risk by evaluating each borrower’s creditworthiness on a case-by-case basis. Collateral held by the Company consists of a first or second mortgage on the borrower’s property. The amount of collateral obtained is based upon an appraisal of the property.

At March 31, 2006, we had approximately $8.6 million in loan commitments, consisting of $925,000 in commitments to originate residential loans and $7.6 million to originate commercial loans. In addition to commitments to originate loans, we had $13.0 million in loans-in-process, $528,000 in unused standby letters of credit and approximately $12.0 million in unused lines of credit.

(9)

Dividend Declaration

On February 24, 2006, the Board of Directors of the Company approved a quarterly dividend of $0.06 per share to stockholders of record as of March 31, 2006 and payable on April 14, 2006.

(10)

Stock Incentive Plans

Under the Bank’s 1995 Stock Option Plan and the 1995 Management Recognition and Development Plan (“MRP”), the Company issued a combined total of 179,176 shares to officers, employees and non-employee directors. Both plans vested pro-rata over a five-year period, with the Stock Option Plan having an expiration date of April 1, 2007. As of March 31, 2006, there were 39,726 options outstanding and no remaining shares available for grant under the 1995 Stock Option Plan. During the three-month period, 3,000 options were exercised.

The Company’s 2004 Stock Incentive Plan authorizes the granting of 698,750 options and 279,500 restricted stock awards to employees and non-employee directors. As of March 31, 2006, there were 401,778 options and 206,711 restricted stock awards granted under this plan which will vest pro-rata over a five-year period. The 2004 plan has an expiration date of January 30, 2014.

The table below summarizes the status of the Company’s stock option plans as of March 31, 2006.


	Nine Months Ended March 31, 2006
	Shares	Weighted- average exercise price
Outstanding at beginning of period	453,036	$	12.60
Granted during the nine-month period	—		—
Options exercised	11,532	$	4.26
Outstanding at March 31, 2006	441,504	$	12.82

Options exercisable at March 31, 2006	200,448	$	11.77

The following information applies to options outstanding at March 31, 2006:


Number outstanding		441,504
Range of exercise prices		$3.52 - $13.69
Weighted-average exercise price		$12.82
Weighted-average remaining contractual life		7.21
Number of options remaining for future issuance		296,972

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, “Share Based Payment” (SFAS 123R), an amendment of FASB Statement No. 123 (SFAS 123), “Accounting for Stock-Based Compensation.” SFAS 123R eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25 (“APB 25”) and requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. This statement is effective for public entities that do not file as small business issuers as of the beginning of the first interim or annual reporting period that begins after June 15, 2005.

Effective July 1, 2005, the Company adopted SFAS 123R using the modified prospective application transition method. This requires the Company to expense the unvested portion of options granted in 2004, which reduces net earnings by approximately $217,000 in fiscal year 2006 and $542,500 in the remaining service period. SFAS 123R provides for the use of alternative models to determine compensation cost related to stock option grants. The estimated fair value of stock options at grant date has been determined using the Black-Scholes option-pricing model based on market data as of January 29, 2004. The expected dividend yield of 1.17% and expected volatility of 7.01% were used to model the value. The risk free rate of return equaled 4.22%, which was based on the yield of a U.S. Treasury note with a term of ten years. The estimated time remaining before the expiration of the options equaled ten years.

Had compensation cost for the Company’s stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method prescribed by SFAS No. 123R, the Company’s net income and earnings per share would have been adjusted to the pro forma amounts indicated below:


	Three months ended March 31, 2005			Nine months ended March 31, 2005
Net Income:
As reported	$	862		$	2,696
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects		(54	)		(162	)

Pro forma	$	808		$	2,534

Basic net earnings per share:
As reported	$	0.12		$	0.36
Pro forma	$	0.11		$	0.34
Earnings per common share assuming dilution:
As reported	$	0.12		$	0.36
Pro forma	$	0.11		$	0.34

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

Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of Jefferson Bancshares. The information contained in this section should be read in conjunction with the financial statements and accompanying notes. For further information, refer to the financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2005.

General

Jefferson Bancshares, Inc. (also referred to as the “Company” or “Jefferson Bancshares”) is the holding company for Jefferson Federal Bank (the “Bank” or “Jefferson Federal”).

The Company has no significant assets, other than all of the outstanding shares of the Bank, and no significant liabilities. Management of the Company and the Bank are substantially similar and the Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Bank. Accordingly, the information set forth in this report, including the consolidated financial statements and related financial data, relates primarily to the Bank.

Jefferson Federal is a community oriented financial institution offering traditional financial services to its local communities. The Bank is engaged primarily in the business of attracting deposits from the general public and using such funds to originate loans secured by first mortgages on owner-occupied,

one-to four- family residential properties, as well as to originate commercial real estate and multi-family mortgage loans, construction loans, consumer loans, commercial non-real estate loans and make other investments permitted by applicable laws and regulations.

