10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

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

For the Fiscal Year Ended December 31, 2010

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

For the Transition Period from _______  to _______

Commission File Number:  0-54241

_______________________

SI FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

_______________________

Maryland	80-0643149
(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)

_______________________

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

Title of each class	Name of Exchange on which registered
Common stock, par value $0.01 per share	The Nasdaq Stock Market LLC

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

None

_______________________

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

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  oNo  o

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

Large Accelerated Filer  oAccelerated Filer  o

Non-Accelerated Filer   x   Smaller Reporting Company Filer  o

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates was $26.4 million, which was computed by reference to the closing price of $6.30, at which the common equity was sold as of June 30, 2010.  Solely for the purposes of this calculation, the shares held by SI Bancorp, MHC and the directors and officers of the registrant are deemed to be affiliates.

As of March 15, 2011, there were 10,576,849 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company’s Annual Report to Shareholders and the Proxy Statement for the 2011 Annual Meeting of Shareholders are incorporated by reference into Parts II and III of this Form 10-K.

SI FINANCIAL GROUP, INC.

TABLE OF CONTENTS

PART I.		Page No.
Item 1.	Business	1
Item 1A.	Risk Factors	37
Item 1B.	Unresolved Staff Comments	42
Item 2.	Properties	42
Item 3.	Legal Proceedings	42
Item 4.	[Removed and Reserved]	43
PART II.
Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	43
Item 6.	Selected Financial Data	43
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	45
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	45
Item 8.	Financial Statements and Supplementary Data	45
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	46
Item 9A.	Controls and Procedures	46
Item 9B.	Other Information	46
PART III.
Item 10.	Directors, Executive Officers and Corporate Governance	47
Item 11.	Executive Compensation	47
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	47
Item 13.	Certain Relationships and Related Transactions and Director Independence	48
Item 14.	Principal Accountant Fees and Services	48
PART IV.
Item 15.	Exhibits and Financial Statement Schedules	48
	Signatures	51

Explanatory Note

SI Financial Group, Inc., a Maryland corporation (the “Registrant” or “SI Financial–Maryland”), was incorporated on September 7, 2010 to become the holding company for Savings Institute Bank and Trust Company (the “Bank”) upon completion of the “second-step” conversion of the Bank from a mutual holding company structure to a stock holding company structure (the “Conversion”).  The Conversion involved the sale by the Registrant of 6,544,493 shares of common stock in a public offering to depositors and community members, the exchange of 4,032,356 shares of common stock of the Registrant for shares of common stock of the former SI Financial Group, Inc. (the “Company”) held by persons other than SI Bancorp, MHC (the “MHC”), and the elimination of the Company and the MHC.  The Conversion was completed on January 12, 2011.  As the Conversion was completed after December 31, 2010, the information in this report is for the Company.  Separate financial statements for the Registrant have not been included in this report because the Registrant, as of December 31, 2010, had not issued any shares and had engaged only in organizational activities to date, had no significant assets, contingent or other liabilities, revenues or expenses.  Per share information in this report is based on outstanding shares as of the dates indicated and does not reflect the Conversion.  Following the Conversion, the Registrant had 10,576,849 shares of common stock outstanding.

Forward-Looking Statements

This report may contain certain “forward-looking statements” within the meaning of the federal securities laws, which are made in good faith pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.   These statements are not historical facts; rather, they are statements based on management’s current expectations regarding our business strategies, intended results and future performance.  Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends,” “estimates,” “projects” and similar expressions.  Management’s ability to predict results of the 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 Item 1A. “Risk Factors” in the Company’s annual report on Form 10-K and in other reports filed with the Securities and Exchange Commission.  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.

PART I.

Item 1.  Business.

General

In certain instances where appropriate, the terms “we,” “us” and “our” refer to SI Financial Group, Inc. and Savings Institute Bank and Trust Company or both.

SI Financial Group, Inc. was established on August 6, 2004 to become the parent holding company for the Bank upon the conversion of the Bank’s former parent, SI Bancorp, Inc., from a state-chartered to a federally-chartered mutual holding company.  At the same time, the Bank also converted from a state-chartered to a federally-chartered savings bank.  On September 30, 2004, the Company completed its minority stock offering with the sale of 5,025,500 shares of its common stock to the public, 251,275 shares contributed to SI Financial Group Foundation and 7,286,975 issued to the MHC.  The Bank is a wholly-owned subsidiary of the Company and management of the Company and the Bank are substantially similar.  The Company neither owns nor leases any property, but instead uses the premises, equipment and other property of the Bank with the payment of appropriate rental fees, as required by applicable law and regulations.  Thus, the financial information and discussion contained herein primarily relates to the activities of the Bank.

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On January 12, 2011, SI Financial-Maryland completed its public stock offering and the concurrent conversion of the Bank from the mutual holding company structure to a stock holding company structure.  A total of 6,544,493 shares of common stock were sold in the subscription and community offerings at $8.00 per share, including 392,670 shares purchased by the Bank’s Employee Stock Ownership Plan.  Additional shares totaling 4,032,356 were issued in exchange for shares of the former federally-chartered SI Financial Group, Inc., at an exchange ratio of 0.8981.  See Note 22 in the Company’s Consolidated Financial Statements included in the Company’s Annual Report to Shareholders, attached hereto as Exhibit 13, for more details.

The Bank operates as a community-oriented financial institution offering a full range of financial services to consumers and businesses in its market area, including insurance, trust and investment services.  The Bank attracts deposits from the general public and uses those funds to originate one- to four-family residential, multi-family and commercial real estate, commercial business and consumer loans.  Beginning in 2008, substantially all of the fixed-rate one- to four-family residential conforming loans the Bank originates are sold in the secondary market with the servicing retained.  Such sales generate mortgage banking fees.  The remainder of the Bank’s loan portfolio is originated for investment.

Availability of Information

The Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to such reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on the Company’s website,www.mysifi.com, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission (the “SEC”).  The information on the Company’s website shall not be considered as incorporated by reference into this Form 10-K.

Market Area and Competition

The Company is headquartered in Willimantic, Connecticut, which is located in eastern Connecticut approximately 30 miles east of Hartford.  The Bank operates 21 full-service offices throughout Windham, New London, Tolland, Hartford and Middlesex counties in Connecticut.  The Bank’s primary lending area is eastern Connecticut and most of the Bank’s deposit customers reside in the areas surrounding the Bank’s branch offices.  The economy in the Company’s market area is relatively diverse and primarily oriented to the educational, service, entertainment, manufacturing and retail industries.  The major employers in the area include several institutions of higher education, the Mohegan Sun and Foxwoods casinos, General Dynamics Defense Systems and Pfizer, Inc.  In addition, there are also many small to mid-sized businesses that support the local economy.

In view of the current economic downturn, our primary market area has remained a relatively stable banking market.  Windham, New London, Tolland, Hartford and Middlesex counties have a total population of 1.6 million and total households of 616,000 according to SNL Financial.  For 2010, median household income levels ranged from $58,000 to $78,000 in the five counties we maintain branch offices, compared to $70,000 for Connecticut as a whole and $54,000 for the United States according to published statistics.

The Bank faces significant competition for the attraction of deposits and origination of loans.  The most direct competition for deposits has historically come from the several financial institutions operating in the Bank’s market area and, to a lesser extent, from other financial service companies, such as brokerage firms, credit unions and insurance companies.  The Bank also faces competition for investors’ funds from money market funds and other corporate and government securities.  At June 30, 2010, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation (the “FDIC”), the Bank held 20.69% of the deposits in Windham County, which is the largest market share out of 10 financial institutions with offices in this county.  Also, at June 30, 2010, the Bank held 0.96% of the deposits in New London, Tolland, Hartford and Middlesex Counties, which is the 16th market share out of 35 financial institutions with offices in these counties.  Bank of America Corp., Webster Bank Financial Corporation, The Toronto-Dominion Bank, People’s United Financial, Inc. and Banco Santander, S.A., all of which are large national or regional bank holding companies, also operate in the Bank’s market area.  These institutions are significantly larger and, therefore, have significantly greater resources than the Bank does and may offer products and services that the Bank does not provide.

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

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

Lending Activities

General. The Bank’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 much lesser extent, the loan portfolio includes construction and consumer loans.  At December 31, 2010, the Bank had loans held for sale totaling $7.4 million.

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

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	At December 31,
	2010						2009						2008						2007						2006
(Dollars in Thousands)				Percent						Percent						Percent						Percent						Percent
	Amount			of Total			Amount			of Total			Amount			of Total			Amount			of Total			Amount			of Total
Real estate loans:
Residential - 1 to 4 family	$	270,923			44.46	%	$	306,244			50.12	%	$	332,399			53.46	%	$	330,389			55.87	%	$	309,695			53.65	%
Multi-family and commercial		160,015			26.26			159,781			26.15			158,693			25.52			132,819			22.46			118,600			20.55
Construction		6,952			1.14			11,400			1.87			27,892			4.49			37,231			6.29			44,647			7.73
Total real estate loans		437,890			71.86			477,425			78.14			518,984			83.47			500,439			84.62			472,942			81.93
Commercial business loans:
SBA and USDA guaranteed		116,492			19.11			77,310			12.65			45,704			7.35			42,267			7.15			51,358			8.90
Other		26,310			4.32			30,239			4.95			34,945			5.62			27,583			4.66			23,813			4.13
Total commercial business loans		142,802			23.43			107,549			17.60			80,649			12.97			69,850			11.81			75,171			13.03
Consumer loans:
Home equity		25,533			4.19			22,573			3.69			18,762			3.02			17,774			3.01			18,489			3.20
Other		3,167			0.52			3,513			0.57			3,345			0.54			3,330			0.56			10,616			1.84
Total consumer loans		28,700			4.71			26,086			4.26			22,107			3.56			21,104			3.57			29,105			5.04
Total loans		609,392			100.00	%		611,060			100.00	%		621,740			100.00	%		591,393			100.00	%		577,218			100.00	%
Deferred loan origination costs, net of deferred fees		1,621						1,523						1,570						1,390						1,258
Allowance for loan losses		(4,799	)					(4,891	)					(6,047	)					(5,245	)					(4,365	)
Loans receivable, net	$	606,214					$	607,692					$	617,263					$	587,538					$	574,111

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One- to Four-Family Residential Loans.  The Bank’s primary lending activity is the origination of mortgage loans to enable borrowers to purchase or refinance existing homes or to construct new residential dwellings in its market area.  The Bank offers fixed-rate and adjustable-rate mortgage loans with terms up to 30 years.  Borrower demand for adjustable-rate loans versus fixed-rate loans is a function of the level of current and anticipated future interest rates, the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and the initial period interest rates and loan fees for adjustable-rate loans. The relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment and the effect each has on the Bank’s interest rate risk.  The loan fees charged, interest rates and other provisions of mortgage loans are determined on the basis of the Bank’s pricing criteria and competitive market conditions.

The Bank offers fixed-rate loans with terms of 10, 15, 20 or 30 years.  The Bank’s adjustable-rate mortgage loans are based primarily on 30-year amortization schedules.  Interest rates and payments on adjustable-rate mortgage loans adjust annually after a one, three, five, seven or ten-year initial fixed period. Interest rates and payments on adjustable-rate loans are adjusted to a rate typically equal to 2.75% (2.875% for jumbo loans) above the one-year constant maturity Treasury index.  The maximum amount by which the interest rate may be increased or decreased is generally 2% per adjustment period and the lifetime interest rate cap is generally 6% over the initial interest rate of the loan.

Generally, the Bank does not originate conventional loans with loan-to-value ratios exceeding 95% and generally originates loans with a loan-to-value ratio in excess of 80% only when secured by first liens on owner-occupied one- to four-family residences.  Loans with loan-to-value ratios in excess of 80% generally require private mortgage insurance or additional collateral.  The Bank requires all properties securing mortgage loans to be appraised by a board approved independent licensed appraiser and requires title insurance on all first mortgage loans.  Borrowers must obtain hazard insurance and flood insurance for loans on property located in a flood zone before closing the loan.

In an effort to provide financing for moderate income and first-time buyers, the Bank offers loans insured by the Federal Housing Administration and the Veterans Administration and participates in the Connecticut Housing Finance Authority Program.  The Bank offers fixed-rate residential mortgage loans through these programs to qualified individuals and originates the loans using modified underwriting guidelines.

Multi-Family and Commercial Real Estate Loans.  The Bank makes multi-family and commercial real estate loans throughout its market area for the purpose of acquiring, developing, improving or refinancing multi-family and commercial real estate where the property is the primary collateral securing the loan, and the income generated from the property is the primary repayment source.  The Bank offers fixed-rate and adjustable-rate mortgage loans secured by multi-family and commercial real estate.  The Bank’s multi-family and commercial real estate loans are generally secured by owner-occupied properties, including churches, retail facilities and other owner-occupied properties located in its market area and used for businesses.  The Bank intends to continue to emphasize this segment of its loan portfolio, as market conditions permit, as such loans produce yields that are generally higher than one- to four-family residential loans and are more sensitive to changes in market interest rates.

The Bank originates adjustable-rate multi-family and commercial real estate loans for amortization periods up to 25 years.  Interest rates and payments on these loans typically adjust every five years after a five-year initial fixed-rate period.  Interest rates and payments on adjustable-rate loans are adjusted to a rate typically 2.5-3.0% above the classic advance rates offered by the Federal Home Loan Bank of Boston (the “FHLB”). There are no adjustment period or lifetime interest rate caps. Loans are secured by first mortgages that generally do not exceed 75% of the property’s appraised value.  At December 31, 2010, the largest outstanding multi-family or commercial real estate loan was $7.0 million.  This loan is secured by a nursing home and rehabilitation facility and was performing according to its terms at December 31, 2010.

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Construction and Land Loans.  The Bank originates loans to individuals, and to a lesser extent, builders, to finance the construction of residential dwellings.  The Bank also originates construction loans for commercial development projects, including condominiums, apartment buildings, single-family subdivisions as well as owner-occupied properties used for businesses.  Residential construction loans generally provide for the payment of interest only during the construction phase, which is usually twelve months.  At the end of the construction phase, the loan generally converts to a permanent mortgage loan.  Commercial construction loans generally provide for the payment of interest only during the construction phase which may range from three to twenty-four months.  Loans generally can be made with a maximum loan-to-value ratio of 80% on residential construction, 75% on construction for nonresidential properties and 80% of the lesser of the appraised value or cost of the project on multi-family construction.  At December 31, 2010, the largest outstanding commercial construction loan commitment for the construction of a residential housing development was $2.0 million, of which $144,000 was outstanding and the largest residential construction loan commitment was $1.8 million, of which $1.5 million was outstanding.  These loans were performing according to their terms at December 31, 2010.  Primarily all commitments to fund construction loans require an appraisal of the property by a board approved independent licensed appraiser.  Also, inspections of the property are required before the disbursement of funds during the term of the construction loan.

The Bank also originates land loans to individuals, local contractors and developers only for making improvements on approved building lots, subdivisions and condominium projects within two years of the date of the loan.  Such loans to individuals generally are written with a maximum loan-to-value ratio based upon the appraised value or purchase price of the land.  Maximum loan-to-value ratio on raw land is 50%, while the maximum loan-to-value ratio for land development loans involving approved projects is 65%.  The Bank offers fixed-rate land loans and variable-rate land loans that adjust annually.  Interest rates and payments on adjustable-rate land loans are adjusted to a rate typically equal to the then current prime rate as reported in The Wall Street Journal plus a 1.0–2.0% margin.  The maximum amount by which the interest rate may be increased or decreased is generally 2% annually and the lifetime interest rate cap is generally 6% over the initial rate of the loan.  Land loans totaled $532,000 at December 31, 2010.

Commercial Business Loans. The Bank originates commercial business loans to a variety of professionals, sole proprietorships and small businesses primarily in its market area.  The Bank offers a variety of commercial lending products, the maximum amount of which is limited by the Bank’s in-house loans to one borrower limit.  At December 31, 2010, the largest commercial loan was a $1.4 million loan, which is secured by a clinical office building.  This loan was performing according to its terms at December 31, 2010.

The Bank offers loans secured by business assets other than real estate, such as business equipment and inventory. These loans are originated with maximum loan-to-value ratios of 75% of the value of the personal property.  The Bank originates lines of credit to finance the working capital needs of businesses to be repaid by seasonal cash flows or to provide a period of time during which the business can borrow funds for planned equipment purchases.  These loans convert to a term loan at the expiration of a draw period, which is not to exceed twelve months, and will be paid over a pre-defined amortization period.  Additional products such as time notes, letters of credit and equipment lease financing are offered.  Additionally, the Bank purchases the portion of commercial business loans that are fully guaranteed by the Small Business Administration (“SBA”) and the United States Department of Agriculture (“USDA”).  At December 31, 2010, purchased SBA and USDA loans totaled $116.5 million.

When originating commercial business loans, the Bank considers the financial statements of the borrower, the borrower’s payment history of both corporate and personal debt, the debt service capabilities of the borrower, the projected cash flows of the business, viability of the industry in which the customer operates and the value of the collateral.

Consumer Loans.  The Bank offers a variety of consumer loans, primarily home equity lines of credit, and, to a lesser extent, loans secured by marketable securities, passbook or certificate accounts, motorcycles, automobiles and recreational vehicles, as well as unsecured loans.  Generally, the Bank offers automobile loans with a maximum loan-to-value ratio of 100% of the purchase price for new vehicles.  Unsecured loans generally have a maximum borrowing limit of $10,000 and a maximum term of five years.

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The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and their ability to meet existing obligations and payments on the proposed loans. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.  Home equity lines of credit have adjustable rates of interest that are indexed to the prime rate as reported in The Wall Street Journal.  A home equity line of credit may be drawn down by the borrower for an initial period of five years from the date of the loan agreement.  During this period, the borrower has the option of paying, on a monthly basis, either principal and interest or only interest.  If the draw period is not extended for an additional 4 years and 10 months, the borrower has to pay back the amount outstanding under the line of credit over a term not to exceed ten years, beginning at the end of the five-year period.  The Bank will offer home equity loans with a maximum combined loan-to-value ratio of 80%.

Loan Underwriting Risks.  While the Bank anticipates that adjustable-rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate mortgages, the increased mortgage payments required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults.  The marketability and collateral value of the underlying property also may be adversely affected in a high interest rate environment.  In addition, although adjustable-rate mortgage loans help make the Bank’s loan portfolio more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.

Loans secured by multi-family and commercial real estate generally have larger balances and involve a greater degree of risk than one- to four-family residential mortgage loans.  Of primary concern in multi-family and commercial real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income-producing properties often depend on the successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy. To monitor cash flows on income-producing properties, the Bank generally requires borrowers and loan guarantors to provide annual financial statements and/or tax returns.  In reaching a decision on whether to make a multi-family or commercial real estate loan, consideration is given to the net operating income of the property, the borrower’s expertise, credit history and the profitability and value of the underlying property.  The Bank generally requires that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.20x.  Environmental screens, surveys and inspections are obtained when circumstances suggest the possibility of the presence of hazardous materials. Further, in connection with our ongoing monitoring of the loan, the Bank typically reviews the property, the underlying loan and guarantors annually.

Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate.  Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction, the estimated cost (including interest) of construction and the ability of the project to be sold upon completion.  During the construction phase, a number of factors could result in delays and cost overruns.  If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the building.  If the estimate of value proves to be inaccurate, the Bank may be confronted, at or before the maturity of the loan, with a building having a value that is insufficient to assure full repayment.  If the Bank is forced to foreclose on a building before or at completion due to a borrower default, the Bank may not be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property the value of which tends to be more easily ascertainable, commercial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flows of the borrower’s underlying business.  As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself.  Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.

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

Loan Originations, Purchases, Sales and Servicing.  Loan originations come from a number of sources.  The primary source of loan originations are the Bank’s in-house loan originators, and to a lesser extent, advertising and referrals from customers.

Regularly, the Bank will purchase whole participations in loans fully guaranteed by the SBA and the USDA.  The loans are primarily for commercial and agricultural properties located throughout the United States.  The Bank purchased $54.0 million and $40.9 million in loans during 2010 and 2009, respectively.

At December 31, 2010, the Bank was a participating lender on three loans totaling $4.3 million, which are secured by commercial real estate.  These loans are serviced by the lead lenders.  The Bank generally performs its own underwriting analysis before purchasing loans and therefore believes there should not be a greater risk of default on these obligations.  However, in a purchased participation loan, the Bank does not service the loan and thus are subject to the policies and practices of the lead lender with regard to monitoring delinquencies, pursuing collections and instituting foreclosure proceedings.

The Bank originates conventional conforming one- to four-family loans which meet Fannie Mae underwriting standards.  Beginning in 2008, substantially all one- to four-family residential conforming loans have been sold in the secondary market on a servicing retained basis.  Such loans are sold to Fannie Mae, the Connecticut Housing Finance Authority and the FHLB under the Mortgage Partnership Finance Program (“MPF”).  The decision to sell loans in the secondary market is based on prevailing market interest rate conditions, an analysis of the composition and risk of the loan portfolio, liquidity needs and interest rate risk management.  Generally, loans are sold without recourse.  The Bank utilizes the proceeds from these sales primarily to meet liquidity needs.  Proceeds from the sale of loans totaled $49.1 million and $56.9 million for the years ended December 31, 2010 and 2009, respectively.  The Bank intends to continue to originate these types of loans for sale in the secondary market in the future to increase its noninterest income.

At December 31, 2010, the Bank retained the servicing rights on $148.6 million of loans for others, consisting primarily of fixed-rate mortgage loans sold with or without recourse to third parties.  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.  At December 31, 2010, the balance of loans sold with recourse totaled $19,000.  Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, processing insurance and tax payments on behalf of borrowers, assisting in foreclosures and property dispositions when necessary and general administration of loans.

- 8 -

The following table sets forth the Bank’s loan originations, loan purchases, loan sales, principal repayments, net charge-offs and other reductions on loans for the years indicated.

	Years Ended December 31,
(In Thousands)	2010			2009			2008
Loans at beginning of year	$	611,060		$	621,740		$	591,393
Originations:
Real estate loans		104,497			129,948			118,113
Commercial business loans		5,337			4,386			15,778
Consumer loans		12,210			11,990			7,697
Total loan originations		122,044			146,324			141,588
Purchases		53,953			40,876			12,281
Deductions:
Principal loan repayments, prepayments and other, net		125,719			131,940			108,693
Loan sales		49,107			56,336			14,232
Loan charge-offs		1,015			4,075			597
Transfers to other real estate owned		1,824			5,529			-
Total deductions		177,665			197,880			123,522
Net (decrease) increase in loans		(1,668	)		(10,680	)		30,347
Loans at end of year	$	609,392		$	611,060		$	621,740

Loan Maturity.  The following table shows the contractual maturity of the Bank’s loan portfolio at December 31, 2010.  The table does not reflect any estimate of prepayments, which significantly shortens the average life of all loans and may cause actual repayment experience to differ from that shown below.  Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.  The amounts shown below exclude deferred loan fees and costs.

	Amounts Due In
(In Thousands)	One Year		More Than One Year to		More Than		Total Amount
	or Less		Five Years		Five Years		Due
Real estate loans:
Residential - 1 to 4 family	$	116	$	6,833	$	263,974	$	270,923
Multi-family and commercial		321		6,160		153,534		160,015
Construction		1,185		-		5,767		6,952
Total real estate loans		1,622		12,993		423,275		437,890
Commercial business loans		9,214		8,748		124,840		142,802
Consumer loans		269		1,382		27,049		28,700
Total loans	$	11,105	$	23,123	$	575,164	$	609,392

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While one- to four-family residential real estate loans are normally originated with terms of up to 30 years, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon the sale of the property pledged as security or upon refinancing the original loan.  Therefore, average loan maturity is a function of, among other factors, the level of purchase, sale and refinancing activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.

The following table sets forth the dollar amount of all scheduled maturities of loans at December 31, 2010 that are due after December 31, 2011, and have either fixed interest rates or adjustable interest rates.

	Due After December 31, 2011
(In Thousands)	Fixed		Floating or Adjustable
	Rates		Rates		Total
Real estate loans:
Residential - 1 to 4 family	$	184,768	$	86,039	$	270,807
Multi-family and commercial		13,366		146,328		159,694
Construction		5,614		153		5,767
Total real estate loans		203,748		232,520		436,268
Commercial business loans		44,896		88,692		133,588
Consumer loans		7,765		20,666		28,431
Total loans	$	256,409	$	341,878	$	598,287

Loan Approval Procedures and Authority.  The Bank’s lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by the Company’s Board of Directors and management.  All residential mortgages and home equity lines of credit in excess of $6.0 million or all commercial loans and other consumer loans in excess of $2.0 million require the approval of the Board of Directors.  The Loan Committee of the Board of Directors has the authority to approve:  (1) residential mortgage loans and consumer home equity lines of credit up to $6.0 million and (2) commercial and other consumer loans up to $2.0 million.  The President and the Senior Credit Officer have approval for:  (1) residential mortgage loans that conform to Fannie Mae and Freddie Mac standards up to $2.0 million or $417,000 for those that are non-conforming and (2) consumer and commercial loans up to $250,000 individually or $2.0 million jointly for home equity lines of credit or $1.0 million jointly for commercial and other consumer loans.  Additionally, certain loan and branch personnel have the authority to approve residential mortgage loans up to $417,000, home equity lines up to $250,000 and consumer loans up to $100,000.

Loans to One Borrower.  The maximum amount that the Bank may lend to one borrower and the borrower’s related entities is limited, by regulation, to 15% of the Bank’s stated capital and reserves.  At December 31, 2010, the Bank’s general regulatory limit on loans to one borrower was approximately $11.4 million.  At that date, the Bank’s largest lending relationship was $8.1 million, representing a commercial business loan, two commercial real estate loans for a nursing home and rehabilitation facility and a commercial real estate loan to purchase an adjacent property.  These loans were performing according to their terms at December 31, 2010.

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

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Delinquencies.  When a borrower fails to make a required loan payment, the Bank takes a number of steps to have the borrower cure the delinquency and restore the loan to current status.  The Bank makes initial contact with the borrower when the loan becomes 15 days past due.  If payment is not then received by the 30th day of delinquency, additional letters and phone calls generally are made. When the loan becomes 90 days past due, a letter is sent notifying the borrower that foreclosure proceedings will commence if the loan is not brought current within 30 days.  Generally, when the loan becomes 120 days past due, the Bank will commence foreclosure proceedings against any real property that secures the loan or attempt to repossess any personal property that secures a consumer or commercial loan.  If a foreclosure action is instituted and the loan is not brought current, paid in full or refinanced before the foreclosure sale, the real property securing the loan is typically sold at foreclosure.  The Bank may consider loan repayment arrangements with certain borrowers under certain circumstances.

Management reports monthly to the Board of Directors or a committee of the Board regarding the amount of loans delinquent 30 days or more, all loans in foreclosure and all foreclosed and repossessed property that the Bank owns.

The following table provides information about delinquencies in the Bank’s loan portfolio at the dates indicated.

	December 31, 2010								December 31, 2009
	60-89 Days				90 Days or More				60-89 Days				90 Days or More
(Dollars in Thousands)	Number		Principal Balance		Number		Principal Balance		Number		Principal Balance		Number		Principal Balance
	of Loans		of Loans		of Loans		of Loans		of Loans		of Loans		of Loans		of Loans
Real estate loans:
Residential - 1 to 4 family		9	$	1,291		19	$	2,364		2	$	484		14	$	2,393
Multi-family and commercial		-		-		1		44		-		-		-		-
Construction		-		-		1		82		-		-		1		375
Total real estate loans		9		1,291		21		2,490		2		484		15		2,768
Commercial business loans:
SBA and USDA guaranteed		-		-		-		-		-		-		-		-
Other		-		-		1		46		1		8		1		27
Total commercial business loans		-		-		1		46		1		8		1		27
Consumer loans:
Home equity		1		50		-		-		-		-		-		-
Other		1		1		-		-		-		-		-		-
Total consumer loans		2		51		-		-		-		-		-		-
Total delinquent loans		11	$	1,342		22	$	2,536		3	$	492		16	$	2,795

Classified Assets.  Management of the Bank, including the Managed Asset Committee, consisting of a number of the Bank’s officers, review and classify the assets of the Bank on a monthly basis and the Board of Directors reviews the results of the reports on a quarterly basis.  Federal regulations and the Bank’s internal policies require that management utilize an internal asset classification system to monitor and evaluate the credit risk inherent in its loan portfolio.  In addition, the Office of Thrift Supervision (the “OTS”) has the authority to identify problem assets and, if appropriate, require them to be classified.  There are three classifications for problem assets; substandard, doubtful and loss.  “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.  “Doubtful assets” have all the weaknesses inherent in those classified as “substandard” with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high probability of loss.  Assets classified as “loss” are those assets considered uncollectible and of such little value that continuance as assets of the institution are not warranted.  The regulations also provide for a “special mention” category, described as assets which do not currently expose us to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weakness deserving close attention.  If the Bank classifies an asset as a loss, a loan loss allowance in the amount of 100% of the portion of the asset classified as a loss is established.

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The following table shows the aggregate amounts of the Bank’s criticized and classified assets as of December 31, 2010.

							Special
(In Thousands)	Loss		Doubtful		Substandard		Mention
Real estate loans:
Residential - 1 to 4 family	$	-	$	-	$	3,066	$	834
Multi-family and commercial		-		-		9,271		16,260
Construction		-		-		82		366
Total real estate loans		-		-		12,419		17,460
Commercial business loans:
USDA and SBA guaranteed		-		-		-		-
Other		-		70		3,239		2,896
Total commercial business loans		-		70		3,239		2,896
Consumer loans:
Home equity		-		-		50		-
Other		-		-		1		-
Total consumer loans		-		-		51		-
Total classified loans		-		70		15,709		20,356
Investment securities:
Non-agency mortgage-backed		-		-		3,676		-
Collateralized debt obligations		-		-		6,716		-
Total classified investment securities		-		-		10,392		-
Total criticized and classified assets	$	-	$	70	$	26,101	$	20,356

At December 31, 2010, total classified assets related to forty-two commercial real estate loans totaling $25.5 million, thirty-one residential mortgage loans totaling $3.9 million, twenty-four commercial business loans totaling $6.2 million, three commercial construction loans totaling $448,000 and ten investment securities with a carrying value totaling $10.4 million.  Substandard assets include $15.7 million of substandard loans, of which $4.9 million were nonperforming at December 31, 2010.  Of the $4.9 million in nonperforming loans, residential real estate loans totaling $2.4 million, construction loans totaling $82,000 and commercial real estate loans totaling $44,000 were 90 days or more past due.  The largest substandard loan, a commercial construction loan totaling $4.5 million, was delinquent in payments but not 60 days or more past due at December 31, 2010.  The substandard assets also included seven collateralized debt obligations totaling $6.7 million and three non-agency mortgage-backed securities totaling $3.7 million.  None of the $20.4 million of special mention loans were 60 days or more past due at December 31, 2010.

Other than disclosed in the above tables, there are no other loans at December 31, 2010 that management has serious doubts about the ability of the borrowers to comply with the present loan repayment terms.

Nonperforming Assets and Restructured Loans.   The Bank considers repossessed assets and loans that are 90 days or more past due to be nonperforming assets.  Loans are generally placed on nonaccrual status when they become 90 days delinquent at which time the accrual of interest ceases and any previously recorded interest is reversed and recorded as a reduction of loan interest and fee income.  Typically, payments received on a nonaccrual loan are applied to the outstanding principal and interest balance as determined at the time of collection of the loan.

- 12 -

Real estate acquired as a result of foreclosure or by deed-in-lieu of foreclosure is classified as foreclosed assets until it is sold.  When property is acquired, it is recorded at the lower of its cost or fair value, less estimated selling expenses.  Holding costs and declines in fair value after acquisition of the property result in charges against income.

The Bank periodically may agree to modify the contractual terms of loans.  When a loan is modified and concessions have been made to the original contractual terms, such as reductions of interest rates or deferral of interest or principal payments, due to the borrower’s financial condition, the modification is considered a troubled debt restructuring (“TDR”).  All TDRs are initially classified as impaired.

The following table provides information with respect to the Bank’s nonperforming assets and TDRs as of the dates indicated.  The Company had no accruing loans past due 90 days or more at each of the dates indicated.

	At December 31,
(Dollars in Thousands)	2010			2009			2008			2007			2006
Nonaccrual loans:
Real estate loans:
Residential - 1 to 4 family	$	2,901		$	2,597		$	2,795		$	755		$	392
Multi-family and commercial		1,775			-			832			42			-
Construction		82			375			5,483			6,082			-
Total real estate loans		4,758			2,972			9,110			6,879			392
Commercial business loans		116			35			217			733			71
Consumer loans		51			-			1			20			929
Total nonaccrual loans		4,925			3,007			9,328			7,632			1,392
Other real estate owned, net (1)		1,285			3,680			-			913			-
Total nonperforming assets		6,210			6,687			9,328			8,545			1,392
Accruing troubled debt restructurings		5,261			67			69			71			72
Total nonperforming assets and troubled debt restructurings	$	11,471		$	6,754		$	9,397		$	8,616		$	1,464
Total nonperforming loans to total loans		0.80	%		0.49	%		1.50	%		1.29	%		0.24	%
Total nonperforming loans to total assets		0.53	%		0.34	%		1.09	%		0.97	%		0.18	%
Total nonperforming assets and troubled debt restructurings to total assets		1.24	%		0.77	%		1.10	%		1.09	%		0.19	%

___________

(1)Other real estate owned balances are shown net of related write-downs or valuation allowance.

The decrease in nonperforming assets was primarily due to a decrease in other real estate owned offset by an increase in nonaccrual loans.  Nonaccrual loans increased due to the addition of three commercial real estate loans totaling $1.8 million and an increase in residential one- to four-family loans of $304,000 at December 31, 2010.  The remaining nonaccrual loans consisted of twenty-five residential loans and two consumer loans.

Other real estate owned decreased $2.4 million from December 31, 2009 to December 31, 2010, primarily as a result of the sale of seven residential and three commercial properties with an aggregate carrying value of $3.6 million.  During 2010, we acquired one commercial and seven residential properties with a net carrying value of $1.8 million and reduced the carrying value of three commercial properties and five residential properties in the amount of $472,000.

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As of December 31, 2010, troubled debt restructuring increased $6.1 million, of which $922,000 is included in nonaccrual loans, as a result of interest rate concessions for seven commercial real estate loans and two residential real estate loans.  As of December 31, 2010, all borrowers are performing in accordance with the terms of their restructured loan agreements and the Bank anticipates that the borrowers will repay all contractual principal and interest.

Interest income that would have been recorded for the year ended December 31, 2010 had nonaccruing loans and troubled debt restructurings been current in accordance with their original terms and had been outstanding throughout the period amounted to $335,000.  The amount of interest recognized on impaired loans was $165,000 for the year ended December 31, 2010.

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.  Loan losses are charged against the allowance for loan losses when management believes that the uncollectibility of the principal loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance for loan losses when received.  In the determination of the allowance for loan losses, management may obtain independent appraisals for significant properties, if necessary.

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 and evaluations of loans and other relevant factors.

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

o Specific allowance for identified impaired loans.  For such loans that are identified as impaired, an allowance is established when the present value of expected cash flows (or collateral value or observable market price if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan.

o General valuation allowance.  The general component represents a valuation allowance on the remainder of the loan portfolio, after excluding impaired loans.  For this portion of the allowance, loans are segregated by category and assigned an allowance percentage based on historical loan loss experience adjusted for qualitative factors stratified by the following loan segments:  residential one- to four-family, multi-family and commercial real estate, construction, commercial business and consumer.   Management uses a rolling average of historical losses based on the time frame appropriate to capture relevant loss data for each loan segment.  This historical loss factor is adjusted for the following qualitative factors:  levels/trends in delinquencies; level of charge-offs and nonperforming loans; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability and depth of lending management and staff and national and local economic trends and conditions.

o Unallocated allowance.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

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In computing the allowance for loan losses, we do not assign a general valuation allowance to the USDA and SBA loans that we purchase as such loans are fully guaranteed.  Such loans account for $116.5 million, or 19.1% of the loan portfolio at December 31, 2010.

The majority of the Company's loans are collateralized by real estate located in eastern Connecticut. Accordingly, the collateral value of a substantial portion of the Company's loan portfolio and real estate acquired through foreclosure is susceptible to changes in market conditions.

Although management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and the Company’s results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations.  Furthermore, while management believes it has established the allowance for loan losses in conformity with U.S. generally accepted accounting principles, the regulatory agencies, in reviewing the loan portfolio, may request that the Company increase its allowance for loan losses based on judgments different from those of the Company.  In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be adequate or increases may be necessary should the quality of any loans deteriorate as a result of the factors discussed above.  Any material increase in the allowance for loan losses would adversely affect the Company’s financial condition and results of operations.

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

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	December 31,
	---------------2010---------------								---------------2009---------------								---------------2008---------------
(Dollars in Thousands)	Amount		% of Allowance in each Category to Total Allowance			% of Loans in each Category to Total Loans			Amount		% of Allowance in each Category to Total Allowance			% of Loans in each Category to Total Loans			Amount		% of Allowance in each Category to Total Allowance			% of Loans in each Category to Total Loans
Real estate loans:
Residential - 1 to 4 family	$	915		19.06	%		44.46	%	$	1,028		21.02	%		50.12	%	$	906		14.98	%		53.46	%
Multi-family and commercial		2,700		56.27			26.26			2,443		49.95			26.15			2,358		38.99			25.52
Construction		64		1.34			1.14			221		4.51			1.87			1,533		25.36			4.49
Commercial business		790		16.45			23.43			906		18.53			17.60			1,097		18.13			12.97
Consumer loans		330		6.88			4.71			293		5.99			4.26			153		2.54			3.56
Total allowance for loan losses	$	4,799		100.00	%		100.00	%	$	4,891		100.00	%		100.00	%	$	6,047		100.00	%		100.00	%

	December 31,
	---------------2007---------------								---------------2006---------------
(Dollars in Thousands)	Amount		% of Allowance in each Category to Total Allowance			% of Loans in each Category to Total Loans			Amount		% of Allowance in each Category to Total Allowance			% of Loans in each Category to Total Loans
Real estate loans
Residential - 1 to 4 family	$	823		15.69	%		55.87	%	$	794		18.19	%		53.65	%
Multi-family and
commercial		1,679		32.01			22.46			1,744		39.95			20.55
Construction		1,653		31.52			6.29			706		16.18			7.73
Commercial business		922		17.57			11.81			783		17.94			13.03
Consumer loans		168		3.21			3.57			338		7.74			5.04
Total allowance for loan losses	$	5,245		100.00	%		100.00	%	$	4,365		100.00	%		100.00	%

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The following table sets forth an analysis of the allowance for loan losses for the years indicated.