The Bank’s savings accounts are insured up to the applicable legal limits by the Federal Deposit Insurance Corporation (“FDIC”) through the Deposit Insurance Fund. Jefferson Federal Bank is a member of the Federal Home Loan Bank (“FHLB”) System.

Private Securities Litigation Reform Act Safe Harbor Statement

This Quarterly Report may contain forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts; but rather, are statements based on Jefferson Bancshares’ current expectations regarding its business strategies and their intended results and its future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.

Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. These factors include, but are not limited to, general economic conditions, changes in the interest rate environment, legislative or regulatory changes that may adversely affect our business, changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or composition of the Company’s loan or investment portfolios. Additional factors that may affect our results are discussed in our Annual Report on Form 10-K for the year ended June 30, 2005 under “Item 1. Business - Risk Factors.” These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Jefferson Bancshares assumes no obligation to update any forward-looking statements.

Results of Operations for the Three and Nine Months Ended March 31, 2006 and 2005

Net Income

Net income was $476,000, or $0.08 per diluted share, for the quarter ended March 31, 2006 compared to net income of $862,000, or $0.12 per diluted share, for the comparable period in 2005. The decline in net income for the three-month period ended March 31, 2006 was primarily the result of an increase in noninterest expense combined with a decrease in net interest income. The increase in noninterest expense was the result of our expansion activities, as well as our adoption of Financial Accounting Standards Board’s (“FASB”) Statement 123R, which requires the expensing of stock options. For the nine months ended March 31, 2006, net income was $2.0 million, or $0.31 per diluted share, compared to $2.7 million, or $0.36 per diluted share, for the comparable period in 2005. The decline in net income for the nine-months ended March 31, 2006 was primarily the result of an increase in noninterest expense, partially offset by an increase in noninterest income.


	Three Months Ended March 31,						Nine Months Ended March 31,
	2006			2005			2006			2005
	(Dollars in thousands, except per share data)						(Dollars in thousands, except per share data)
Net earnings	$	476		$	862		$	1,971		$	2,696
Net earnings per share, basic	$	0.08		$	0.12		$	0.31		$	0.36
Net earnings per share, diluted	$	0.08		$	0.12		$	0.31		$	0.36
Return on average assets (annualized)		0.61	%		1.16	%		0.86	%		1.18	%
Return on average equity (annualized)		2.49	%		3.98	%		3.33	%		4.01	%

Net Interest Income

Net interest income before loan loss provision decreased $96,000 to $2.7 million for the three months ended March 31, 2006 compared to the same period in 2005. The increase in short-term interest rates has improved the yield on earning assets; however, our cost of funds has also been affected by the increase in rates. The interest rate spread and net interest margin for the quarter ended March 31, 2006 were 3.04% and 3.80%, respectively, compared to 3.36% and 4.02% for the same period in 2005. The average yield on interest-earning assets increased 70 basis points to 6.38% and the average volume of earning assets increased $6.8 million, to $288.7 million for the three months ended March 31, 2006 compared to the same period in 2005. The average rate paid on interest-bearing liabilities increased 103 basis points to 3.34%, while the average volume of interest-bearing liabilities increased $21.7 million, to $223.3 million for the three months ended March 31, 2006 compared to the same period in 2005.

The following table summarizes changes in interest income and expense for the three-month periods ended March 31, 2006 and 2005:


	Three Months Ended March 31,				$ Change			% Change
	2006		2005		$ Change			% Change
	(Dollars in thousands)
Interest income:
Loans	$	4,155	$	3,330	$	825		24.8	%
Investment securities		373		594		(221	)	(37.2	)%
Interest-earning deposits		53		58		(5	)	(8.6	)%
FHLB stock		24		18		6		33.3	%

Total interest income		4,605		4,000		605		15.1	%
Interest expense:
Deposits		1,470		1,064		406		38.2	%
Borrowings		396		101		295		292.1	%

Total interest expense		1,866		1,165		701		60.2	%

Net interest income	$	2,739	$	2,835	$	(96	)	(3.4	)%

Net interest income before loan loss provision decreased $20,000 to $8.4 million for the nine months ended March 31, 2006 compared to the same period in 2005. The interest rate spread and net interest margin for the nine months ended March 31, 2006 were 3.24% and 3.96%, respectively, compared to 3.25% and 3.88% for the same period in 2005. The average yield on interest-earning assets increased

79 basis points to 6.22% while the average volume of earning assets declined $6.5 million, to $282.8 million for the nine months ended March 31, 2006 compared to the same period in 2005. The average rate paid on interest-bearing liabilities increased 80 basis points to 2.98%, while the average volume of interest-bearing liabilities increased $8.6 million, to $214.8 million for the nine months ended March 31, 2006, compared to the same period in 2005.

The following table summarizes changes in interest income and expense for the nine-month periods ended March 31, 2006 and 2005:


	Nine Months Ended March 31,				$ Change			% Change
	2006		2005		$ Change			% Change
	(Dollars in thousands)
Interest income:
Loans	$	11,669	$	9,655	$	2,014		20.9	%
Investment securities		1,272		1,938		(666	)	(34.4	)%
Interest-earning deposits		182		141		41		29.1	%
FHLB stock		68		52		16		30.8	%

Total interest income		13,191		11,786		1,405		11.9	%
Interest expense:
Deposits		3,964		3,080		884		28.7	%
Borrowings		833		292		541		185.3	%

Total interest expense		4,797		3,372		1,425		42.3	%

Net interest income	$	8,394	$	8,414	$	(20	)	(0.2	)%

The following table summarizes average balances and average yields and costs:


	Three Months Ended March 31,								Nine Months Ended March 31,
	2006				2005				2006				2005
	Average Balance		Yield/ Cost		Average Balance		Yield/ Cost		Average Balance		Yield/ Cost		Average Balance		Yield/ Cost
	(Dollars in thousands)								(Dollars in thousands)
Loans	$	239,795	6.93	%	$	197,923	6.73	%	$	226,793	6.86	%	$	198,856	6.47	%
Investment securities		40,047	3.73	%		70,887	3.35	%		46,008	3.69	%		77,778	3.32	%
Interest-earning deposits		7,111	2.98	%		11,392	2.04	%		8,264	2.94	%		10,996	1.71	%
FHLB stock		1,712	5.61	%		1,625	4.43	%		1,687	5.37	%		1,608	4.31	%
Deposits		185,588	3.17	%		189,527	2.25	%		186,122	2.84	%		194,344	2.11	%
Borrowings		37,666	4.21	%		12,000	3.37	%		28,667	3.87	%		11,889	3.27	%

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


	Three Months 2006 Compared to 2005									Nine Months 2006 Compared to 2005
	Increase (Decrease) Due To						Net			Increase (Decrease) Due To						Net
	Volume			Rate			Net			Volume			Rate			Net
	(In thousands)									(In thousands)
Interest income:
Loans receivable	$	723		$	102		$	825		$	1,413		$	601		$	2,014
Investment securities		(309	)		88			(221	)		(935	)		269			(666	)
Other		(2	)		3			1			(23	)		80			57

Total interest-earning assets		412			193			605			455			950			1,405

Interest expense:
Deposits		(22	)		428			406			(124	)		1,008			884
Borrowings		264			31			295			479			62			541

Total interest-bearing liabilities		242			459			701			355			1,070			1,425

Net change in interest income	$	170		$	(266	)	$	(96	)	$	100		$	(120	)	$	(20	)

Total interest income increased $605,000, or 15.1%, to $4.6 million for the three months ended March 31, 2006, and increased $1.4 million, or 11.9%, to $13.2 million for the nine months ended March 31, 2006. The increase in interest income was primarily due to an increase in both the volume and yield on average loans more than offsetting a decrease in the volume of investment securities.

Interest on loans increased $825,000, or 24.8%, to $4.2 million for the three months ended March 31, 2006 and increased $2.0 million, or 20.9%, to $11.7 million for the nine months ended March 31, 2006. The increase in interest on loans is the result of a higher average balance, primarily due to growth in the commercial and consumer loan portfolio, combined with a higher average yield. The increase in the average yield on loans was primarily the result of increases in the prime lending rate. The average yield on loans increased 20 basis points, to 6.93%, for the three months and increased 39 basis points, to 6.86%, for the nine months ended March 31, 2006 compared to the corresponding periods in 2005. Most of the commercial loans that have been originated have been tied to prime and will reprice quickly as interest rates change.

Interest on investment securities decreased $221,000, or 37.2%, to $373,000 for the three months ended March 31, 2006 and decreased $666,000, or 34.4%, to $1.3 million, for the nine months ended March 31, 2006. The decrease for both periods was the result of a decrease in the average balance of investment securities more than offsetting an increase in the average yield. The average balance of investment securities decreased $30.8 million, to $40.0 million for the three months ended March 31, 2006 and decreased $31.8 million, to $46.0 million for the nine months ended March 31, 2006. Proceeds from the sale of investment securities were used to fund stock repurchases and to fund growth in the loan portfolio. The average yield on investments increased 38 basis points to 3.73% for the three months ended March 31, 2006 and increased 37 basis points to 3.69% for the nine months ended March 31, 2006 compared to the same periods in 2005. Dividends on Federal Home Loan Bank (“FHLB”) stock were $24,000 and $68,000, respectively, for the three- and nine-month periods ended March 31, 2006, compared to $18,000 and $52,000 for the comparable periods in 2005. FHLB dividends are paid with additional shares of FHLB stock.