	Years Ended December 31,
(Dollars in Thousands)	2010			2009			2008			2007			2006
Allowance at beginning of year	$	4,891		$	6,047		$	5,245		$	4,365		$	3,671
Provision for loan losses		902			2,830			1,369			1,062			881
Charge-offs:
Real estate loans:
Residential - 1 to 4 family		(285	)		(257	)		(80	)		-			-
Multi-family and commercial		(221	)		(149	)		(42	)		(246	)		-
Construction		(293	)		(2,927	)		(41	)		-			-
Commercial business loans		(166	)		(645	)		(359	)		-			-
Consumer loans		(50	)		(97	)		(75	)		(188	)		(199	)
Total charge-offs		(1,015	)		(4,075	)		(597	)		(434	)		(199	)
Recoveries:
Real estate loans:
Residential - 1 to 4 family		1			43			4			4			4
Multi-family and commercial		14			-			-			131			-
Construction		-			-			-			-			-
Commercial business loans		3			37			21			-			2
Consumer loans		3			9			5			117			6
Total recoveries		21			89			30			252			12
Net charge-offs		(994	)		(3,986	)		(567	)		(182	)		(187	)
Allowance at end of year	$	4,799		$	4,891		$	6,047		$	5,245		$	4,365
Ratios:
Allowance to total loans outstanding at year end		0.78	%		0.80	%		0.97	%		0.89	%		0.76	%
Allowance to nonperforming loans		97.44			162.65			64.83			68.72			313.58
Net charge-offs to average loans outstanding during the year		0.16			0.64			0.09			0.03			0.03

The allowance as a percentage of total loans declined to 0.78% at December 31, 2010 compared to 0.80% at December 31, 2009.  The lower provision for 2010 resulted from a reduction in net loan charge-offs, predominately construction loans, offset by an increase in specific loan loss allowances on nonperforming loans.  Higher loan charge-offs for the year ended December 31, 2009 primarily related to two commercial construction loan relationships aggregating $2.9 million.  Specific loan loss allowances relating to impaired loans increased to $502,000 at December 31, 2010 compared to $267,000 at December 31, 2009.  At December 31, 2010, nonperforming loans totaled $4.9 million, compared to $3.0 million at December 31, 2009.   While the Company has no direct exposure to sub-prime mortgages in its loan portfolio, economic conditions have negatively impacted the residential and commercial construction markets and contributed to the decrease in credit quality for commercial loans.

Risk Management

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

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Credit Risk Management. Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. Further, the Company has strengthened its oversight of problem assets by maintaining a Managed Assets Committee. The Committee, which consists of our Chief Executive Officer, Chief Financial Officer and other loan and credit administration officers, meets monthly to review classified and watch list credits to ensure the appropriateness of the current classification and to attempt to identify any new problem loans. The Board of Directors reviews the committee’s reports on a quarterly basis.

Investment Activities

The Company has legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies, government-sponsored enterprises, state and municipal governments, mortgage-backed securities and certificates of deposit of federally-insured institutions. Within certain regulatory limits, the Company also may invest a portion of its assets in corporate securities and mutual funds.  The Company is also required to maintain an investment in FHLB stock. While the Company has the authority under applicable law and its investment policies to invest in derivative securities, the Company had no such investments at December 31, 2010.

The Company’s primary source of income continues to be derived from its loan portfolio.  The investment portfolio is mainly used to meet the cash flow needs of the Company, provide adequate liquidity for the protection of customer deposits and yield a favorable return on investments.  The type of securities and the maturity periods are dependent on the composition of the loan portfolio, interest rate risk, liquidity position and tax strategies of the Company.  The Company’s investment objectives are to provide and maintain liquidity, to maintain a balance of high quality, diversified investments to minimize risk, to provide collateral for pledging requirements, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak, to generate a favorable return and to assist in the financing needs of various local public entities, subject to credit quality review and liquidity concerns.

The Company’s Board of Directors has the overall responsibility for the investment portfolio, including approval of the Company’s Investment Policy and appointment of the Investment Committee.  The Investment Committee is responsible for the approval of investment strategies and monitoring investment performance.  The execution of specific investment initiatives and the day-to-day oversight of the Company’s investment portfolio is the responsibility of the Chief Executive Officer and the Chief Financial Officer.  These officers, and others designated by the Board, are authorized to execute investment transactions up to specified limits based on the type of security without prior approval of the Investment Committee.  Transactions exceeding these limitations require the approval of two of these officers, one of whom must be either the Chief Executive Officer or the Chief Financial Officer.  Individual investment transactions are reviewed and approved by the Board of Directors on a monthly basis, while portfolio composition and performance are reviewed at least quarterly by the Investment Committee.  Management determines the appropriate classification of securities at the date individual securities are acquired, and the appropriateness of such classification is reassessed at each balance sheet date.

Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost.  Securities purchased and held principally for the purpose of trading in the near term are classified as “trading securities.”  These securities are carried at fair value, with unrealized gains and losses recognized in earnings.  Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss), net of taxes.

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At December 31, 2010, the Company’s investment portfolio consisted of available for sale securities, totaling $180.0 million and trading securities totaling $248,000, together representing 19.5% of assets.  The Company’s available for sale securities consisted primarily of “agency” mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae with stated final maturities of 30 years or less, U.S. Government and agency obligations, “private-label” mortgage-backed securities with maturities of 30 years or less and government-sponsored enterprises securities with maturities of 20 years or less and corporate debt securities. The Company’s trading securities consisted solely of collateralized debt obligations.

During the third quarter of 2010, the Company elected to fair value two collateralized debt obligations, previously reported as available for sale securities, and reclassified them to trading securities in accordance with applicable guidance.  These securities had amortized costs of $248,000, $1.7 million and $1.2 million and fair values of $248,000, $739,000 and $1.2 million at December 31, 2010, 2009 and 2008, respectively.  Cumulative unrealized losses at the date of election totaling $652,000 were reclassified from accumulated other comprehensive loss to retained earnings as a cumulative effect adjustment resulting from a change in accounting principle.  The Company does not purchase securities with the intent of selling them in the near term, thus there are no other securities in the trading portfolio.  For the year ended December 31, 2010, the net loss in fair value on trading securities held at the reporting date was $408,000.

The following table sets forth the amortized costs and fair values of the Company’s securities portfolio at the dates indicated.

	December 31,
	2010				2009				2008
(In Thousands)	Amortized		Fair		Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value		Cost		Value
Available for sale securities:
U.S. Government and agency obligations	$	23,399	$	23,583	$	35,945	$	36,229	$	2,453	$	2,415
Government-sponsored enterprises		29,912		29,993		13,980		14,035		25,985		26,587
Mortgage-backed securities: (1)
Agency - residential		84,408		87,370		89,751		93,099		81,383		83,651
Non-agency - residential		11,039		10,455		18,690		16,219		36,347		30,463
Non-agency - HELOC		3,797		3,199		4,328		2,196		3,089		2,816
Corporate debt securities		14,502		14,717		6,979		7,321		5,901		5,958
Collateralized debt obligations		6,466		2,532		8,153		5,038		6,625		5,392
Obligations of state and political subdivisions		6,800		6,905		5,003		5,131		4,000		4,037
Tax-exempt securities		140		144		3,210		3,219		280		280
Foreign government securities		100		100		100		100		100		100
Total debt securities		180,563		178,998		186,139		182,587		166,163		161,699
Equity securities - financial services		1,024		1,038		1,043		975		1,060		1,000
Total available for sale securities		181,587		180,036		187,182		183,562		167,223		162,699
Trading securities:
Collateralized debt obligations		248		248		-		-		-		-
Total securities	$	181,835	$	180,284	$	187,182	$	183,562	$	167,223	$	162,699

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___________

(1) Agency securities refer to debt obligations issued or guaranteed by government corporations or government-sponsored enterprises (“GSEs”).  Non-agency securities, or private-label securities, are the sole obligation of their issuer and are not guaranteed by one of the GSEs or the U.S. Government.

The Company had no individual investments that had an aggregate book value in excess of 10% of its shareholders’ equity at December 31, 2010.

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The following table sets forth the amortized cost, weighted-average yields and contractual maturities of securities at December 31, 2010.  Weighted-average yields on tax-exempt securities are not presented on a tax equivalent basis because the impact would be insignificant.  Certain mortgage-backed securities and collateralized debt obligations have adjustable interest rates and will reprice periodically within the various maturity ranges.  These repricing schedules are not reflected in the table below.  At December 31, 2010, the amortized cost of mortgage-backed securities with adjustable rates totaled $28.8 million.

						More than One Year					More than Five Years
	One Year or Less					to Five Years					to Ten Years					More than Ten Years					Total
(Dollars in Thousands)	Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield
Available for sales securities:
U.S. Government and agency obligations	$	-		0.00	%	$	1,698		2.30	%	$	7,321		2.90	%	$	14,380		3.10	%	$	23,399		2.98	%
Government-sponsored enterprises		2,000		3.37			24,993		1.95			2,919		2.57			-		0.00			29,912		2.11
Mortgage-backed securities:
Agency - residential		-		0.00			4,619		3.79			16,579		4.59			63,210		3.89			84,408		4.02
Non-agency - residential		-		0.00			-		0.00			-		0.00			11,039		5.14			11,039		5.14
Non-agency - HELOC		-		0.00			-		0.00			-		0.00			3,797		1.01			3,797		1.01
Corporate debt securities		495		2.56			10,172		2.73			2,835		3.23			1,000		4.82			14,502		2.96
Collateralized debt obligations		-		0.00			-		0.00			-		0.00			6,466		1.48			6,466		1.48
Obligations of state and
political subdivisions		-		0.00			5,530		4.27			770		3.19			500		4.37			6,800		4.16
Tax-exempt securities		70		3.87			70		3.87			-		0.00			-		0.00			140		3.87
Foreign government securities		50		2.38			50		2.39			-		0.00			-		0.00			100		2.39
Total debt securities		2,615					47,132					30,424					100,392					180,563
Equity securities - financial services		-		0.00			-		0.00			-		0.00			1,024		2.38			1,024		2.38
Total available for sale securities		2,615		3.21			47,132		2.59			30,424		3.83			101,416		3.65			181,587		3.40
Trading securities:
Collateralized debt obligations		-		-			-		-			-		-			248		1.11			248		1.11
Total securities	$	2,615		3.21	%	$	47,132		2.59	%	$	30,424		3.83	%	$	101,664		3.64	%	$	181,835		3.40	%

During 2009, the Company adopted new guidance regarding recognition and presentation of other-than-temporary impairments(“OTTI”) which makes the guidance more operational and improves the presentation and disclosure of OTTI on debt and equity securities in the financial statements.  This guidance does not amend existing recognition and measurement guidance related to OTTI of equity securities.

Each reporting period, the Company evaluates all securities classified as available for sale or held to maturity with a decline in fair value below the amortized cost of the investment to determine whether or not the impairment is deemed to have OTTI. The evaluation is based upon factors such as the creditworthiness of the issuers/guarantors, the underlying collateral, if applicable, and the continuing performance of the securities.  Management also evaluates other facts and circumstances that may be indicative of an OTTI condition.  This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost and near-term prospects of the issuers.  OTTI is required to be recognized (1) if the Company intends to sell the security; (2) if it is “more likely than not” that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, if the present value of expected cash flows is not sufficient to recover the entire amortized cost basis.

Marketable equity securities are evaluated for OTTI based on the severity and duration of the impairment and, if deemed to be other-than-temporary, the declines in fair value are reflected in earnings as realized losses.  For all impaired securities that the Company intends to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI through earnings.  Credit-related OTTI for all other impaired debt securities is recognized through earnings and noncredit-related OTTI is recognized in other comprehensive income (loss), net of applicable taxes.  The adoption of this new guidance resulted in a cumulative effect adjustment of $2.7 million (net of taxes) to retained earnings with a corresponding adjustment to accumulated other comprehensive loss on January 1, 2009.  During 2010, the Company recognized additional OTTI for credit losses on debt securities of $492,000.  See Notes 3 and 15 in the Company’s Consolidated Financial Statements included in the Company’s Annual Report to Shareholders, attached hereto as Exhibit 13, for more details.

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Deposit Activities and Other Sources of Funds

General.  Deposits, other borrowings, repayments and sale of loans and investment securities are the major sources of the Company’s funds for lending and other investment purposes.  Loan and investment security repayments are a relatively stable source of funds, while deposit inflows and loan and investment security prepayments are significantly influenced by general interest rates and money market conditions.

Deposit Accounts.  Substantially all of the Bank’s depositors are residents of the State of Connecticut.  The Bank attracts deposits in its market areas through advertising and through the offering of a broad selection of deposit instruments, including noninterest-bearing demand accounts (such as checking accounts), interest-bearing accounts (such as NOW and money market accounts, regular savings accounts and certificates of deposit).  CDARS deposits, which are generally offered to in-market retail and commercial customers, offer our customers the ability to receive Federal Deposit Insurance Corporation insurance on deposits up to $50.0 million.  The Bank also utilizes brokered deposits, which were $4.1 million at December 31, 2010, $2.1 million of which were CDARS deposits.   Brokered deposits, which are deposits sold by brokers to banks, are generally out-of-market, thus, they are less likely to remain with the institution after their maturity, which may require us to replace these deposits with higher cost alternative funds.  Also, because they generally have larger balances, they often are accompanied by a higher interest rate.  The Bank does not currently utilize brokered deposits as a primary funding source.  Rather, the Bank occasionally maintains a minimal amount of such deposits to ensure access to another liquidity source should the need arise.  Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rates, among other factors.  In determining the terms of the Bank’s deposit accounts, the Bank considers the rates offered by its competition, liquidity needs, profitability, matching deposit and loan products and customer preferences and concerns.  The Bank generally reviews its deposit mix and pricing weekly.  The Bank’s current strategy is to offer competitive rates, but not be the market leader in every account type and maturity.

The following table sets forth the distribution of the Bank’s deposit accounts for the dates indicated.

	December 31,
	2010					2009					2008
			% of					% of					% of
(Dollars in Thousands)	Balance		Total			Balance		Total			Balance		Total
Noninterest-bearing demand deposits	$	66,845		10.06	%	$	65,407		9.87	%	$	57,647		9.23	%
NOW and money market accounts		247,811		37.31			220,759		33.33			187,699		30.07
Savings accounts (1)		59,920		9.03			64,903		9.80			64,119		10.27
Certificates of deposit (2)		289,563		43.60			311,309		47.00			314,811		50.43
Total deposits	$	664,139		100.00	%	$	662,378		100.00	%	$	624,276		100.00	%

___________

(1) Includes mortgagors’ and investors’ escrow accounts in the amount of $3.4 million, $3.6 million and $3.6 million at December 31, 2010, 2009 and 2008, respectively.

(2) Includes brokered deposits of $4.1 million, $1.5 million and $4.5 million at December 31, 2010, 2009 and 2008, respectively.

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The Bank had $99.5 million of certificates of deposit of $100,000 or more outstanding as of December 31, 2010, maturing as follows:

(Dollars in Thousands)	Amount		Weighted Average Rate
Maturity Period:
Three months or less	$	15,542		2.00	%
Over three through six months		6,954		1.81
Over six through twelve months		13,593		2.23
Over twelve months		63,428		2.41
Total	$	99,517		2.28	%

The following table sets forth certificates of deposit accounts classified by the rates at December 31, 2010.

(Dollars in Thousands)	Less Than One Year		One to Two Years		Two to Three Years		Three to Four Years		More than Four Years		Total		Percent of Total Certificate Accounts
0.20 - 1.00%	$	50,728	$	9,839	$	222	$	-	$	-	$	60,789		20.99	%
1.01 - 2.00%		31,170		34,747		4,411		776		8		71,112		24.56
2.01 - 3.00%		10,104		18,499		51,726		2,302		19,421		102,052		35.24
3.01 - 4.00%		20,249		390		1,338		8,761		2,809		33,547		11.59
4.01 - 5.00%		10,868		3,285		5,702		67		403		20,325		7.02
5.01 - 5.38%		1,213		250		275		-		-		1,738		0.60
Total	$	124,332	$	67,010	$	63,674	$	11,906	$	22,641	$	289,563		100.00	%

Cash Management Services.  The Bank offers a variety of deposit accounts designed for the businesses operating in its market area.  The Bank’s business banking deposit products include a commercial checking account and checking accounts specifically designed for small businesses and non-profit organizations.  The Bank also offers remote capture products for business customers to meet their online banking needs.  Additionally, the Bank offers sweep accounts and money market accounts for businesses.  The Bank is seeking to increase its commercial deposits through the offering of these types of cash management products.

FHLB Borrowings.  The Bank utilizes advances from the FHLB to supplement its supply of lendable funds and to meet deposit withdrawal requirements.  As of December 31, 2010, the Bank had outstanding borrowings with the FHLB of $114.2 million.

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

Junior Subordinated Debt Owed to Unconsolidated Trust.  In 2006, SI Capital Trust II (the “Trust”), a business trust, issued $8.0 million of trust preferred securities in a private placement and issued approximately 248 shares of common stock at $1,000 par value to the Company.  The Trust has no independent assets or operations and was formed to issue trust preferred securities and invest the proceeds in an equivalent amount of junior subordinated debentures issued by the Company.  The trust preferred securities mature in 30 years and bear interest at three-month LIBOR plus 1.70%.  The interest rate on these securities at December 31, 2010 was 2.00%.  The Company may redeem the trust preferred securities, in whole or in part, on or after September 15, 2011, or earlier under certain conditions.

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On July 1, 2010, the Company entered into an interest rate swap agreement with a third-party financial institution with a notional amount of $8.0 million whereby the counterparty will pay a variable rate equal to three-month LIBOR and the Company will pay a fixed rate of 2.44%.  The agreement became effective on December 15, 2010 and terminates on December 15, 2015.  This agreement was designated as a cash flow hedge against the trust preferred securities issued by the Trust.  This effectively fixes the interest rate on the $8.0 million of trust preferred securities at 4.14% for the period December 15, 2010 through December 15, 2015.