Total interest expense increased $701,000, or 60.2%, to $1.9 million for the three-month period ended March 31, 2006 compared to the same period in 2005. For the nine months ended March 31, 2006, total interest expense increased $1.4 million, or 42.3%, to $4.8 million compared to the same period in 2005. The increase in both periods was due to an increase in the average rate paid on interest-bearing liabilities combined with an increase in the average balance of FHLB advances. Interest expense on deposits increased $406,000, or 38.2%, to $1.5 million for the three-month period ended March 31, 2006 and increased $884,000, or 28.7%, to $4.0 million for the nine-month period ended March 31, 2006. The increase for both periods was due to an increase in the average rate paid on deposits more than offsetting a decrease in the average balance of deposits. The average rate paid on deposits increased 92 basis points to 3.17% for the three months ended March 31, 2006 and increased 73 basis points to 2.84% for the nine months ended March 31, 2006 due to higher rates paid on money market accounts and time deposits. The increase in the rate paid on deposits reflects an increase in short-term market interest rates. Interest expense on FHLB advances was $396,000 for the three months ended March 31, 2006 compared to $101,000 for the same period in 2005. For the nine months ended March 31, 2006, interest expense on FHLB advances was $833,000 compared to $292,000 for the same period in 2005. The increase for both periods was due to a higher average balance and a higher rate paid. FHLB advances were utilized as a funding source for supporting loan growth during the three- and nine-month periods ended March 31, 2006.

Provision for Loan Losses

We review the level of the loan loss allowance on a monthly basis and establish the provision for loan losses based on the volume and types of lending, delinquency levels, loss experience, the amount of classified loans, economic conditions and other factors related to the collectibility of the loan portfolio. Net charge-offs for the three- and nine-month periods ended March 31, 2006 amounted to $43,000 and $102,000, respectively, compared to $50,000 and $141,000 for the comparable periods in 2005. There were no additions to the allowance for loan losses for either nine-month period. Nonperforming loans totaled $62,000 at March 31, 2006 compared to $342,000 at March 31, 2005.

Noninterest Income

Noninterest income decreased $14,000 to $313,000 for the three months ended March 31, 2006 compared to $327,000 for the corresponding period in 2005. A loss on sale of investment securities totaling $46,000 was recorded in the three-month period ended March 31, 2006 and included as a component of noninterest income. Proceeds from the sale of investment securities were used to fund stock repurchases and to fund growth in the loan portfolio. Gain on sale of foreclosed property was $8,000 for the three months ended March 31, 2006 compared to $38,000 for the same period in 2005. Mortgage origination fee income accounted for the largest increase in noninterest income with $129,000 for the three months ended March 31, 2006 and $40,000 for the comparable period in 2005. For the three months ended March 31, 2006, we originated $11.7 million in non-portfolio loans that were sold in the secondary market compared to $5.3 million for the three months ended March 31, 2005.

The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the three months ended March 31, 2006 compared to the same period in 2005.


	Three Months Ended March 31,					$ Change			% Change
	2006			2005		$ Change			% Change
	(Dollars in thousands)
Dividends from investments	$	12		$	20	$	(8	)	(0.4	)%
Mortgage origination fee income		129			40		89		222.5	%
Service charges and fees		131			132		(1	)	(0.8	)%
Loss on sale of investment securities, net		(46	)		—		(46	)	NM
Gain on sale of foreclosed real estate, net		8			38		(30	)	(78.9	)%
BOLI increase in cash value		49			45		4		8.9	%
Other		30			52		(22	)	(43.3	)%

Total noninterest income	$	313		$	327	$	(14	)	(4.3	)%

Noninterest income increased $393,000, or 49.8%, to $1.2 million for the nine months ended March 31, 2006 compared to $789,000 for the comparable period in 2005. Mortgage origination fee income accounted for the largest increase in noninterest income with $446,000 for the current nine-month period and $40,000 for the comparable period in 2005. In January 2005, we began originating and selling loans in the secondary market. Loss on sale of investment securities amounted to $90,000 for the nine months ended March 31, 2006 compared to $43,000 for the corresponding period in 2005. Gain on sale of foreclosed property was $168,000 for the nine months ended March 31, 2006 compared to $71,000 for the same period in 2005.

The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the nine months ended March 31, 2006 compared to the same period in 2005.