The debentures are the sole assets of the Trust and are subordinate to all of the Company’s existing and future obligations for borrowed money, its obligations under letters of credit and certain derivative contracts and any guarantees by the Company of any such obligations.  The trust preferred securities generally rank equal to the trust common securities in priority of payment, but rank before the trust common securities if and so long as the Company fails to make principal or interest payments on the debentures.  Concurrently with the issuance of the debentures and the trust preferred and common securities, the Company issued a guarantee related to the trust securities for the benefit of the holders.  The Company’s obligations under the guarantee and the Company’s obligations under the debentures, the related indentures and the trust agreement relating to the trust securities, constitute a full and unconditional guarantee by the Company of the obligations of the Trust under the trust preferred securities.  If the Company defers interest payments on the junior subordinated debt, or otherwise is in default of the obligations, the Company would be prohibited from making dividend payments to its shareholders.

The debentures are also subject to redemption before September 15, 2011, at a specified price after the occurrence of certain events that would either have a negative tax effect on the Trust or the Company or would result in the Trust being treated as an investment company that is required to be registered under the Investment Company Act of 1940. Upon repayment of the debentures at their stated maturity or following their redemption, the Trust will use the proceeds of such repayment to redeem an equivalent amount of outstanding trust preferred securities and trust common securities.

Other Borrowings.  The Company occasionally utilizes collateralized borrowings, which represent loans sold that do not meet the criteria for derecognition, due primarily to recourse and other provisions that could not be measured at the date of transfer.  Such borrowings are derecognized when all recourse and other provisions that could not be measured at the time of transfer either expire or become measurable.  The Company had no collateralized borrowings at December 31, 2010.

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The following table sets forth information regarding the Company’s borrowings at and for the years indicated.

	At or For the Years Ended December 31,
(Dollars in Thousands)	2010			2009			2008
Maximum amount of advances outstanding at any month-end during the year:
FHLB advances	$	121,100		$	143,600		$	147,664
Subordinated debt		8,248			8,248			8,248
Average balance outstanding during the year:
FHLB advances	$	115,152		$	131,460		$	143,697
Subordinated debt		8,248			8,248			8,248
Weighted average interest rate during the year:
FHLB advances		3.66	%		4.15	%		4.40	%
Subordinated debt		2.10			2.63			4.81
Balance outstanding at end of year:
FHLB advances	$	114,169		$	116,100		$	139,600
Subordinated debt		8,248			8,248			8,248
Weighted average interest rate at end of year:
FHLB advances		3.63	%		3.61	%		4.24	%
Subordinated debt		4.14			1.95			3.70

Trust Services

The Bank’s trust department provides fiduciary services, investment management and retirement services, to individuals, partnerships, corporations and institutions.  Additionally, the Bank acts as guardian, conservator, executor or trustee under various trusts, wills and other agreements.  The Bank has implemented comprehensive policies governing the practices and procedures of the trust department, including policies relating to investment of trust property, maintaining confidentiality of trust records, avoiding conflicts of interest and maintaining impartiality.  Consistent with its operating strategy, the Bank will continue to emphasize the growth of its trust business to accumulate assets and increase fee-based income.  At December 31, 2010, trust assets under administration were $143.0 million, consisting of 296 accounts, the largest of which totaled $10.5 million, or 7.3%, of the trust department’s total assets.  SI Trust Servicing, a third-party provider of trust outsourcing services for community banks, expands the wealth management products offered by the Bank, and offers trust services to other community banks.  As of December 31, 2010, SI Trust Servicing provided trust outsourcing services to 14 clients, consisting of 6,906 accounts totaling $6.1 billion in assets.  For the years ended December 31, 2010 and 2009, total trust services revenue was $3.9 million and $3.7 million, respectively.

Subsidiary Activities

The Company’s subsidiaries include Savings Institute Bank and Trust Company and SI Capital Trust II.

The following are descriptions of the Bank’s wholly-owned subsidiaries.

803 Financial Corp.  803 Financial Corp. was established in 1995 as a Connecticut corporation to maintain an ownership interest in a third-party registered broker-dealer, Infinex Investments, Inc.  Due to a regulatory restriction on federally-chartered thrifts, on December 31, 2004, 803 Financial Corp. sold its interest in Infinex to the Company.  As a result, 803 Financial Corp. has no other holdings or business activities.

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SI Realty Company, Inc.   SI Realty Company, Inc., established in 1999 as a Connecticut corporation, holds real estate owned by the Bank, including foreclosure properties.  At December 31, 2010, SI Realty Company, Inc. had $4.1 million in assets.

SI Mortgage Company.  In January 1999, the Bank formed SI Mortgage Company to manage and hold loans secured by real property.  SI Mortgage Company qualifies as a “passive investment company,” which exempts it from Connecticut income tax under current law.  Income tax savings to the Bank from the use of a passive investment company was $207,000 and $2,000 for the years ended December 31, 2010 and 2009, respectively.

Personnel

At December 31, 2010, the Company had 237 full-time employees and 38 part-time employees.  None of the Company’s employees are represented by a collective bargaining unit.  The Company believes its relationship with its employees is good.

REGULATION AND SUPERVISION

General

The Bank is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as the insurer of its deposits.  The Bank is a member of the Federal Home Loan Bank System and its deposit accounts are insured up to applicable limits by the Deposit Insurance Fund managed by the FDIC.  The Bank must file reports with the OTS concerning its activities and financial condition in addition to obtaining regulatory approvals before entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS to evaluate the Bank’s safety and soundness and compliance with various regulatory requirements. This regulatory structure is intended primarily for the protection of the insurance fund and depositors.  The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan losses for regulatory purposes.  Any change in such policies, whether by the OTS, the FDIC or Congress, could have a material adverse impact on the Company and the Bank and their operations.  The Company, as a savings and loan holding company, will be required to file certain reports with, is subject to examination by, and otherwise must comply with the rules and regulations of the OTS.  The Company is also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.

Certain of the regulatory requirements that are applicable to the Bank and the Company are described below.  This description of statutes and regulations is not intended to be a complete explanation of such statutes and regulations and their effects on the Bank and the Company and is qualified in its entirety by reference to the actual statutes and regulations.

Regulatory Reform Legislation

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), signed by the President on July 21, 2010, provides for the regulation and supervision of federal savings institutions like the Bank to be transferred from the OTS to the Office of the Comptroller of the Currency, the agency that regulates national banks.  The Office of the Comptroller of the Currency will assume primary responsibility for examining the Bank and implementing and enforcing many of the laws and regulations applicable to federal savings institutions.  The OTS will be eliminated.  The transfer will occur one year from the July 21, 2010 enactment of the Dodd-Frank Act, subject to a possible six month extension.  At the same time, the responsibility for supervising and regulating savings and loan holding companies will be transferred to the Federal Reserve Board, which currently supervises bank holding companies.  The Dodd-Frank Act also provides for the creation of a new agency, the Consumer Financial Protection Bureau, as an independent bureau of the Federal Reserve Board, to take over the implementation of federal consumer financial protection and fair lending laws from the depository institution regulators.  However, institutions of $10.0 billion or fewer in assets will continue to be examined for compliance with such laws and regulations by, and subject to the primary enforcement authority of, the prudential regulator rather than the Consumer Financial Protection Bureau.

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In addition to eliminating the OTS and creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, requires changes in the way that institutions are assessed for deposit insurance, mandates the imposition of consolidated capital requirements on savings and loan holding companies, requires that originators of securitized loans retain a percentage of the risk for the transferred loans, directs the Federal Reserve Board to regulate pricing of certain debit card interchange fees, reduces the federal preemption afforded to federal savings associations and contains a number of reforms related to mortgage originations.  Many of the provisions of the Dodd-Frank Act contain delayed effective dates and/or require the issuance of regulations.  As a result, it will be some time before their impact on operations can be assessed by management.  However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in an increased regulatory burden and higher compliance, operating and possibly interest costs for the Company and the Bank.

Federal Banking Regulation

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

The Dodd-Frank Act authorizes the payment of interest on commercial checking accounts, effective July 21, 2011.

Capital Requirements.  The OTS’s capital regulations require savings associations to meet three minimum capital standards:

o a tangible capital ratio requirement of 1.5% of adjusted total assets;

o a leverage ratio of 4% of Tier 1 (core) capital to adjusted total assets (3% for institutions that are not anticipating or experiencing significant growth and have well diversified risk; i.e., generally, the highest examination rating); and

o a risk-based capital ratio requirement of 8% of total capital (core and supplementary capital) to total risk-weighted assets of which at least half must be core capital

In addition, the prompt corrective action standards discussed below also established, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.

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

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The OTS also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular risks or circumstances. At December 31, 2010, the Bank met each of its capital requirements.

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

In addition to the increase in capital requirements set forth in the Dodd-Frank Act, Federal bank regulators have the authority to impose higher capital requirements on an individual bank basis. These requirements may be greater than those set forth in the Dodd-Frank Act or that would qualify a bank as being “well capitalized” under the FDIC’s prompt corrective action regulations. If the Company or the Bank were to become subject to higher individual capital requirements, such action may have a negative impact on their ability to execute their business plans, as well as their ability to grow, pay dividends or engage in mergers and acquisitions and may result in restrictions in their operations.

Insurance of Deposit Accounts.  The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC.  Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments.  An institution’s assessment rate depends upon the category to which it is assigned and certain adjustments specified by FDIC regulations.   Assessment rates range from 7 to 77.5 basis points.  The Dodd-Frank Act requires the FDIC to amend its procedures to base assessments on total assets less tangible equity rather than deposits.

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On February 7, 2011, the FDIC issued final rules, effective April 1, 2011, implementing changes to the assessment rules resulting from the Dodd-Frank Act.  Initially, the base assessment rates will range from 2.5 to 45 basis points.  The rate schedules will automatically adjust in the future when the Deposit Insurance Fund reaches certain milestones.

The FDIC may adjust the scale uniformly from one quarter to the next, except that no adjustment can deviate more than three basis points from the base scale without notice and comment.  No institution may pay a dividend if in default of the federal deposit insurance assessment.

The FDIC imposed on all insured institutions, a special emergency assessment of five basis points of total assets minus Tier 1 capital, as of June 30, 2009 (capped at ten basis points of an institution’s deposit assessment base), in order to cover losses to the Deposit Insurance Fund.  That special assessment was collected on September 29, 2009.  The FDIC provided for similar assessments during the final two quarters of 2009, if deemed necessary.  However, in lieu of further special assessments, the FDIC required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 through the fourth quarter of 2012.  The estimated assessments, which included an assumed annual assessment base increase of 5%, were recorded as a prepaid expense asset as of December 31, 2009.  As of December 31, 2009, and each quarter thereafter, a charge to earnings is recorded for each regular assessment with an offsetting credit to the prepaid asset.

Due to the recent difficult economic conditions, deposit insurance per account owner has been raised to $250,000.  That coverage was made permanent by the Dodd-Frank Act.  In addition, the FDIC adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010, subsequently extended to December 31, 2010, and certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and October 31, 2009 would be guaranteed by the FDIC through June 30, 2012, or in some cases, December 31, 2012.  The Bank participates in the unlimited noninterest-bearing transaction account coverage; the Bank and the Company optednotto participate in the unsecured debt guarantee program.  The Dodd-Frank Act extended the unlimited coverage for certain noninterest-bearing transactions accounts through December 31, 2012 without the opportunity for opt out.

In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund.  This payment is established quarterly and during the calendar year ended December 31, 2010 averaged 1.02 basis points of assessable deposits.

The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10.0 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC and the FDIC has recently exercised that discretion by establishing a long range fund ratio of 2.0%.

The FDIC has the authority to increase insurance assessments.  A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank.  Management cannot predict what insurance assessment rates will be in the future.

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

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Loans to One Borrower.  Federal law provides that savings associations are generally subject to the limits on loans to one borrower applicable to national banks.  Generally, subject to certain exceptions, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral. See Item 1. Business. “Lending Activities – Loans to One Borrower.”

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

A savings association that fails the qualified thrift lender test is subject to certain operating restrictions.  The Dodd-Frank Act subjects violations of the qualified thrift lender requirements to possible enforcement action for violation of the law.  As of December 31, 2010, the Bank maintained 71.65% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test.

Limitation on Capital Distributions.  Federal regulations impose limitations upon all capital distributions by a savings association, 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 OTS is required before any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under OTS regulations (i.e., generally, examination and Community Reinvestment Act ratings in the two top 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 the OTS.  If an application is not required, the institution must still provide prior notice to the OTS of the capital distribution if, like the Bank, it is a subsidiary of a holding company.  If the Bank’s capital ever fell below its regulatory requirements or the OTS notified it that it was in need of increased supervision, its ability to make capital distributions could be restricted.  In addition, the OTS could prohibit a proposed capital distribution, which is otherwise permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice.

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

Community Reinvestment Act.  All federal savings associations have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income neighborhoods.  An institution’s failure to comply with the provisions of the Community Reinvestment Act could result in denials of applications for transactions such as mergers, acquisitions and branches.  The Bank received an “outstanding” Community Reinvestment Act rating in its most recently completed examination.  The responsibility for implementing the Community Reinvestment Act is not being transferred to the new Consumer Financial Protection Bureau but rather is remaining with the prudential regulators.

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

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

Enforcement.  The OTS currently has primary enforcement responsibility over federal savings associations and has authority to bring actions against the institution and all institution-affiliated parties, including shareholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful actions likely to have an adverse effect on an insured institution.  Formal enforcement action may range from the issuance of a capital directive or cease and desist order for removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance.  Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1.0 million per day in especially egregious cases.  The FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings institution.  If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances.  Federal law also establishes criminal penalties for certain violations.  The OTS’s enforcement authority will transfer to the Office of the Comptroller of the Currency under the Dodd-Frank Act regulatory restructuring.

Assessments.  Savings associations are required to pay assessments to the OTS to fund the agency’s operations. The general institution (and savings and loan holding companies) assessment, paid on a semi-annual basis, is computed based upon the savings association’s (including consolidated subsidiaries) total assets, financial condition and complexity of its business.  The OTS assessments paid by the Bank for 2010 were $234,000.  The Office of the Comptroller of the Currency similarly assesses its regulated institutions to fund its operations.

Federal Home Loan Bank System.  The Bank is a member of the Federal Home Loan Bank System, which consists of twelve regional Federal Home Loan Banks.  The Federal Home Loan Banks provide a central credit facility primarily for member institutions.  The Bank, as a member of the FHLB, is required to acquire and hold shares of capital stock in the FHLB of Boston.  The Bank was in compliance with this requirement with an investment in FHLB stock at December 31, 2010 of $8.4 million.

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The Federal Home Loan Banks have been required to provide funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. Such requirements, and general financial condition, affect the amount of dividends that the Federal Home Loan Banks pay to their members and the rate of interest that the Federal Home Loan Banks impose on advances to their members.

Federal Reserve System. The Federal Reserve Board regulations require savings associations to maintain noninterest-earning reserves against their transaction accounts (primarily Negotiable Order of Withdrawal “NOW” and regular checking accounts).  For 2010, the regulations generally provide that reserves be maintained against aggregate transaction accounts as follows:  a 3% reserve ratio is assessed on net transaction accounts up to and including $55.2 million; a 10% reserve ratio is applied above $55.2 million.  The first $10.7 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements.  The amounts are adjusted annually and, for 2011, require a 3.0% ratio for up to $58.8 million and an exemption of $10.7 million.  The Bank complies with the foregoing requirements.

Other Regulations

The Bank’s operations are also subject to federal laws applicable to credit transactions, such as, but not limited to, the:

o Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

o Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

o Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

o Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

o Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

The operations of the Bank also are subject to the:

o Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumers’ financial records and prescribes procedures for complying with administrative subpoenas of financial records;

o Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and

o Check Clearing for the 21st Century Act (also known as “Check 21"), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check.

Holding Company Regulation

General.  The Company is a unitary savings and loan holding company within the meaning of federal law. As such, it is registered with the OTS and is subject to OTS regulations, examinations, supervision, reporting requirements and regulations.  In addition, the OTS has enforcement authority over the Company and its non-savings institution subsidiaries.  Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the Bank.  The Dodd-Frank Act added that any savings and loan holding company that engages in activities permissible for a financial holding company must meet the qualitative requirements for a bank holding company to be a financial holding company and conducts the activities in accordance with the requirements that would apply to a financial holding company’s conduct of the activity.

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As part of the Dodd-Frank Act regulatory restructuring, the OTS’s authority over savings and loan holding companies will be transferred to the Federal Reserve Board, which is the agency that regulates and supervises bank holding companies.

A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings association or savings and loan holding company, without prior regulatory approval, and from acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings associations, factors considered include, among other things, the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive effects.

No acquisition may be approved that would result in a multiple savings and loan holding company controlling savings associations in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings association in another state if the laws of the state of the target savings association specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves.  Instruments such as cumulative preferred stock and trust preferred securities will no longer be includable as Tier 1 capital as is currently the case with bank holding companies.  Instruments issued by May 19, 2010 will be grandfathered for companies with consolidated assets of $15.0 billion or less.  There is a five-year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the capital requirements will apply to savings and loan holding companies.

The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies.  The regulatory agencies must issue regulations requiring that all banks and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.

The Bank must notify the OTS thirty days before declaring any dividend to the Company.  The financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the OTS and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.

Acquisition of Control.  Under the federal Change in Bank Control Act, a notice must be submitted to the OTS if any person (including a company), or group acting in concert, seeks to acquire “control” of a savings and loan holding company or savings association. An acquisition of “control” can occur upon the acquisition of 10% or more of the voting stock of a savings and loan holding company or savings institution or as otherwise defined by the OTS. Under the Change in Bank Control Act, the OTS has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control would then be subject to regulation as a savings and loan holding company.

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Federal Securities Laws

The Company’s common stock is registered with the SEC under the Securities Exchange Act of 1934. As a result, the Company files quarterly and annual reports with the SEC and is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act. Upon completion of the conversion and offering, the Company’s common stock will be registered with the SEC under the Securities Exchange Act. As a result, the Company will be required to file quarterly and annual reports with the SEC and will be subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act.

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Federal Income Taxation

General. The Company reports its income on a calendar year basis using the accrual method of accounting.  The federal income tax laws apply to the Company in the same manner as to other corporations with some exceptions, including particularly the Bank’s reserve for bad debts discussed below.  The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Company and its subsidiaries.  With limited exception, the Company is no longer subject to United States federal, state and local income tax examinations by the tax authorities for the years prior to 2007.  The Company’s maximum federal income tax rate was 34.0% for 2010.

Bad Debt Reserves.  For fiscal years beginning before June 30, 1996, thrift institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve.  A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method.  The reserve for nonqualifying loans was computed using the experience method.  Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts for institutions with assets in excess of $500.0 million and the percentage of taxable income method for all institutions for tax years beginning after 1995 and required savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves.  However, those tax-based bad debt reserves accumulated prior to 1988 (“Base Year Reserves”) were not required to be recaptured unless the institution failed certain tests.  Approximately $3.7 million of the Bank’s accumulated tax-based bad debt reserves would not be recaptured into taxable income unless it makes a “non-dividend distribution” to the Company as described below.