	Nine Months Ended March 31,						$ Change			% Change
	2006			2005			$ Change			% Change
	(Dollars in thousands)
Dividends from investments	$	29		$	46		$	(17	)	(37.0	)%
Mortgage origination fee income		446			40			406		1015.0	%
Service charges and fees		404			416			(12	)	(2.9	)%
Loss on sale of investment securities, net		(90	)		(43	)		(47	)	109.3	%
Gain on sale of foreclosed real estate, net		168			71			97		136.6	%
BOLI increase in cash value		155			153			2		1.3	%
Other		70			106			(36	)	(34.0	)%

Total noninterest income	$	1,182		$	789		$	393		49.8	%

Noninterest Expense

Noninterest expense increased $371,000 or 19.4%, to $2.3 million for the three-month period ended March 31, 2006, primarily due to an increase in compensation and benefits expense. Compensation and benefits expense increased $413,000, or 38.6%, to $1.5 million for the three-month period ended March 31, 2006, primarily due to staff additions for our future branch office in Morristown, Tennessee which is scheduled to open in 2006 and two future branch offices in Knoxville, Tennessee which are anticipated to open in 2006 and early 2007. There were 95 bank employees at March 31, 2006 compared to 75 employees at March 31, 2005. Further, on July 1, 2005, we adopted FASB Statement No. 123R, “Share-Based Payment,” using the modified prospective approach, which requires the expensing of unvested stock options granted prior to the adoption date. The expense will be based on

the grant-date fair value and will be recognized over the remaining vesting period. The cost of stock options that have vested prior to the adoption of SFAS 123R is never recognized. Accordingly, for the three months ended March 31, 2006, compensation expense included $66,000 related to the expensing of stock options.

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the three months ended March 31, 2006 compared to the same period in 2005.


	Three Months Ended March 31,				$ Change			% Change
	2006		2005		$ Change			% Change
	(Dollars in thousands)
Compensation and benefits	$	1,483	$	1,070	$	413		38.6	%
Occupancy expense		108		89		19		21.3	%
Equipment and data processing expense		276		273		3		1.1	%
Deposit insurance premiums		6		7		(1	)	(14.3	)%
Advertising		28		47		(19	)	(40.4	)%
REO expense		9		26		(17	)	(65.4	)%
Other		376		403		(27	)	(6.7	)%

Total noninterest expense	$	2,286	$	1,915	$	371		19.4	%

For the nine months ended March 31, 2006, noninterest expense increased $1.4 million, or 27.0%, to $6.4 million due primarily to an increase in compensation and benefits expense. Compensation and benefits expense increased $1.1 million, or 39.4%, to $4.1 million for the nine months ended March 31, 2006 due to staff additions and stock option expensing. Compensation and benefits expense related to stock option expense totaled $199,000 for the nine months ended March 31, 2006.

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the nine months ended March 31, 2006 compared to the same period in 2005.


	Nine Months Ended March 31,				$ Change			% Change
	2006		2005		$ Change			% Change
	(Dollars in thousands)
Compensation and benefits	$	4,063	$	2,914	$	1,149		39.4	%
Occupancy expense		305		241		64		26.6	%
Equipment and data processing expense		735		710		25		3.5	%
Deposit insurance premiums		19		22		(3	)	(13.6	)%
Advertising		173		140		33		23.6	%
REO expense		46		58		(12	)	(20.7	)%
Other		1,107		994		113		11.4	%

Total noninterest expense	$	6,448	$	5,079	$	1,369		27.0	%

Income Taxes

Income tax expense for the three months ended March 31, 2006 was $290,000 compared to $385,000 for the same period in 2005 due to lower taxable income. For the nine months ended March 31, 2006, income tax expense decreased $271,000, or 19.0%, to $1.2 million due to lower taxable income.

Financial Condition

Assets

At March 31, 2006, total assets were $312.4 million, an increase of $17.3 million, or 5.9%, compared to $295.0 million at June 30, 2005. The increase in assets was primarily attributable to an increase in loans, more than offsetting a decline in investment securities. Proceeds from sales and maturities of investment securities and repayments of mortgage-backed securities were utilized to fund stock repurchases and to fund growth in the loan portfolio. Additional FHLB advances were used to fund asset growth.

Investments

Our investment portfolio consists primarily of federal agency securities with maturities of seven years or less, municipal securities and mortgage-backed securities with stated final maturities of 30 years or less. Investment securities decreased $13.5 million, or 25.2%, to $39.9 million due primarily to sales of investment securities during the nine-month period. Proceeds from the sale of investment securities were used to fund stock repurchases and to fund growth in the loan portfolio. Investment securities classified as available-for-sale are carried at fair market value and reflect an unrealized loss of $905,000, or $558,000 net of taxes.

The following table sets forth the carrying values of our investment securities portfolio at the dates indicated. All of our investment securities are classified as available-for-sale.