Distributions.  If the Bank makes “non-dividend distributions” to the Company, the distributions will be considered to have been made from the Bank’s unrecaptured tax-based bad debt reserves, including the balance of its Base Year Reserves as of December 31, 1987, to the extent of the “non-dividend distributions,” and then from the Bank’s supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves, will be included in the Bank’s taxable income.  Non-dividend distributions include distributions in excess of the Bank’s current and accumulated earnings and profits as calculated for federal income tax purposes, distributions in redemption of stock and distributions in partial or complete liquidation.  Dividends paid out of the Bank’s current or accumulated earnings and profits will not be so included in the Bank’s taxable income.

The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if the Bank makes a non-dividend distribution to the Company, approximately one and one-half times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 34% federal corporate income tax rate.  The Bank does not intend to pay non-dividend distributions that would result in a recapture of any portion of its bad debt reserves.

State Income Taxation

The Company and its subsidiaries are subject to the Connecticut corporation business tax.  The Company and its subsidiaries are eligible to file a combined Connecticut income tax return and pay the regular corporation business tax.  The Connecticut corporation business tax is based on the federal taxable income before net operating loss and special deductions of the Company and its subsidiaries and makes certain modifications to federal taxable income to arrive at Connecticut taxable income.  Connecticut taxable income is multiplied by the state tax rate (7.5% for fiscal year 2010) to arrive at Connecticut income tax.

In May 1998, the State of Connecticut enacted legislation permitting the formation of passive investment company subsidiaries by financial institutions.  This legislation exempts qualifying passive investment companies from the Connecticut corporation business tax and excludes dividends paid from a passive investment company from the taxable income of the parent financial institution.  The Bank’s formation of a passive investment company in January 1999 substantially eliminates the state income tax expense of the Company and its subsidiaries under current law.  See Item 1. Business.  “Subsidiary Activities – SI Mortgage Company” for a discussion of the Bank’s passive investment company.

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Executive Officers of the Registrant

Our executive officers are elected by the Board of Directors and serve at the Board’s discretion.  Certain executive officers of the Bank also serve as executive officers of the Company.  The day-to-day management duties of the executive officers of the Company and the Bank relate primarily to their duties as to the Bank.  The executive officers of the Company currently are as follows:

Name	Age (1)	Position
Rheo A. Brouillard	56	President and Chief Executive Officer of Savings Institute Bank and Trust Company and SI Financial Group
Brian J. Hull	50	Executive Vice President, Chief Financial Officer and Treasurer of Savings Institute Bank and Trust Company and SI Financial Group
David T. Weston	48	Senior Vice President and Senior Trust Officer of Savings Institute Bank and Trust Company
William E. Anderson, Jr.	41	Senior Vice President and Retail Banking Officer of Savings Institute Bank and Trust Company
Laurie L. Gervais	46	Senior Vice President and Director of Human Resources of Savings Institute Bank and Trust Company
Michael J. Moran	62	Senior Vice President and Senior Credit Officer of Savings Institute Bank and Trust Company

___________

(1) Ages presented are as of December 31, 2010.

Biographical Information:

Rheo A. Brouillardhas been the President and Chief Executive Officer of Savings Institute Bank and Trust Company and SI Financial Group since 1995 and 2004, respectively.  Mr. Brouillard has been a director of the Company since 1995.

Brian J. Hullhas been Executive Vice President since 2002 and Chief Financial Officer and Treasurer since he joined Savings Institute Bank and Trust Company in 1997.  Mr. Hull has served as Chief Financial Officer and Treasurer of Savings Institute Bank and Trust Company and SI Financial Group since 2000 and 2004, respectively.

David T. Weston has been Senior Vice President and Senior Trust Officer since 2008.  Mr. Weston oversees wealth management services, which includes trust, investment and insurance operations.  Mr. Weston served as a Vice President within Savings Institute Bank and Trust Company’s Trust Department since 2004.

William E. Anderson, Jr. was named Senior Vice President in 2009 after having served as Vice President since 2002.  Mr. Anderson joined Savings Institute Bank and Trust Company in 1995.

Laurie L. Gervaiswas named Senior Vice President in 2009 after having served as Vice President since 2003.  Ms. Gervais serves as Senior Vice President and Corporate Secretary for SI Financial Group.  Ms. Gervais joined Savings Institute Bank and Trust Company in 1983.

Michael J. Moran has been Senior Vice President and Senior Credit Officer since 2008 and previously held this position from 1998 through 2006.  Mr. Moran served as Senior Vice President and Senior Commercial Real Estate Officer from January 2007 until November 2008.  Mr. Moran joined Savings Institute Bank and Trust Company in 1995.

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Item 1A.  Risk Factors.

Prospective investors in the Company’s common stock should carefully consider the following factors.

o The economic recession could result in increases in the Bank’s level of nonperforming loans and/or reduce demand for its products and services, which would lead to lower revenue, higher loan losses and lower earnings.

Our business activities and earnings are affected by general business conditions in the United States and in our local market area. These conditions include short-term and long-term interest rates, inflation, unemployment levels, real estate values, monetary supply, consumer confidence and spending, fluctuations in both debt and equity capital markets, and the strength of the economy in the United States generally and in our market area in particular. The national economy has recently experienced a recession, with rising unemployment levels, declines in real estate values and an erosion in consumer confidence. Dramatic declines in the U.S. housing market over the past few years, with falling home prices and increasing foreclosures, have negatively affected the credit performance of mortgage loans and resulted in significant write-downs of asset values by many financial institutions. Our local economy has mirrored the overall economy. A prolonged or more severe economic downturn, continued elevated levels of unemployment, further declines in the values of real estate, or other events that affect household and/or corporate incomes could impair the ability of our borrowers to repay their loans in accordance with their terms. Nearly all of our loans are secured by real estate or made to businesses in the counties in which we have offices in Connecticut. As a result of this concentration, a prolonged or more severe downturn in the local economy could result in significant increases in nonperforming loans, which would negatively impact our interest income and result in higher provisions for loan losses, which would hurt our earnings. The economic downturn could also result in reduced demand for credit, which would hurt our revenues.

o The Bank’s level of nonperforming loans and classified assets expose it to increased risk of loss. Further, the allowance for loan losses may prove to be insufficient to absorb losses in the Bank’s loan portfolio.

At December 31, 2010, loans that were classified as either special mention, substandard, doubtful or loss totaled $36.1 million, representing 5.9% of total loans, including nonperforming loans of $4.9 million, representing 0.80% of total loans. If these loans do not perform according to their terms and the value of the collateral is insufficient to pay the remaining loan balance or if the economy and/or the real estate market continues to weaken, we could experience loan losses or be required to add further reserves to our allowance for loan losses, either of which could have a material adverse effect on our operating results. Like all financial institutions, we maintain an allowance for loan losses at a level representing management’s best estimate of known losses in the portfolio based upon management’s evaluation of the portfolio’s collectibility as of the corresponding balance sheet date. However, our allowance for loan losses may be insufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results.

At December 31, 2010, our allowance for loan losses totaled $4.8 million, which represented 0.78% of total loans and 97.44% of nonperforming loans. Our regulators, as an integral part of their examination process, periodically review the allowance for loan losses and may require us to increase the allowance for loan losses by recognizing additional provisions for loan losses charged to income, or to charge-off loans, which, net of any recoveries, would decrease the allowance for loan losses. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our operating results.

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o The Bank’s commercial lending exposes us to lending risks.

At December 31, 2010, $302.8 million, or 49.7%, of our loan portfolio consisted of commercial real estate and commercial business loans. We intend to continue to emphasize these types of lending. Commercial loans generally expose a lender to greater risk of non-payment and loss than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the business and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan.

o The Bank’s emphasis on residential mortgage loans and home equity loans exposes it to lending risks.

At December 31, 2010, $270.9 million, or 44.5%, of our loan portfolio consisted of one- to four-family residential mortgage loans and $25.5 million, or 4.2%, of our loan portfolio consisted of home equity lines of credit. Recent declines in the housing market have resulted in declines in real estate values in our market areas. These declines in real estate values could cause some of our mortgage and home equity loans to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by selling the real estate collateral.

o The Company’s investment portfolio may suffer reduced returns, material losses or other-than-temporary impairment losses.

During an economic downturn, our investment portfolio could be subject to higher risk. The value of our investment portfolio is subject to the risk that certain investments may default or become impaired due to a deterioration in the financial condition of one or more issuers of the securities held in our portfolio, or due to a deterioration in the financial condition of an issuer that guarantees an issuer’s payments of such investments. Such defaults and impairments could reduce our net investment income and result in realized investment losses.

Our investment portfolio is also subject to increased risk as the valuation of investments is more subjective when markets are illiquid, thereby increasing the risk that the estimated fair value (i.e. the carrying amount) of the portion of the investment portfolio that is carried at fair value as reflected in our financial statements is not reflective of prices at which actual transactions would occur.

Because of the risks set forth above, the value of our investment portfolio could decrease, we could experience reduced net investment income, and we could recognize investment losses, which could materially and adversely affect our results of operations, financial position and liquidity.

Additionally, we review our securities portfolio at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of our equity securities has declined below its carrying value, we are required to assess whether the decline is other-than-temporary. We are required to write-down the value of that security through a charge to earnings if we conclude that the decline is other-than-temporary. In the case of debt securities, we are required to charge to earnings any decreases in value that are credit-related. As of December 31, 2010, the amortized cost and the fair value of our available for sale securities portfolio totaled $181.6 million and $180.0 million, respectively, and the amortized cost and the fair value of our trading securities totaled $248,000. Changes in the expected cash flows of these securities and/or prolonged price declines in future periods may result in a charge to earnings to write-down these securities. Any charges for other-than-temporary impairment would not impact cash flow, tangible capital or liquidity. For the years ended December 31, 2010 and 2009, we recognized other-than-temporary impairment losses on certain debt securities related to credit-related factors totaling $492,000 and $228,000, respectively.

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o Recently enacted regulatory reform may have a material impact on the Company’s operations.

On July 21, 2010, the President signed into law the Dodd-Frank Act. The Dodd-Frank Act restructures the regulation of depository institutions. Under the Dodd-Frank Act, the Office of Thrift Supervision, which currently regulates the Bank, will be merged into the Office of the Comptroller of the Currency, which regulates national banks. Savings and loan holding companies, including the Company, will be regulated by the Board of Governors of the Federal Reserve System. Also included is the creation of a new federal agency to administer consumer protection and fair lending laws, a function that is now performed by the depository institution regulators. The federal preemption of state laws currently accorded federally chartered depository institutions will be reduced as well and State Attorneys General will have greater authority to bring a suit against a federally chartered institution, such as the Bank, for violations of certain state and federal consumer protection laws. The Dodd-Frank Act also will impose consolidated capital requirements on savings and loan holding companies effective in five years, which will limit our ability to borrow at the holding company and invest the proceeds from such borrowings as capital in the Bank that could be leveraged to support additional growth. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008-2009. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs.

In addition to the enactment of the Dodd-Frank Act, the federal regulatory agencies recently have begun to take stronger supervisory actions against financial institutions that have experienced increased loan losses and other weaknesses as a result of the current economic crisis. These actions include the entering into of written agreements and cease and desist orders that place certain limitations on their operations. Federal bank regulators recently have also been using with more frequency their ability to impose individual minimal capital requirements on banks, which requirements may be higher than those imposed under the Dodd-Frank Act or which would otherwise qualify the bank as being “well capitalized” under the FDIC’s prompt corrective action regulations. If the Company or the Bank were to become subject to a supervisory agreement or higher individual capital requirements, such action may have a negative impact on their ability to execute their business plans, as well as their ability to grow, pay dividends or engage in mergers and acquisitions and may result in restrictions in their operations.  See Item 1. Business. “Regulation and Supervision” for a discussion of regulatory capital requirements.

o The Company’s inability to achieve profitability on new branches may negatively impact its earnings.

We consider our primary market area to consist of Hartford, Middlesex, New London, Tolland and Windham counties in Connecticut. However, the majority of our facilities are located in and a substantial portion of our business is derived from Windham county, which has the lowest median household income and the highest unemployment rate among the counties in Connecticut. To address this, in recent years, we have expanded our presence throughout our market area and may pursue further expansion through the establishment of additional branches in Hartford, Middlesex, New London and Tolland counties, each of which has more favorable economic conditions than Windham county. The profitability of our expansion policy will depend on whether the income that we generate from the additional branches we establish or purchase will offset the increased expenses resulting from operating new branches. We expect that it may take a period of time before new branches can become profitable, especially in areas in which we do not have an established presence. During this period, operating new branches may negatively impact our operating results.

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o Fluctuations in interest rates could reduce the Company’s profitability and affect the value of its assets.

Like other financial institutions, we are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. Changes in the general level of interest rates can affect our net interest income by affecting the difference between the weighted-average yield earned on our interest-earning assets and the weighted-average rate paid on our interest-bearing liabilities, or interest rate spread and the average life of our interest-earning assets and interest-bearing liabilities. Changes in interest rates also can affect: (1) the ability to originate loans; (2) the value of our interest-earning assets and our ability to realize gains from the sale of such assets; (3) the ability to obtain and retain deposits in competition with other available investment alternatives; and (4) the ability of our borrowers to repay adjustable or variable rate loans. Interest rates are highly sensitive to many factors, including government monetary policies, domestic and international economic and political conditions and other factors beyond our control. Although we believe that the estimated maturities of our interest-earning assets currently are well balanced in relation to the estimated maturities of our interest-bearing liabilities, our profitability could be adversely affected during any period of changes in interest rates.

o The Company’s cost of operations is high relative to its assets. The Company’s failure to maintain or reduce its operating expenses could hurt its profits.

Our noninterest expenses totaled $31.5 million and $31.4 million for the years ended December 31, 2010 and 2009, respectively. We continue to analyze our expenses and achieve efficiencies where available, but we have experienced increased costs, a substantial portion of which are associated with the new full-service branches that we have opened or acquired since 2000. Although we have generated increases in both net interest income and noninterest income, our efficiency ratio remains high as a result of the higher operating expenses. Our efficiency ratio totaled 86.71% and 90.64% for the years ended December 31, 2010 and 2009, respectively. Failure to control or maintain our expenses could hurt future profits.

o Strong competition within the Bank’s market area could hurt its profits and slow growth.

We face intense competition both in making loans and attracting deposits. This competition has made it more difficult for us to make new loans and at times has forced us to offer higher deposit rates. Price competition for loans and deposits might result in our earning less on our loans and paying more on our deposits, which reduces net interest income. As of June 30, 2010, we held approximately 1.60% of the deposits in Hartford, Middlesex, New London, Tolland and Windham counties in Connecticut, which represented the 13th market share of deposits out of 36 financial institutions in these counties. Some of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area.
 

o The Company is subject to liquidity risks.

Market conditions could negatively affect the level or cost of liquidity available to us, which would affect our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations and fund asset growth and new business transactions at a reasonable cost, in a timely manner, and without adverse consequences. Core deposits and FHLB advances are our primary sources of funding. A significant decrease in our core deposits, an inability to renew FHLB advances, an inability to obtain alternative funding to core deposits or FHLB advances, or a substantial, unexpected, or prolonged change in the level or cost of liquidity could have a negative effect on our business and financial condition.

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o Increased and/or special FDIC assessments will hurt the Company’s earnings.

The recent economic recession has caused a high level of bank failures, which has dramatically increased FDIC resolution costs and led to a significant reduction in the balance of the Deposit Insurance Fund. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. Increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the FDIC imposed a special assessment on all insured institutions. Our special assessment, which was reflected in earnings for the quarter ended June 30, 2009, was $393,000. In lieu of imposing an additional special assessment, the FDIC required all institutions to prepay their assessments for all of 2010, 2011 and 2012, which for us totaled $3.5 million. Additional increases in the base assessment rate or additional special assessments would negatively impact our earnings.

o If the goodwill recorded in connection with the Company’s acquisitions becomes impaired, it could have a negative impact on the Company’s profitability.

Applicable accounting standards require that the acquisition method of accounting be used for all business combinations. Under this method, if the purchase price of an acquired entity exceeds the fair value of its net assets, the excess is carried on the acquirer’s balance sheet as goodwill. At December 31, 2010, we had $4.1 million of goodwill on our balance sheet. Companies evaluate goodwill for impairment at least annually or more frequently if events or changes in circumstances warrant such evaluation. Our annual review of our goodwill occurs in November. Write-downs of the amount of impairment, if necessary, are to be charged to the results of operations in the period in which the impairment occurs. For the years ended December 31, 2010 and 2009, we recorded goodwill impairment of $37,000 related to our Colchester branch acquisition and $57,000 related to our New London branch acquisition, respectively. Future evaluations of goodwill may result in findings of impairment and related write-downs, which could have a material adverse effect on our financial condition and results of operations.

o Turmoil in the financial markets could have an adverse effect on the Company’s financial position or results of operations.

Beginning in 2008, United States and global financial markets experienced severe disruption and volatility, and general economic conditions have declined significantly. Adverse developments in credit quality, asset values and revenue opportunities throughout the financial services industry, as well as general uncertainty regarding the economic, industry and regulatory environment, have had a negative impact on the industry. The United States and the governments of other countries have taken steps to try to stabilize the financial system, including investing in financial institutions, and have implemented programs intended to improve general economic conditions. The U.S. Department of the Treasury created the Capital Purchase Program under the Troubled Asset Relief Program, pursuant to which the Treasury Department provided additional capital to participating financial institutions through the purchase of preferred stock or other securities. Other measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; regulatory action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. Notwithstanding the actions of the United States and other governments, there can be no assurances that these efforts will be successful in restoring industry, economic or market conditions to their previous levels and that they will not result in adverse unintended consequences. Factors that could continue to pressure financial services companies, including the Company, are numerous and include (1) worsening credit quality, leading among other things to increases in loan losses, (2) continued or worsening disruption and volatility in financial markets, leading among other things to continuing reductions in asset values, (3) capital and liquidity concerns regarding financial institutions generally, (4) limitations resulting from or imposed in connection with governmental actions intended to stabilize or provide additional regulation of the financial system, or (5) recessionary conditions that are deeper or last longer than currently anticipated.

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o The Company is subject to security and operational risks relating to use of its technology that could damage its reputation and business.

Security breaches in our internet banking activities could expose us to possible liability and damage our reputation. Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our systems from compromises or breaches of our security measures that could result in damage to our reputation and business. Additionally, we outsource our data processing to a third-party. If our third-party provider encounters difficulties or if we have difficulty in communicating with such third-party, it will significantly affect our ability to adequately process and account for customer transactions, which would significantly affect our business operations.

Item 1B.  Unresolved Staff Comments.

None.

Item 2.  Properties.

The Company conducts its business through its executive office at 803 Main Street, Willimantic, Connecticut, its 21 branch offices located in Connecticut and its trust servicing office located in Rutland, Vermont.  Of the 22 offices, 4 are owned and 18 are leased.  Lease expiration dates range from 2011 to 2028 with renewal options of 5 to 20 years.

	Number of
Office Locations	Offices
Connecticut:
New London County		8
Windham County		7
Tolland County		3
Hartford County		2
Middlesex County		1
Vermont:
Rutland County		1
Total:		22

Additionally, the Bank owns or leases 3 other properties used, in part, for banking operations and an employee training center.  The total net book value of the properties at December 31, 2010 was $9.2 million.  See Notes 6 and 12 in the Company’s Consolidated Financial Statements included in the Company’s Annual Report to Shareholders, attached hereto as Exhibit 13, for more information.