At March 31, 2006
	Amortized Cost			Unrealized Gains		Unrealized Losses			Fair Value
	(Dollars in thousands)
Securities available-for-sale
Debt securities:
Federal agency	$	31,322		$	—	$	(786	)	$	30,536
Municipals		4,507			1		(120	)		4,388
Mortgage-backed		4,977			14		(13	)		4,978

Total securities available- for-sale	$	40,806		$	15	$	(919	)	$	39,902

Weighted-average rate		3.51	%


At June 30, 2005
	Amortized Cost			Unrealized Gains		Unrealized Losses			Fair Value
	(Dollars in thousands)
Securities available-for-sale
Debt securities:
Federal agency	$	42,447		$	83	$	(393	)	$	42,137
Municipals		3,475			2		(60	)		3,417
Mortgage-backed		7,695			117		—			7,812

Total securities available- for-sale	$	53,617		$	202	$	(453	)	$	53,366

Weighted-average rate		3.42	%

Loans

Net loans increased $32.4 million, or 15.6%, to $240.9 million at March 31, 2006. Our expansion into the Knoxville, Tennessee market has generated additional lending opportunities, which has resulted in significant growth in our loan portfolio. Our primary lending activity is the origination of loans secured by real estate. Real estate loans totaled $199.9 million, or 82.1% of gross loans, at March 31, 2006 compared to $168.8 million, or 80.0% of gross loans, at June 30, 2005. We originate real estate loans secured by one- to four-family homes, commercial real estate, multi-family real estate and land. We also originate construction loans and home equity loans. The largest portion of loan growth occurred in commercial real estate, due to our emphasis on this type of lending. Commercial real estate loans increased $20.0 million, or 37.0%, to $74.3 million at March 31, 2006.

Commercial business loans decreased $2.0 million, or 5.8%, to $32.6 million at March 31, 2006. Commercial business loans were 13.4% of gross loans at March 31, 2006 compared to 16.4% of gross loans at June 30, 2005. Most of the commercial business loans that we have originated have been tied to prime and will reprice quickly as interest rates change.

We originate a variety of consumer loans, including loans secured by automobiles, mobile homes and deposit accounts at Jefferson Federal. Consumer loans totaled $10.8 million and represented 4.5% of total loans at March 31, 2006 compared to $7.6 million, or 3.6% of total loans at June 30, 2005. Consumer loans increased in the nine months ended March 31, 2006 due to an increase in indirect automobile loans.

Loans receivable, net, are summarized as follows:


	At March 31, 2006					At June 30, 2005
	Amount			Percent of Portfolio		Amount			Percent of Portfolio		$ Change			% Change
	(Dollars in thousands)
Real estate loans:
Residential one-to four-family	$	78,036		32.1	%	$	79,652		37.7	%	$	(1,616	)	(2.0	)%
Multi-family		7,258		3.0	%		8,568		4.1	%		(1,310	)	(15.3	)%
Construction		11,486		4.7	%		7,029		3.3	%		4,457		63.4	%
Commercial		74,301		30.5	%		54,252		25.7	%		20,049		37.0	%
Land		22,782		9.4	%		14,415		6.8	%		8,367		58.0	%
Home equity line of credit		6,033		2.5	%		4,898		2.3	%		1,135		23.2	%

Total real estate loans		199,896		82.1	%		168,814		80.0	%		31,082		18.4	%

Commercial business loans		32,603		13.4	%		34,603		16.4	%		(2,000	)	(5.8	)%

Consumer loans:
Loans secured by deposit accounts		953		0.4	%		1,041		0.5	%		(88	)	(8.5	)%
Other consumer loans		1,751		0.7	%		1,705		0.8	%		46		2.7	%
Loans secured by automobiles		7,870		3.2	%		4,457		2.1	%		3,413		76.6	%
Mobile home loans		264		0.1	%		379		0.2	%		(115	)	(30.3	)%

Total non-real estate loans		10,838		4.5	%		7,582		3.6	%		3,256		42.9	%

Total commercial business and consumer loans		43,441		17.9	%		42,185		20.0	%		1,256		3.0	%

Total gross loans		243,337		100.0	%		210,999		100.0	%		32,338		15.3	%
Less:
Deferred loan fees, net		(286	)				(268	)				(18	)	6.7	%
Allowance for losses		(2,191	)				(2,293	)				102		(4.4	)

Loans receivable, net	$	240,860				$	208,438				$	32,422		15.6	%

Loan Loss Allowance

The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish reserves against losses on loans on a monthly basis. When additional reserves are necessary, a provision for loan losses is charged to earnings. In connection with assessing the allowance, we consider the level of classified loans, delinquency levels and loss experience. In addition, we assess the allowance using factors that cannot be associated with specific credit or loan categories. These factors include our subjective evaluation of local and national economic and business conditions, portfolio concentration and changes in the character and size of the loan portfolio. The allowance methodology appropriately reflects a margin for the imprecision necessarily inherent in estimates of expected credit losses.

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

Due to net charge-offs, the allowance for loan losses decreased $102,000 to $2.2 million at March 31, 2006. There were no additions to the allowance for loan losses during the nine-month period ended March 31, 2006. Our allowance for loan losses represented 0.90% of total gross loans at March 31, 2006 compared to 1.09% of total gross loans at June 30, 2005.


	Three Months Ended March 31,						Nine Months Ended March 31,
	2006			2005			2006			2005
	(Dollars in thousands)						(Dollars in thousands)
Balance at beginning of period	$	2,234		$	2,388		$	2,293		$	2,479
Provision for loan losses		—			—			—			—
Recoveries		49			66			125			252
Charge-offs		(92	)		(116	)		(227	)		(393	)

Net charge-offs		(43	)		(50	)		(102	)		(141	)

Allowance at end of period	$	2,191		$	2,338		$	2,191		$	2,338

Net charge-offs to average outstanding loans during the period, annualized		0.07	%		0.10	%		0.06	%		0.09	%

Nonperforming Assets

We consider repossessed assets and nonaccrual loans to be nonperforming assets. Loans are reviewed on a monthly basis and are generally placed on nonaccrual status when the loan becomes more than 90 days delinquent. Nonperforming assets were $223,000 at March 31, 2006 compared to $1.3 million at June 30, 2005. Nonperforming loans were $62,000 and $426,000 at March 31, 2006 and June 30, 2005, respectively. Foreclosed real estate decreased $753,000 to $161,000 at March 31, 2006 due to the disposition of several pieces of foreclosed property. Foreclosed real estate is initially recorded at the lower of the amount of the loan or the fair value, less estimated selling costs. Any writedown to fair value is charged to the allowance for loan losses. Any subsequent writedown of foreclosed real estate is charged against earnings.


	March 31, 2006			June 30, 2005
	(Dollars in thousands)
Nonaccruing loans:
Real estate	$	62		$	426
Commercial business		—			—
Consumer		—			—

Total nonaccrual loans		62			426

Real estate owned		161			914
Other repossessed assets		—			—


Total nonperforming assets	$	223		$	1,340

Total nonperforming assets to total assets		0.07	%		0.45	%
Total nonperforming loans to total loans		0.03	%		0.20	%
Allowance for loan losses to total nonperforming loans		3533.87	%		538.26	%

Bank Owned Life Insurance

We hold bank owned life insurance (“BOLI”) to help offset the cost of employee benefit plans. BOLI provides earnings from accumulated cash value growth and provides tax advantages inherent in a life insurance contract. The cash surrender value of the BOLI at March 31, 2006 was $5.4 million.

Deposits

Total deposits increased $2.2 million to $196.9 million at March 31, 2006. Transaction accounts increased $4.9 million, or 6.6%, to $78.4 million, while time deposits decreased $2.7 million, or 2.2%, to $118.5 million at March 31, 2006. We have focused on attracting lower cost transaction accounts to manage our cost of funds. Transaction accounts represented 39.8% of total deposits at March 31, 2006 compared to 37.8% at June 30, 2005 and 35.9% at March 31, 2005. The decrease in time deposits is the result of our pricing strategy combined with strong competition for time deposits in our market.


	March 31, 2006		June 30, 2005		$ Change			% Change
	(Dollars in thousands)
Certificates of deposit	$	118,456	$	121,130	$	(2,674	)	(2.2	)%
Savings accounts		12,175		12,944		(769	)	(5.9	)%
Money market accounts		39,683		31,841		7,842		24.6	%
NOW accounts		16,225		18,818		(2,593	)	(13.8	)%
Non-interest bearing accounts		10,340		9,973		367		3.7	%

	$	196,879	$	194,706	$	2,173		1.1	%

Advances and Other Liabilities

FHLB advances increased $22.0 million to $39.0 million at March 31, 2006. We utilize FHLB cash management overnight advances as a funding source to manage daily liquidity needs. In addition, a combination of fixed and variable rate FHLB advances, with maturities ranging from August 2006 to March 2011, have been used as a funding source for loan growth.

Stockholders’ Equity

Stockholders’ equity decreased $6.5 million, or 8.0%, to $75.5 million at March 31, 2006. Retained earnings increased $883,000 to $35.0 million at March 31, 2006 due to net earnings of $2.0 million partially offset by the payment of dividends to shareholders in the amount of $1.2 million. Unrealized gains and losses, net of taxes, in the available-for-sale investment portfolio are reflected as an adjustment to stockholders’ equity. At March 31, 2006, the adjustment to stockholders’ equity was an unrealized loss of $558,000 compared to a net unrealized loss of $155,000 at June 30, 2005. During the nine-month period ended March 31, 2006, there were 605,899 shares of treasury stock purchased at a cost of $8.1 million.

Liquidity and Capital Resources

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

We regularly adjust our investments in liquid assets based on our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term U.S. Government agency obligations.

Our most liquid assets are cash and cash equivalents and interest-earning assets. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At March 31, 2006, cash and cash equivalents totaled $3.2 million and interest-earning deposits totaled $5.5 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $39.9 million at March 31, 2006. In addition, at March 31, 2006, we had arranged the ability to borrow a total of approximately $63.4 million from the Federal Home Loan Bank of Cincinnati. In the nine-month period ended March 31, 2006, Federal Home Loan Bank advances increased $22.0 million to $39.0 million.