Item 3.  Legal Proceedings.

Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold a security interest, claims involving the making and servicing of real property loans and other issues incident to our business.  At December 31, 2010, neither the Company nor the Bank was involved in any pending legal proceedings believed by management to be material to the Company’s financial condition, results of operations or cash flows.

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Item 4.  [Removed and Reserved]

PART II.

Item 5.  Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The market for the registrant’s common equity and related shareholder matters required by this item is incorporated herein by reference to the section captioned “Common Stock Information” in the Company’s Annual Report to Shareholders.

For a description of restrictions on the Bank’s ability to pay dividends to the Company and the Company’s ability to pay cash dividends, see Item 1.  Business.  “Regulation and Supervision – Regulation of Federal Savings Associations - Limitation on Capital Distributions” in this annual report on Form 10-K and Note 18 in the Company’s Consolidated Financial Statements included in the Company’s Annual Report to Shareholders, attached hereto as Exhibit 13, for more information.

Item 6.  Selected Financial Data.

The Company has derived the following selected consolidated financial and other data in part from its consolidated financial statements and notes appearing elsewhere in this annual report.

Selected Financial Condition Data:	At December 31,
(In Thousands)	2010		2009		2008		2007		2006
Total assets	$	926,409	$	872,354	$	853,122	$	790,198	$	757,037
Cash and cash equivalents		78,321		24,204		23,203		20,669		26,108
Securities available for sale		180,036		183,562		162,699		141,914		119,508
Loan receivable, net		606,214		607,692		617,263		587,538		574,111
Deposits (1)		664,139		662,378		624,276		551,772		541,922
Federal Home Loan Bank advances		114,169		116,100		139,600		141,619		111,956
Junior subordinated debt owed to unconsolidated trust(s)		8,248		8,248		8,248		8,248		15,465
Total shareholders' equity		81,104		77,462		72,927		82,087		82,386

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Selected Operating Data:	Years Ended December 31,
(In Thousands, Except Per Share Data)	2010		2009		2008			2007		2006
Interest and dividend income	$	39,875	$	43,385	$	46,499		$	43,347	$	40,777
Interest expense		13,824		18,861		22,459			21,783		18,261
Net interest income		26,051		24,524		24,040			21,564		22,516
Provision for loan losses		902		2,830		1,369			1,062		881
Net interest income after provision for loan losses		25,149		21,694		22,671			20,502		21,635
Noninterest income		10,685		10,181		3,136			9,378		8,258
Noninterest expenses		31,518		31,405		30,040			27,928		25,959
Income (loss) before income tax provision (benefit)		4,316		470		(4,233	)		1,952		3,934
Income tax provision (benefit)		1,313		35		(1,360	)		540		1,156
Net income (loss)	$	3,003	$	435	$	(2,873	)	$	1,412	$	2,778
Basic income (loss) per share	$	0.26	$	0.04	$	(0.25	)	$	0.12	$	0.24
Diluted income (loss) per share	$	0.26	$	0.04	$	(0.25	)	$	0.12	$	0.23

Selected Operating Ratios:	At or For the Years Ended December 31,
Performance Ratios:	2010			2009			2008			2007			2006
Return (loss) on average assets		0.34	%		0.05	%		(0.34	)%		0.18	%		0.38	%
Return (loss) on average equity		3.70			0.58			(3.71	)		1.71			3.44
Interest rate spread (2)		2.88			2.67			2.61			2.47			2.81
Net interest margin (3)		3.12			2.98			3.00			2.98			3.26
Noninterest expenses to average assets		3.55			3.61			3.55			3.66			3.56
Dividend payout ratio (4)		13.49			41.61			(25.63	)		57.61			27.98
Efficiency ratio (5)		86.71			90.64			88.72			90.57			83.58
Average interest-earning assets to average interest-bearing liabilities		114.40			113.28			113.83			117.02			117.07
Average equity to average assets		9.14			8.68			9.16			10.88			11.07
Capital Ratios:
Total risk-based capital ratio		15.34			14.30			13.32			15.21			15.84
Tier 1 risk-based capital ratio		14.40			13.36			12.33			14.37			14.86
Tier 1 capital ratio		7.81			8.02			7.59			8.75			8.97
Asset Quality Ratios:
Allowance for loan losses as a percent of total loans		0.78			0.80			0.97			0.89			0.76
Allowance for loan losses as a percent of nonperforming loans		97.44			162.65			64.83			68.72			313.58
Net charge-offs to average outstanding loans during period		0.16			0.64			0.09			0.03			0.03

___________

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

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

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

(4) Dividends paid divided by basic net income.

(5) Represents noninterest expenses divided by the sum of net interest income and noninterest income, excluding gains or losses on the sale of securities and other-than-temporary impairment of securities.

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The information required by this item is incorporated herein by reference to the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report to Shareholders attached hereto as Exhibit 13.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.

The information required by this item is incorporated herein by reference to the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report to Shareholders attached hereto as Exhibit 13.

Item 8.  Financial Statements and Supplementary Data.

The financial statements and supplementary data required by this item are incorporated herein by reference to the audited consolidated financial statements and notes thereto included in the Company’s Annual Report to Shareholders attached hereto as Exhibit 13.

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Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A.  Controls and Procedures.

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

Management’s Annual Report on Internal Control Over Financial Reporting

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

A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company’s management assessed the effectiveness of its internal control over financial reporting as of December 31, 2010, using the criteria established in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).  Based on this assessment, management has concluded that, as of December 31, 2010, the Company’s internal control over financial reporting was effective based on the criteria.

Changes in Internal Control Over Financial Reporting

In addition, based on that evaluation, no changes in the Company’s internal control over financial reporting occurred during the quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B.  Other Information.

None.

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PART III.

Item 10.  Directors, Executive Officers and Corporate Governance.

Directors

Information relating to the directors of the Company required by this item is incorporated herein by reference to the section captioned “Items to be Voted on by Stockholders – Item 1 – Election of Directors” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders.

Executive Officers

Information relating to officers of the Company required by this item is incorporated herein by reference to Part I, Item 1, “Business — Executive Officers of the Registrant” to this annual report on Form 10-K.

Compliance with Section 16(a) of the Exchange Act

Information regarding compliance with Section 16(a) of the Exchange Act required by this item is incorporated herein by reference to the cover page to this annual report on Form 10-K and the section captioned “Other Information Relating to Directors and Executive Officers - Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders.

Code of Ethics

Information concerning the Company’s code of ethics required by this item is incorporated herein by reference to the information contained under the section captioned “Corporate Governance and Board Matters – Code of Ethics and Business Conduct” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders.  A copy of the code of ethics and business conduct is available to shareholders on the “Governance Documents” portion of the Investor Relations’ section on the Company’s website at www.mysifi.com.

Corporate Governance

Information regarding the audit committee and its composition and the audit committee’s financial expert required by this item is incorporated herein by reference to the section captioned “Corporate Governance and Board Matters – Committees of the Board of Directors – Audit Committee” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders.

Item 11.  Executive Compensation.

Information regarding executive compensation and the compensation committee report required by this item is incorporated herein by reference to the sections captioned “Executive Compensation,” “Compensation Discussion and Analysis,” “Compensation Committee Report” and “Corporate Governance and Board Matters - Directors’ Compensation” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders.

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information relating to the security ownership of certain beneficial owners and management required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders.

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The following table sets forth information about the Company’s common stock that may be issued upon the exercise of stock options, warrants and rights under all of the Company’s equity compensation plans as of December 31, 2010.

Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)		Weighted-average exercise price of outstanding options, warrants and rights (b)		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
Equity compensation plans approved by security holders		496,750	$	9.55		118,873
Equity compensation plans not approved by security holders		-		-		-
Total		496,750	$	9.55		118,873

Item 13.  Certain Relationships and Related Transactions and Director Independence.

Certain Relationships and Related Transactions

Information regarding certain relationships and related transactions required by this item is incorporated herein by reference to the section captioned “Other Information Relating to Directors and Executive Officers - Transactions with Related Persons” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders.

Corporate Governance

Information regarding director independence required by this item is incorporated herein by reference to the section captioned “Corporate Governance and Board Matters– Director Independence” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders.

Item 14.  Principal Accountant Fees and Services.

Information relating to the principal accountant fees and expenses required by this item is incorporated herein by reference to the section captioned ”Audit-Related Matters – Audit Fees” and “Audit-Related Matters – Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services by the Independent Registered Public Accounting Firm” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders.

PART IV.

Item 15.  Exhibits and Financial Statement Schedules.

(1)  Financial Statements

The following consolidated financial statements of the Company and its subsidiaries are filed as part of this report:

o Report of Independent Registered Public Accounting Firm

o Consolidated Balance Sheets as of December 31, 2010 and 2009

o Consolidated Statements of Operations for the Years Ended December 31, 2010, 2009 and 2008

o Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2010, 2009 and 2008

o Consolidated Statements of Cash Flows for the Years Ended December 31, 2010, 2009 and 2008

o Notes to Consolidated Financial Statements

Such financial statements are incorporated by reference to the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report to Shareholders.

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(2)  Financial Statement Schedules

All financial statement schedules have been omitted because they are either not applicable or the required information is included in the consolidated financial statements or notes thereto included in the Company’s Annual Report to Shareholders.

(3)  Exhibits

The exhibits listed below are filed as part of this report or are incorporated by reference herein.

3.1	Articles of Incorporation of SI Financial Group, Inc. (1)
3.2	Bylaws of SI Financial Group, Inc. (2)
4.0	Specimen Stock Certificate of SI Financial Group, Inc. (1)
10.1	*Savings Institute Profit Sharing and 401(k) Savings Plan (3)
10.2	*Employee Agreement between Rheo A. Brouillard, SI Financial Group, Inc. and Savings Institute Bank and Trust Company, as amended and restated (4)
10.3	* Employee Agreement between Brian J. Hull, SI Financial Group, Inc. and Savings Institute Bank and Trust Company, as amended and restated (4)
10.4	*Amended and Restated Savings Institute Bank and Trust Employee Severance Compensation Plan (5)
10.5	*Savings Institute Directors Retirement Plan (3)
10.6	*Amended and Restated Savings Institute Bank and Trust Company Supplemental Executive Retirement Plan (5)
10.7	* Savings Institute Group Term Replacement Plan (3)
10.8	* Form of Savings Institute Executive Supplemental Retirement Plan – Defined Benefit (3)
10.9	*Form of First Amendment to Savings Institute Executive Supplemental Retirement Plan – Defined    Benefit (5)
10.10	*Form of Savings Institute Director Deferred Fee Agreement (5)
10.11	*Form of Savings Institute Director Consultation Plan (3)
10.12	*SI Financial Group, Inc. 2005 Equity Incentive Plan (6)
10.13	*Change in Control Agreement, and related amendments, by and among SI Financial Group, Inc., Savings Institute Bank and Trust Company and David T. Weston (5)
10.14	*Change in Control Agreement between Laurie Gervais, SI Financial Group, Inc., Savings Institute Bank and Trust Company (1)
10.15	*Change in Control Agreement between Michael Moran, SI Financial Group, Inc., Savings Institute Bank and Trust Company (7)
10.16	*Form of Section 409A Amendment to the Change in Control Agreement (2)

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13.0	Annual Report to Shareholders
21.0	List of Subsidiaries
23.1	Consent of Wolf & Company, P.C.
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

___________

*     Management contract or compensation plan or arrangement.

(1)	Incorporated herein by reference into this document from the Exhibits on the Registration Statement on Form S-1 (File No. 333-169302), and any amendments thereto, filed with the Securities and Exchange Commission on September 10, 2010.
(2)	Incorporated herein by reference into this document from the Exhibits to the Company’s Current Report on Form 8-K (File No. 000-54241) filed with the Securities and Exchange Commission on February 17, 2011.
(3)	Incorporated herein by reference into this document from the Exhibits on the Registration Statement on Form S-1 (File No. 333-116381), and any amendments thereto, filed with the Securities and Exchange Commission on June 10, 2004.
(4)	Incorporated herein by reference into this document from the Exhibits on the Company’s Annual Report on Form 10-K/A (File No. 000-50801) filed with the Securities and Exchange Commission on April 17, 2009.
(5)	Incorporated herein by reference into this document from the Exhibits on the Company’s Annual Report on Form 10-K (File No. 000-50801) filed with the Securities and Exchange Commission on March 27, 2009.
(6)	Incorporated by reference into this document from the Appendix to the Proxy Statement for the 2005 Annual Meeting of Shareholders (File No. 000-50801) filed with the Securities and Exchange Commission on April 6, 2005.
(7)	Incorporated herein by reference into this document from the Exhibits to the Company’s Quarterly Report on Form 10-Q (File No. 000-50801) filed with the Securities and Exchange Commission on November 15, 2004.

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SIGNATURES

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

The Company, Inc.

By:	/s/ Rheo A. Brouillard
	Rheo A. Brouillard
	President and Chief Executive Officer
	March 28, 2011

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

Name	Title	Date
/s/ Rheo A. Brouillard	President and Chief Executive	March 28, 2011
Rheo A. Brouillard	Officer (principal executive officer)
/s/ Brian J. Hull	Executive Vice President, Treasurer	March 28, 2011
Brian J. Hull	and Chief Financial Officer (principal
	accounting and financial officer)
/s/ Henry P. Hinckley	Chairman of the Board	March 28, 2011
Henry P. Hinckley
/s/ Donna M. Evan	Director	March 28, 2011
Donna M. Evan
/s/ Roger Engle	Director	March 28, 2011
Roger Engle
/s/ Robert O. Gillard	Director	March 28, 2011
Robert O. Gillard
/s/ Mark D. Alliod	Director	March 28, 2011
Mark D. Alliod
/s/ Michael R. Garvey	Director	March 28, 2011
Michael R. Garvey

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EX-13.0

Exhibit 13.0

EXPLANATORY NOTE

SI Financial Group, Inc., a Maryland corporation (the “Registrant”), was incorporated on September 7, 2010 to become the holding company for Savings Institute Bank and Trust Company (the “Bank”) upon completion of the “second-step” conversion of the Bank from a mutual holding company structure to a stock holding company structure (the “Conversion”).  The Conversion involved the sale by the Registrant of 6,544,493 shares of common stock in a public offering to depositors and community members, the exchange of 4,032,356 shares of common stock of the Registrant for shares of common stock of the former SI Financial Group, Inc. (the “Company”) held by persons other than SI Bancorp, MHC (the “MHC”), and the elimination of the Company and the MHC.  The Conversion was completed on January 12, 2011.  As the Conversion was completed after December 31, 2010, the information in this report is for the Company.  Separate financial statements for the Registrant have not been included in this report because the Registrant, as of December 31, 2010, had not issued any shares and had engaged only in organizational activities to date, had no significant assets, contingent or other liabilities, revenues or expenses.  Per share information in this report is based on outstanding shares as of the dates indicated and does not reflect the Conversion.  Following the Conversion, the Registrant had 10,576,849 shares of common stock outstanding.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

General

Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding changes in the Company’s financial condition as of December 31, 2010 and 2009 and the results of operations for the years ended December 31, 2010, 2009 and 2008.  The information contained in this section should be read in conjunction with the consolidated financial statements and notes contained elsewhere in this annual report.

This report may contain certain “forward-looking statements” within the meaning of the federal securities laws, which are made in good faith pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends,” “estimates,” “projects” and similar expressions.  These statements are not historical facts; rather, they are statements based on management’s current expectations regarding our business strategies, intended results and future performance.

Management’s ability to predict results of the 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 Item 1A. “Risk Factors” in the Company’s annual report on Form 10-K and in other reports filed with the Securities and Exchange Commission (the “SEC”).  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.

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Management Strategies

The Company’s mission is to operate and grow a profitable community-oriented financial institution.   The Company plans to achieve this by continuing its strategies of:

o Offering a full range of financial products and services.The Bank has a long tradition of focusing on the needs of consumers and small and medium-sized businesses in the community and being an active corporate citizen.  The Bank believes its community orientation, quicker decision-making process and customized products are attractive to its customers and distinguishes it from the large regional banks that operate in its market area.  In this context, the Bank strives to become a financial services company offering one-stop shopping for all of its customers’ financial needs through banking, investments, insurance and trust products and services.  The Bank believes that its broad array of product offerings deepen its relationships with its current customers and entice new customers to begin banking with them, ultimately increasing fee income and profitability.

o Actively managing the balance sheet and diversifying the asset mix. The recent economic recession has underscored the importance of a strong balance sheet. The Company manages its balance sheet by: (1) prudently increasing the percentage of its assets consisting of multi-family and commercial real estate and commercial business loans, which offer higher yields, shorter maturities and more sensitivity to interest rate fluctuations; (2) managing its interest rate risk by diversifying the type and maturity of its assets in its loan and investment portfolios and monitoring the maturities in its deposit portfolio; and (3) maintaining strong capital levels and liquidity. Multi-family and commercial real estate and commercial business loans increased $35.5 million, $28.0 million and $36.7 million for the years ended December 31, 2010, 2009 and 2008, respectively, and comprised 49.7% of total loans at December 31, 2010.  The Company intends to continue to pursue the opportunities from the many multi-family and commercial properties and businesses located in its market area.

o Continuing conservative underwriting practices and maintaining a high quality loan portfolio.The Bank believes that strong asset quality is a key to long-term financial success.  The Bank has sought to maintain a high level of asset quality and moderate credit risk by using conservative underwriting standards and by diligent monitoring and collection efforts.  Nonperforming loans increased from $3.0 million at December 31, 2009 to $4.9 million at December 31, 2010.  At December 31, 2010, nonperforming loans were 0.80% of the total loan portfolio and 0.53% of total assets.  Although the Bank intends to increase its multi-family and commercial real estate and commercial business lending, it intends to continue its philosophy of managing large loan exposures through conservative loan underwriting and credit administration standards.

o Increasing core deposits. The Company’s primary source of funds is retail deposit accounts.  At December 31, 2010, 56.2% of our deposits were core deposits, consisting of demand, savings and money market accounts. The Company values core deposits because they represent longer-term customer relationships and a lower cost of funding compared to certificates of deposit. Core deposits have continued to increase primarily due to the investments we have made in our branch network, new product offerings, competitive interest rates and the movement of customer funds out of riskier investments, including the stock market. The Company intends to continue to increase its core deposits and to focus on gaining market share in counties outside of Windham County by continuing to offer exceptional customer service, cross-selling its loan and deposit products and trust, insurance and investment services and increasing its commercial deposits from small and medium-sized businesses through additional business banking and cash management products.

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o Supplementing fee income through expanded mortgage banking operations.The Company views the changing regulatory landscape and historically low interest rate environment as an opportunity to gain noninterest income by leveraging its expertise in originating residential mortgages and selling such increased originations in the secondary market. This strategy enables the Company to have a much larger lending capacity, provide a more comprehensive product offering and reduce the interest rate, prepayment and credit risks associated with originating residential loans for retention in its loan portfolio. Further, this strategy allows the Company to be more flexible with the single-family residential loans that are held in portfolio. To accelerate this initiative, the Company hired two additional mortgage originators in 2010 and intends to hire at least one more originator in 2011.

o Grow through acquisitions.The Company intends to pursue expansion opportunities in its existing market areas or adjacent areas in strategic locations that maximize growth opportunities or with companies that add complementary products to its existing business. The Company believes that the recent economic recession will increase the rate of consolidation in the banking industry. The Company will look to be opportunistic to expand through the acquisition of banks or other financial service companies and believes the additional capital raised through its recently completed offering will better position the Company to take advantage of those opportunities.

Critical Accounting Policies

The discussion and analysis of the financial condition and results of operations are based on the Company’s consolidated financial statements, which are prepared in conformity with generally accepted accounting principles in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of income and expenses.  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 its critical accounting policies.  The Company considers the allowance for loan losses, other-than-temporary impairment of securities, deferred income taxes and the impairment of long-lived assets to be its critical accounting policies.

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 our historical loss experience, delinquency trends, economic conditions and other qualitative factors.  The applied loss factors are re-evaluated quarterly to ensure their relevance in the current economic 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.  Additionally, a portion of the allowance is established based on the level of specific nonperforming loans and classified assets.

Although management believes that it uses the best information available to establish the allowance for loan losses, which is based on estimates that are susceptible to change, future additions to the allowance may be necessary as a result of changes in economic conditions and other factors.  Additionally, the Bank’s regulators, as a part of their examination process, periodically review its allowance for loan losses and may require the Bank to increase its allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease its allowance for loan losses by recognizing loan charge-offs.  See Notes 1 and 4 in the Company’s Consolidated Financial Statements for additional information.

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Other-Than-Temporary Impairment of Securities. One of the significant estimates related to securities is the evaluation of investments for other-than-temporary impairment (“OTTI”). Marketable equity securities are evaluated for OTTI based on the severity and duration of the impairment and, if deemed to be other-than-temporary, the declines in fair value are reflected in earnings as realized losses.  For those debt securities for which the fair value is less than its amortized cost and the Company does not intend to sell such security and it is not more likely than not that it will be required to sell such security prior to the recovery of its amortized cost basis (which may be maturity) less any credit losses, the credit-related OTTI loss is recognized as a charge to earnings.  Noncredit-related OTTI losses for debt securities are recognized in other comprehensive income (loss), net of applicable taxes.

The evaluation of securities for impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period. Management evaluates securities for OTTI at least on a quarterly basis and more frequently when economic or market conditions warrant such evaluation.  See Notes 1 and 3 in the Company’s Consolidated Financial Statements for additional information.

Deferred Income Taxes.  The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  If current available information raises doubt as to the realization of the deferred tax asset, a valuation allowance is established.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The Company exercises significant judgment in evaluating the amount and timing of recognition of the resulting tax assets and liabilities.  These judgments require us to make projections of future taxable income.  These judgments and estimates, which are inherently subjective, are reviewed periodically as regulatory and business factors change.  A reduction in estimated future taxable income may require the Company to record a valuation allowance against its deferred tax asset.  A valuation allowance would result in additional income tax expense in the period, which would negatively affect earnings.  See Notes 1 and 10 in the Company’s Consolidated Financial Statements.

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 and goodwill, 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 at least annually 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.  See Notes 1, 6 and 7 in the Company’s Consolidated Financial Statements for additional information.

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Analysis of Net Interest Income

Average Balance Sheet.  The following sets forth information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resulting yields and rates paid, interest rate spread, net interest margin and the ratio of average interest-earning assets to average interest-bearing liabilities for the periods indicated.

	Years Ended December 31,
	2010								2009								2008
	Average Balance		Interest & Dividends			Average Yield/ Rate			Average Balance		Interest & Dividends			Average Yield/ Rate			Average Balance		Interest & Dividends			Average Yield/ Rate
	(Dollars in Thousands)
Interest-earning assets:
Loans (1) (2)	$	610,480	$	33,381			5.47	%	$	624,647	$	35,440			5.67	%	$	608,838	$	37,192			6.11	%
Securities (3)		190,568		6,393			3.35			177,609		7,849			4.42			178,146		8,946			5.02
Other interest-earning assets		35,309		114			0.32			20,709		112			0.54			14,160		366			2.58
Total interest-earning assets		836,357		39,888			4.77			822,965		43,401			5.27			801,144		46,504			5.80
Noninterest-earning assets		51,584								47,377								44,518
Total assets	$	887,941							$	870,342							$	845,662
Interest-bearing liabilities:
Deposits:
NOW and money market	$	240,592		1,618			0.67		$	206,012		2,189			1.06		$	180,699		3,149			1.74
Savings (4)		64,415		295			0.46			62,717		408			0.65			66,796		668			1.00
Certificates of deposit (5)		302,706		7,524			2.49			318,029		10,586			3.33			304,361		11,921			3.92
Total interest-bearing deposits		607,713		9,437			1.55			586,758		13,183			2.25			551,856		15,738			2.85
Federal Home Loan Bank advances		115,152		4,214			3.66			131,460		5,461			4.15			143,697		6,324			4.40
Subordinated debt		8,248		173			2.10			8,248		217			2.63			8,248		397			4.81
Total interest-bearing liabilities		731,113		13,824			1.89			726,466		18,861			2.60			703,801		22,459			3.19
Noninterest-bearing liabilities		75,667								68,350								64,436
Total liabilities		806,780								794,816								768,237
Total shareholders' equity		81,161								75,526								77,425
Total liabilities and shareholders' equity	$	887,941							$	870,342							$	845,662
Net interest-earning assets	$	105,244							$	96,499							$	97,343
Tax equivalent net interest income (3)				26,064								24,540								24,045
Tax equivalent interest rate spread (6)							2.88	%							2.67	%							2.61	%
Tax equivalent net interest margin as a percentage of interest-earning assets (7)							3.12	%							2.98	%							3.00	%
Average of interest-earning assets to average interest-bearing liabilities							114.40	%							113.28	%							113.83	%
Less tax equivalent adjustment (3)				(13	)							(16	)							(5	)
Net interest income			$	26,051							$	24,524							$	24,040

_________

(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 immaterial.

(3) Municipal 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 amounts reported in the statements of operations.

(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 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.

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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.

	2010 Compared to 2009									2009 Compared to 2008
	Increase (Decrease) Due To									Increase (Decrease) Due To
	Rate			Volume			Net			Rate			Volume			Net
	(In Thousands)
Interest-earning assets:
Interest and dividend income:
Loans (1)(2)	$	(1,266	)	$	(793	)	$	(2,059	)	$	(2,700	)	$	948		$	(1,752	)
Securities (3)		(1,997	)		541			(1,456	)		(1,070	)		(27	)		(1,097	)
Other interest-earning assets		(57	)		59			2			(374	)		120			(254	)
Total interest-earning assets		(3,320	)		(193	)		(3,513	)		(4,144	)		1,041			(3,103	)
Interest-bearing liabilities:
Interest expense:
Deposits (4)		(3,593	)		(153	)		(3,746	)		(3,429	)		874			(2,555	)
Federal Home Loan Bank advances		(611	)		(636	)		(1,247	)		(343	)		(520	)		(863	)
Subordinated debt		(44	)		-			(44	)		(180	)		-			(180	)
Total interest-bearing liabilities		(4,248	)		(789	)		(5,037	)		(3,952	)		354			(3,598	)
Change in net interest income (5)	$	928		$	596		$	1,524		$	(192	)	$	687		$	495

_________

(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 immaterial.

(3) Municipal 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 amounts reported in the statements of operations.

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

(5) Presented on a tax equivalent basis using a tax rate of 34%.

Comparison of Financial Condition at December 31, 2010 and December 31, 2009

Assets:

Summary.Total assets increased $54.1 million, or 6.2%, to $926.4 million at December 31, 2010, as compared to $872.4 million at December 31, 2009, primarily due to increases of $54.1 million in cash and cash equivalents and $7.0 million in loans held for sale, offset by decreases of $3.3 million in securities, $2.4 million in other real estate owned, $1.5 million in net loans receivable, $973,000 in prepaid Federal Deposit Insurance Corporation (“FDIC”) deposit insurance assessment, $843,000 in premises and equipment and $349,000 in net deferred tax asset.  Cash and cash equivalents increased as a result of subscription funds received from the stock offering totaling $48.3 million.  The decrease in the Company’s securities portfolio was due to a reduction in mortgage-backed securities, U.S. government and agency obligations and tax-exempt municipal bonds, offset by increases in government-sponsored enterprise securities and corporate debt securities.  The Company obtained ownership of one commercial and seven residential properties aggregating $1.8 million into other real estate owned, offset by write-downs of $472,000 and proceeds from the sale of seven residential and three commercial properties totaling $3.7 million resulting in a net loss of $62,000.  The decrease in net unrealized losses on available for sale securities resulted in a decrease in the net deferred tax asset.  An increase in accumulated depreciation and amortization contributed to the decrease in premises and equipment at December 31, 2010.

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Loans Receivable, Net.  Net loans receivable decreased $1.5 million as a result of a decline in loan originations and the sale of fixed-rate residential mortgage loans.  Loan originations decreased $24.3 million, or 16.6%, during the year ended December 31, 2010 compared to 2009 due primarily to reduced demand and more stringent underwriting practices.  Lower loan originations in 2010 were offset by the purchase of $54.0 million in United States Department of Agriculture (“USDA”) and Small Business Administration (“SBA”) loans that are fully guaranteed by the U.S. government.  The conversion of construction loans to permanent mortgage loans and principal pay-offs contributed to the decrease in construction loans.  Changes in the loan portfolio consisted of the following:

o Residential Mortgage Loans.  Residential mortgage loans comprise 44.5% of total loans at December 31, 2010.   Residential mortgage loans decreased $35.3 million, or 11.5%.  The sale of $48.7 million in residential mortgage loans from current production during 2010 and the decrease in residential mortgage loan originations by $29.6 million during 2010 contributed to the decrease in residential mortgage loans.

o Commercial Loans.  At December 31, 2010, the commercial loan portfolio, which includes multi-family and commercial real estate and commercial business loans, represented 49.7% of the Company’s total loan portfolio.  Multi-family and commercial real estate loans increased $234,000, or 0.2%.  Commercial business loans increased $35.3 million for 2010 as a result of the purchase of $54.0 million in USDA and SBA loans that are fully guaranteed by the U.S. government.  Loan originations for commercial real estate and commercial business loans increased $4.1 million and $951,000, respectively, during 2010.

o Consumer Loans.  Consumer loans represent 4.7% of the Company’s total loan portfolio and increased $2.6 million, or 10.0%, resulting from an increase in home equity lines of credit.  Loan originations for consumer loans increased $220,000 over 2009.

The allowance for loan losses totaled $4.8 million at December 31, 2010 compared to $4.9 million at December 31, 2009.  The ratio of the allowance for loan losses to total loans decreased from 0.80% at December 31, 2009 to 0.78% at December 31, 2010.

Liabilities.  Total liabilities were $845.3 million at December 31, 2010 compared to $794.9 million at December 31, 2009.  Deposits increased $1.9 million, or 0.3%, which included increases in NOW and money market accounts of $27.1 million and noninterest-bearing deposits of $1.4 million, offset by decreases in certificates of deposit of $21.7 million and savings accounts of $4.8 million.  Deposit growth was attributable to marketing and promotional initiatives and competitively-priced deposit products.  Borrowings decreased $1.9 million from $124.3 million at December 31, 2009 to $122.4 million at

December 31, 2010, resulting from net repayments of Federal Home Loan Bank advances.

Equity:

Summary.  Total shareholders’ equity increased $3.6 million from $77.5 million at December 31, 2009 to $81.1 million at December 31, 2010.  The increase in shareholders’ equity was attributable to earnings of $3.0 million, a decrease in net unrealized losses on available for sale securities aggregating $714,000 (net of taxes) and the amortization of share-based awards aggregating $459,000, offset by dividends of $375,000, net unrealized loss on an effective cash flow hedge of $85,000 and treasury stock repurchases totaling $74,000.  On July 1, 2010, the Company recognized a cumulative effect adjustment for a change in accounting principle of $652,000 as a reduction in retained earnings and a corresponding decrease in accumulated other comprehensive loss as a result of electing to fair value two investments in the Company’s securities portfolio in accordance with guidance provided by Financial Accounting Standards Board’s (“FASB”) Scope Exception Related to Embedded Credit Derivatives.  See Note 1 under “Recent Accounting Pronouncements” for more details.

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Effective March 31, 2009, the adoption of new accounting guidance regarding the recognition and presentation of OTTI of securities required management to separately identify whether OTTI charges totaling $7.1 million that were previously recognized in earnings during the third and fourth quarters of 2008 were related to credit losses or other noncredit factors at the measurement date of impairment.  Management determined, based on the present value of expected cash flows in accordance with applicable guidance, that $4.0 million of the $7.1 million in OTTI charges recognized during 2008 were related to noncredit factors and, therefore, recorded a cumulative effect adjustment of $2.7 million (net of taxes) to retained earnings with a corresponding adjustment to accumulated other comprehensive loss.  The Company does not intend to sell these impaired securities and it is more likely than not that the Company will not be required to sell these securities before recovery of the amortized cost basis of each of these securities.

Accumulated Other Comprehensive Loss.  Accumulated other comprehensive loss is comprised of the unrealized gains and losses on available for sale securities, net of taxes and unrealized gains and losses on derivative instruments, net of taxes.  Net unrealized losses on available for sale securities, net of taxes, totaled $1.0 million at December 31, 2010 compared to net unrealized losses on available for sale securities, net of taxes, of $2.4 million at December 31, 2009.  Unrealized holding losses on available for sale securities primarily resulted from a decline in the market value of the debt securities portfolio, which was recognized in accumulated other comprehensive loss on the consolidated balance sheet and a component of comprehensive income on the consolidated statement of changes in shareholders’ equity.  A majority of the unrealized losses relate to non-agency mortgage-backed securities and collateralized debt obligations.  The Company does not intend to sell such securities and it is more likely than not that it will not be required to sell such securities prior to the recovery of its amortized cost basis, which may be at maturity, less any credit losses.  Net unrealized loss on derivative instruments, net of taxes, totaled $85,000 at  December 31, 2010.  There were no losses on derivative instruments at December 31, 2009.

Comparison of Operating Results for the Years Ended December 31, 2010 and 2009

General.The Company’s results of operations depends primarily on net interest income, which is the difference between the interest 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, fees earned from mortgage banking activities, fees from deposit and trust and investment management services, insurance commissions and other fees.  The Company’s noninterest expenses primarily consist of employee compensation and benefits, occupancy, computer services, furniture and equipment, outside professional services, electronic banking fees, 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.

The Company recorded net income of $3.0 million for the year ended December 31, 2010, an increase of $2.6 million, compared to net income of $435,000 for the year ended December 31, 2009.

Interest and Dividend Income.  Total interest and dividend income decreased $3.5 million, or 8.1%, for 2010, primarily due to a lower yield on interest-earning assets.  Lower market interest rates contributed to decreases in the yield of 107 basis points on securities, 22 basis points on federal funds and other interest-earning assets and 20 basis points on loans during 2010. The yield earned on interest-earning assets decreased 50 basis points to 4.77% for 2010.  Additionally, the yield on loans was negatively impacted by the increase in unrecognized interest related to nonaccrual loans.  Average interest-earning assets increased $13.4 million to $836.4 million in 2010, mainly due to a higher average balance of federal funds and other interest-earning assets and securities of $14.6 million and $13.0 million, respectively, offset by a decrease of $14.2 million in loans.

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Interest Expense.  Interest expense decreased $5.0 million, or 26.7%, to $13.8 million for 2010 compared to $18.9 million in 2009, primarily due to lower rates paid on interest-bearing liabilities, offset by a higher average balance of deposits.  Overall, average rates declined as a result of the lower interest rate environment during 2010.  Average interest-bearing deposits rose $21.0 million and the average rate decreased 70 basis points.  An increase in the average balance of NOW and money market accounts totaling $34.6 million contributed the largest increase to the average balance for deposit accounts, as customers shifted from certificates of deposit to NOW and money market accounts.  The average rate on these deposits decreased 39 basis points to 0.67%.  The average balance of certificates of deposit decreased $15.3 million and the average rate paid decreased 84 basis points to 2.49%.  The average balance of FHLB advances decreased $16.3 million and the average rate decreased 49 basis points to 3.66% for 2010.  Rates on subordinated borrowings decreased 53 basis points due to a reduction in the three-month LIBOR rate.

Provision for Loan Losses.  The provision for loan losses decreased $1.9 million to $902,000 in 2010.  The lower provision resulted from a reduction in net loan charge-offs, predominately in commercial real estate loans, offset by an increase in specific loan loss allowances on nonperforming loans.  For the year ended December 31, 2010, net loan charge-offs totaled $994,000, compared to $4.0 million for the year ended December 31, 2009.  Higher loan charge-offs for 2009 primarily related to two commercial construction relationships aggregating $2.9 million.  Specific loan loss allowances relating to impaired loans increased to $502,000 at December 31, 2010, compared to $267,000 at December 31, 2009.  At December 31, 2010, nonperforming loans totaled $4.9 million, as compared to $3.0 million at December 31, 2009.  Unfavorable economic conditions continue to have a negative impact on the Company’s residential and commercial real estate loan portfolio and contribute to the decrease in credit quality related to our commercial business loans.  The ratio of the allowance for loan losses to total loans decreased from 0.80% at December 31, 2009 to 0.78% at December 31, 2010.

Noninterest Income.  Total noninterest income increased $504,000 to $10.7 million in 2010.  The following table shows the components of noninterest income and the dollar and percentage changes from 2009 to 2010.

	Years Ended December 31,						Change
	2010			2009			Dollars			Percent
	(Dollars in Thousands)
Service fees	$	5,093		$	5,033		$	60			1.2	%
Wealth management fees		4,083			3,912			171			4.4
Increase in cash surrender value of bank-owned life insurance		290			294			(4	)		(1.4	)
Net gain on sale of securities		878			285			593			208.1
Net impairment losses recognized in earnings		(492	)		(228	)		(264	)		115.8
Mortgage banking fees		1,090			707			383			54.2
Net loss in fair value on trading securities and derivatives		(429	)		-			(429	)		n/a
Net (loss) gain on disposal of equipment		(5	)		99			(104	)		(105.1	)
Other		177			79			98			124.1
Total noninterest income	$	10,685		$	10,181		$	504			5.0	%

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Higher sales volume of available for sale securities resulted in an increase in the net gain on the sale of securities during 2010.  Residential mortgage loan sales totaled $48.7 million for the year ended December 31, 2010 compared to $56.3 million for the year ended December 31, 2009.   Despite the lower volume of sales in 2010, the Company recognized an increase in the fees from the sale of residential mortgage loans due to higher premiums received from loan sales in the secondary market.  Trust service fees contributed to the increase in wealth management fees for 2010, primarily resulting from an increase in the market value of trust assets under management.  Service fees rose in response to higher electronic banking usage.  A decline in credit conditions resulted in  OTTI charges on one non-agency mortgage-backed security totaling $492,000 and $228,000 for the years ended December 31, 2010 and 2009, respectively.  The net loss in fair value on trading securities and derivatives resulted from the Company recognizing unrealized losses related to a decline in the fair value of two trading securities totaling $408,000 and derivative loan commitments and forward loan sale commitments totaling $21,000.  Other noninterest income was offset by impairment charges of $12,000 and $383,000, which were recorded to reduce the Bank’s carrying value in two small business investment company limited partnerships during the years ended December 31, 2010 and 2009, respectively.  Additionally, other noninterest income included a net gain of $291,000 in death benefit proceeds received from a bank-owned life insurance policy during 2009.