We anticipate that we will have sufficient funds available to meet current loan commitments. At March 31, 2006, we had approximately $8.6 million in loan commitments, consisting of $925,000 in commitments to originate residential loans and $7.6 million to originate commercial loans. In addition to commitments to originate loans, we had $13.0 million in loans-in-process, $528,000 in unused standby letters of credit and approximately $12.0 million in unused lines of credit. We had $73.8 million in certificates of deposit due within one year and $78.4 million in other deposits without specific maturities at March 31, 2006. We believe, based on past experience, that a significant portion of those deposits will remain with us. Deposit flows are affected by the overall level of interest rates and products offered by us and our local competitors and other factors. We have the ability to attract and retain deposits by adjusting the interest rates offered. We experienced a net increase in total deposits of $2.2 million during the nine-month period ended March 31, 2006.

At March 31, 2006, the average liquidity ratio was 18.55% compared to 32.29% at March 31, 2005. The level of liquidity has been reduced as net proceeds from the stock offering have been used for lending, operational growth and expansion activities.

Off-Balance Sheet Arrangements

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, unused lines of credit, amounts due mortgagors on construction loans, amounts due on commercial loans and commercial letters of credit.

For the three months ended March 31, 2006, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

Capital Compliance

The following table presents our capital position relative to our regulatory capital requirements at March 31, 2006 and June 30, 2005:


	Actual				For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount			Ratio		Amount			Ratio
	(Dollars in thousands)
At March 31, 2006

Total Capital
(To Risk Weighted Assets)	$	67,461	30.0	%	$	18,013	³	8.0	%	$	22,517	³	10.0	%

Core Capital
(To Tangible Assets)		65,455	21.2	%		12,367	³	4.0	%		15,459	³	5.0	%

Tangible Capital
(To Tangible Assets)		65,455	21.2	%		4,638	³	1.5	%		N/A

Tier 1 Capital
(To Risk Weighted Assets)		65,455	29.1	%		N/A					13,510	³	6.0	%

At June 30, 2005

Total Capital
(To Risk Weighted Assets)	$	67,648	35.4	%	$	15,293	³	8.0	%	$	19,116	³	10.0	%

Core Capital
(To Tangible Assets)		65,539	22.7	%		11,539	³	4.0	%		14,424	³	5.0	%

Tangible Capital
(To Tangible Assets)		65,539	22.7	%		4,327	³	1.5	%		N/A

Tier 1 Capital
(To Risk Weighted Assets)		65,539	34.3	%		N/A					11,470	³	6.0	%

Item 3. Quantitative and Qualitative Disclosures About Market Risk

For a discussion of the Company’s asset and liability management policies, as well as the potential impact of interest rate changes upon the market value of the Company’s portfolio equity, see Item 7A in the Company’s Annual Report on Form 10-K for the year ended June 30, 2005. Management, as part of its regular practices, performs periodic reviews of the impact of interest rate changes upon net interest income and the market value of the Company’s portfolio equity. Based on, among other factors, such reviews, management believes that there have been no material changes in the market risk of the Company’s asset and liability position since June 30, 2005.

Item 4. Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the quarter ended March 31, 2006 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

There have been no material changes to the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended June 30, 2005.

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


Period	(a) Total Number of Shares (or units) Purchased	(b) Average Price Paid per Share (or Unit)		(c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs	(d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Yet Be Purchased Under the Plans or Programs
Month #1
January 1, 2006 through January 31, 2006	—		—	—	176,068	(1)

Month #2
February 1, 2006 through February 28, 2006	180,587	$	13.43	180,587	685,742	(1)

Month #3
March 1, 2006 through March 31, 2006	30,108	$	13.52	30,108	655,634	(1)
Total	210,695	$	13.44	210,695	655,634

(1)

On July 30, 2004, the Company announced a Stock Repurchase Program under which the Company may repurchase up to an aggregate of 838,552 shares, or 10%, of the Company’s common stock, from time to time, subject to market conditions. On April 29, 2005, the Company announced a stock repurchase program under which the Company may repurchase an additional 838,552 shares of the Company’s common stock, from time to time, subject to market conditions. The 2004 and 2005 repurchase authorizations were completed during the three months ended March 31, 2006. On February 24, 2006, the Company announced a Stock Repurchase Program under which the Company may repurchase an additional 690,261 shares of the Company’s common stock, from time to time, subject to market conditions. The repurchase program will continue until 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



31.1		Rule 13a-14(a)/15d-14(a) certification of the principal executive officer

31.2		Rule 13a-14(a)/15d-14(a) certification of the principal financial officer

32.1		Section 1350 certification

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.


						JEFFERSON BANCSHARES, INC.

May 10, 2006						/s/ Anderson L. Smith
						Anderson L. Smith President and Chief Executive Officer




May 10, 2006						/s/ Jane P. Hutton
						Jane P. Hutton Chief Financial Officer, Treasurer and Secretary