Noninterest Expenses.  Noninterest expenses increased $113,000 for 2010 compared to 2009.  The following table shows the components of noninterest expenses and the dollar and percentage changes from 2009 to 2010.

	Years Ended December 31,				Change
	2010		2009		Dollars			Percent
	(Dollars in Thousands)
Salaries and employee benefits	$	15,487	$	15,767	$	(280	)		(1.8	)%
Occupancy and equipment		5,628		5,559		69			1.2
Computer and electronic banking services		3,785		3,477		308			8.9
Outside professional services		944		975		(31	)		(3.2	)
Marketing and advertising		757		791		(34	)		(4.3	)
Supplies		491		524		(33	)		(6.3	)
FDIC deposit insurance and regulatory assessments		1,306		1,756		(450	)		(25.6	)
Other		3,120		2,556		564			22.1
Total noninterest expenses	$	31,518	$	31,405	$	113			0.4	%

Noninterest expenses increased in 2010 primarily due to increases in computer and electronic banking services and other noninterest expenses.  Computer and electronic banking services expense increased due to higher telecommunication costs and transaction activity.  Other noninterest expenses increased as a result of an increase in costs associated with other real estate owned. Noninterest expenses for 2009 reflected an FDIC-imposed industry-wide five basis point special assessment of $393,000 and prepayment penalties totaling $111,000 for the early extinguishment of Federal Home Loan Bank borrowings.  Salary expense and related payroll taxes were lower for 2010 compared to 2009 due to lower staffing levels and a reduction in share-based compensation expense.

Income Tax Provision.  For 2010, the Company’s income tax provision was $1.3 million compared to $35,000 for 2009.  The income tax provision for 2010 resulted from higher taxable income, offset by a reduction in the Company’s valuation allowance of $90,000 related to the expiration of unrealized federal charitable contribution and capital loss carry-forwards.  The effective tax rate was 30.4% and 7.4% for 2010 and 2009, respectively.  The lower effective tax rate for the year ended December 31, 2009 was due to lower pre-tax net income and a tax-exempt gain on bank-owned life insurance proceeds.

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Comparison of Operating Results for the Years Ended December 31, 2009 and 2008

The Company recorded net income of $435,000 for the year ended December 31, 2009, an increase of $3.3 million, compared to a net loss of $2.9 million for the year ended December 31, 2008.  The net loss for the year ended December 31, 2008 was primarily attributable to a $7.1 million OTTI charge on certain securities to reduce their carrying value to fair value.

Interest and Dividend Income.  Total interest and dividend income decreased $3.1 million, or 6.7%, for 2009, primarily due to a lower yield on interest-earning assets, offset by an increase in interest-earning assets.  Lower market interest rates contributed to decreases in the yield of 60 basis points and 44 basis points on securities and loans, respectively, during 2009.  Additionally, the yield on loans was negatively impacted by the increase in unrecognized interest related to nonaccrual loans.  Average interest-earning assets increased $21.8 million to $823.0 million in 2009, mainly due to a higher average balance of loans and, to a lesser extent, a higher average balance on federal funds and other interest-earning assets.   The average balance of loans increased $15.8 million while the rate earned on loans decreased to 5.67% for 2009 from 6.11% for 2008.

Interest Expense.  Interest expense decreased $3.6 million, or 16.0%, to $18.9 million for 2009 compared to $22.5 million in 2008, primarily due to lower rates paid on interest-bearing liabilities, offset by a higher average balance of deposits.  Overall, average rates declined as a result of the lower interest rate environment during 2009.  Average interest-bearing deposits rose $34.9 million and the average yield decreased 60 basis points.  An increase in the average balance of NOW and money market accounts totaling $25.3 million contributed the largest increase to the average balance for deposit accounts, as customers shifted from savings accounts to NOW and money market accounts.  The average yield on these deposits decreased 68 basis points.  The average balance of certificates of deposit increased $13.7 million and the average rate paid decreased 59 basis points to 3.33%.  The average balance of FHLB advances decreased $12.2 million and the average yield decreased 25 basis points to 4.15% for 2009.  Rates on subordinated borrowings decreased 218 basis points due to a reduction in the three-month LIBOR rate.

Provision for Loan Losses.  The provision for loan losses increased $1.5 million to $2.8 million in 2009.  The higher provision relates to an increase in charge-offs due to the impact of continued adverse economic and real estate market conditions.  For the year ended December 31, 2009, net loan charge-offs totaled $4.0 million, compared to $567,000 for the year ended December 31, 2008.  Specific loan loss allowances relating to impaired loans decreased to $267,000 at December 31, 2009 compared to $1.2 million at December 31, 2008.  At December 31, 2009, nonperforming loans totaled $3.0 million, as compared to $9.3 million at December 31, 2008.  The increase in loan charge-offs and the decrease in nonperforming loans and specific loan loss allowances for the year ended December 31, 2009 primarily resulted from the charge-off of two commercial construction loan relationships aggregating $2.9 million that were previously identified as impaired with established specific loan loss allowances and the transfer of loans totaling $5.5 million into other real estate owned.  While the Company has no direct exposure to sub-prime mortgages in its loan portfolio, economic conditions have negatively impacted the residential and commercial construction markets and contributed to the decrease in credit quality for commercial loans.  The ratio of the allowance for loan losses to total loans decreased from 0.97% at December 31, 2008 to 0.80% at December 31, 2009.

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Noninterest Income.  Total noninterest income increased $7.0 million to $10.2 million in 2009.  The following table shows the components of noninterest income and the dollar and percentage changes from 2008 to 2009.

	Years Ended December 31,						Change
	2009			2008			Dollars			Percent
	(Dollars in Thousands)
Service fees	$	5,033		$	5,251		$	(218	)		(4.2	)%
Wealth management fees		3,912			3,923			(11	)		(0.3	)
Increase in cash surrender value of bank-owned life insurance		294			304			(10	)		(3.3	)
Net gain on sale of securities		285			463			(178	)		(38.4	)
Net impairment losses recognized in earnings		(228	)		(7,148	)		6,920			(96.8	)
Mortgage banking fees		707			202			505			250.0
Net gain on disposal of equipment		99			-			99			n/a
Other		79			141			(62	)		(44.0	)
Total noninterest income	$	10,181		$	3,136		$	7,045			224.6	%

An increase in noninterest income for the year ended December 31, 2009 primarily resulted from lower OTTI charges and an increase in mortgage banking fees, offset by decreases in service fees and the net gain on the sale of available for sale securities.  For 2009, the Company reported mortgage banking fees of $707,000 resulting from the sale of $56.3 million of fixed-rate longer-term residential mortgage loans, compared to mortgage banking fees of $202,000 resulting from the sale of $14.2 million of fixed-rate longer-term residential mortgage loans in 2008.  Service fees declined for the year ended December 31, 2009 due to lower overdraft charges on certain deposit products.  The Company realized net gains on the sale of bonds and stocks totaling $215,000 and $70,000, respectively, during 2009 compared to a net gain on the sale of bonds totaling $463,000 for 2008.  Other noninterest income included a net gain of $291,000 in death benefit proceeds received from a bank-owned life insurance policy during 2009, offset by impairment charges of $383,000 and $63,000, which were recorded to reduce the Bank’s carrying value in two small business investment company limited partnerships during the years ended December 31, 2009 and 2008, respectively.

Noninterest Expenses.  Noninterest expenses increased $1.4 million for 2009 as compared to 2008.  The following table shows the components of noninterest expenses and the dollar and percentage changes from 2008 to 2009.

	Years Ended December 31,				Change
	2009		2008		Dollars			Percent
	(Dollars in Thousands)
Salaries and employee benefits	$	15,767	$	16,211	$	(444	)		(2.7	)%
Occupancy and equipment		5,559		5,733		(174	)		(3.0	)
Computer and electronic banking services		3,477		3,084		393			12.7
Outside professional services		975		842		133			15.8
Marketing and advertising		791		800		(9	)		(1.1	)
Supplies		524		569		(45	)		(7.9	)
FDIC deposit insurance and regulatory assessments		1,756		567		1,189			209.7
Other		2,556		2,234		322			14.4
Total noninterest expenses	$	31,405	$	30,040	$	1,365			4.5	%

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Noninterest expenses increased in 2009 primarily due to increases in the FDIC assessment, computer and electronic banking services, other noninterest expenses and outside professional services.  The increase in the FDIC assessment of $1.2 million for the year ended December 31, 2009 was attributable to the expiration of credits during 2008, an increase in the assessment rate for 2009 and an FDIC-imposed industry-wide five basis point special assessment totaling $393,000.  Computer and electronic banking services expense increased due to higher telecommunication costs and transaction activity.  Other noninterest expenses increased as a result of higher custodian fees for trust operations of $167,000, prepayment penalties for the early extinguishment of FHLB borrowings of $111,000 and an increase in mortgage appraisal fees of $122,000, offset by a decrease in the provision for credit losses of $124,000.  Additionally, the Company recorded an impairment charge of $57,000 during the fourth quarter of 2009 on the goodwill from its New London branch acquisition in 2008.  The decrease in salaries and employee benefits primarily related to higher deferred costs associated with the increase in residential mortgage originations in 2009.  Occupancy and equipment expense was impacted by the Company’s purchase of the Norwich, Connecticut branch office and the training facility, resulting in lower lease expense for 2009.

Income Tax Provision.  For 2009, the Company had an income tax provision of $35,000 compared to an income tax benefit of $1.4 million for 2008.  The income tax provision for 2009 resulted from an increase in taxable income, offset by a nontaxable gain on bank-owned life insurance proceeds.  The effective tax rate was 7.4% and 32.1% for 2009 and 2008, respectively.  For the year ended December 31, 2009, the effective tax rate was impacted by an increase in the valuation allowance to $139,000 from $118,000 at December 31, 2008 due to the uncertainty of realization of the Company’s charitable contribution deduction.  For the year ended December 31, 2008, the valuation allowance of $118,000 was established due to the uncertainty of realization of federal capital loss carry-forwards and OTTI losses on equity securities.  As a result of the Emergency Economic Stabilization Act of 2008 (“EESA”), which was enacted into law in October 2008, the Company recorded a deferred tax benefit during the year ended December 31, 2008 associated with the OTTI losses recognized for the Company’s preferred stock holdings of Fannie Mae and Freddie Mac.  Prior to the enactment of EESA, such losses were treated as capital losses for both tax and financial reporting purposes.  Under EESA, ordinary loss treatment is available to financial institutions for such securities.

Liquidity and Capital Resources

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

The Company regularly adjusts its investment in liquid assets based upon its assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of the Company’s asset/liability management, funds management and liquidity policies.  The Company’s policy is to maintain liquid assets less short-term liabilities within a range of 10.0% to 20.0% of total assets.  Liquid assets were 21.5% of total assets at December 31, 2010, primarily as a result of subscription funds received from the stock offering totaling $48.3 million.  Excess liquid assets are generally invested in interest-earning deposits and short- and intermediate-term securities.

The Company’s most liquid assets are cash and cash equivalents.  The levels of these assets depend on the Company’s operating, financing, lending and investing activities during any given period.  At December 31, 2010, cash and cash equivalents totaled $78.3 million.  Interest-bearing deposits and federal funds sold totaled $67.1 million.  Securities classified as available for sale, which provide additional sources of liquidity, totaled $180.0 million at December 31, 2010.  In addition, at December 31, 2010, the Company had the ability to borrow $159.2 million from the FHLB, which includes overnight lines of credit of $10.0 million.  On that date, the Company had FHLB advances outstanding of $114.2 million and no overnight advances outstanding.  Additionally, the Company has the ability to access the Federal Reserve Bank’s Discount Window on a collateralized basis and maintains a $7.0 million unsecured line of credit with a financial institution to access federal funds.  The Company believes that its liquid assets combined with the available line from the FHLB provide adequate liquidity to meet its current financial obligations.

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At December 31, 2010, the Bank had $51.6 million in loan commitments outstanding, which included $6.7 million in undisbursed construction loans, $21.1 million in unused home equity lines of credit, $12.2 million in commercial lines of credit, $10.2 million in commitments to grant loans, $1.3 million in overdraft protection lines and $115,000 in standby letters of credit.  Certificates of deposit due within one year of December 31, 2010 totaled $124.3 million, or 18.8% of total deposits.  Management believes that the amount of deposits in shorter-term certificates of deposit reflects customers’ hesitancy to invest their funds in longer-term certificates of deposit due to the uncertain interest rate environment.  To compensate, the Bank has increased the duration of its borrowings with the FHLB and offered attractive rates on certain certificates of deposit in an effort to extend the maturity of its deposits.  The Bank will be required to seek other sources of funds, including other certificates of deposit and lines of credit, if maturing certificates of deposit are not retained.  Depending on market conditions, the Bank may be required to pay higher rates on such deposits or other borrowings than are currently paid on certificates of deposit.  Additionally, a shorter duration in the securities portfolio may be necessary to provide liquidity to compensate for any deposit outflows.  The Bank believes, however, based on past experience, a significant portion of its certificates of deposit will be retained.  The Bank has the ability, if necessary, to adjust the interest rates offered to its customers in an effort to attract and retain deposits.

In addition, the Company believes that its branch network, which is presently comprised of 21 full-service retail banking offices located throughout its primary market area, and the general cash flows from its existing lending and investment activities, will afford it sufficient long-term liquidity.

The Company’s primary investing activities are the origination, purchase and sale of loans and the purchase and sale of securities.  For the year ended December 31, 2010, the Bank originated $122.0 million of loans and purchased $91.7 million of securities and $54.0 million of loans.  In fiscal 2009, the Bank originated $146.3 million of loans and purchased $95.1 million of securities and $40.9 million of loans.
 

Financing activities consist primarily of activity in deposit accounts and in borrowed funds.   The increased liquidity needed to fund asset growth has been provided through increased deposits.  The net increase in total deposits, including mortgagors’ and investors’ escrow accounts, was $1.8 million and $38.1 million for the years ended December 31, 2010 and 2009, respectively.  Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by the Bank and its local competitors and other factors.  The Bank generally manages the pricing of its deposits to be competitive and to increase core deposits and commercial banking relationships.  Occasionally, the Bank offers promotional rates on certain deposit products to attract deposits.  The Bank decreased FHLB advances by $1.9 million and $23.5 million for the years ended December 31, 2010 and 2009, respectively, with excess funds from the increase in deposits.

In February 2008, the Company’s Board of Directors approved the repurchase of up to 596,000 shares of the Company’s outstanding common stock.  During 2010, the Company repurchased 11,706 shares at a cost of $74,000.  As a result of the stock conversion in January 2011, no additional shares will be repurchased under this plan.

The Bank has managed its capital to maintain strong protection for depositors and creditors.  The Bank is subject to various regulatory capital requirements administered by the OTS, including a risk-based capital measure.  The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories.  At December 31, 2010, the Bank exceeded all of its regulatory capital requirements and is considered “well capitalized” under regulatory guidelines.  As a savings and loan holding company regulated by the OTS, the Company is not subject to any separate regulatory capital requirements.  In addition, due in part to its sufficient capital level, the Company did not participate in the U.S. Government sponsored Troubled Asset Relief program.   See Note 14 in the Company’s Consolidated Financial Statements for additional information relating to the Bank’s regulatory capital requirements.

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Payments Due Under Contractual Obligations

The following table presents information relating to the Company’s payments due under contractual obligations as of December 31, 2010.

	Payments Due by Period
	Less Than One Year		One to Three Years		Three to Five Years		More Than Five Years		Total
	(In Thousands)
Federal Home Loan Bank advances	$	11,000	$	52,100	$	44,069	$	7,000	$	114,169
Operating lease obligations (1)		1,381		2,343		1,829		6,178		11,731
Other long-term liabilities reflected on the balance sheet (2)		-		-		-		8,248		8,248
Total contractual obligations	$	12,381	$	54,443	$	45,898	$	21,426	$	134,148

_________

(1) Payments are for the lease of real property.

(2) Represents junior subordinated debt owed to an unconsolidated trust.

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 amounts of commitments to extend credit represent the amounts of potential accounting loss 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 December 31, 2010 and 2009 are as follows:

	December 31,
	2010		2009
	(In Thousands)
Commitments to extend credit:
Future loan commitments	$	10,166	$	8,648
Undisbursed construction loans		6,708		9,843
Undisbursed home equity lines of credit		21,106		18,733
Undisbursed commercial lines of credit		12,239		12,390
Overdraft protection lines		1,311		1,425
Standby letters of credit		115		784
Total commitments	$	51,645	$	51,823

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Future loan commitments at December 31, 2010 and 2009 included fixed rate loan commitments of $6.1 million and $5.1 million, respectively, at interest rates ranging from 3.500% to 5.750% and 4.375% to 7.000%, respectively.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  The Company evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty.  Collateral held varies but may include residential and commercial property, accounts receivable, inventory, property, plant and equipment, deposits and securities.

Undisbursed commitments under construction, home equity or commercial lines of credit are commitments for future extensions of credit to existing customers.  Total undisbursed amounts on lines of credit may expire without being fully drawn upon and therefore, do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Letters of credit are primarily issued to support public or private borrowing arrangements.  Essentially all letters of credit issued have expiration dates within one year.

The Bank is a limited partner in two small business investment corporations.  At December 31, 2010, the Bank’s remaining off-balance sheet commitment for the capital investments was $465,000.  See Note 12 in the Company’s Consolidated Financial Statements.

In 2004, the Bank established an Employee Stock Ownership Plan (“ESOP”) for the benefit of its eligible employees.  At December 31, 2010, the Bank had repaid principal payments on the loan to the ESOP of $1.6 million.  Allocated shares and shares unallocated or committed to be allocated to participants totaled 155,306 and 322,955, respectively, at December 31, 2010.  As of December 31, 2010, the amount of unallocated common shares held in suspense totaled 290,660, with a fair value of $2.6 million, which represents a commitment of the Bank to the ESOP.  See Note 11 in the Company’s Consolidated Financial Statements.

As of December 31, 2010, the Company did not engage in any off-balance sheet transactions reasonably likely to have a material effect on its financial condition, results of operations or cash flows.  See Note 12 in the Company’s Consolidated Financial Statements.

Impact of Inflation and Changes in Prices

The financial statements and financial data presented within this document have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial condition and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on the Company’s operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

- 16 -

Impact of Recent Accounting Standards

For information relating to new accounting pronouncements, reference Note 1 – “Nature of Business and Summary of Significant Accounting Policies – Recent Accounting Pronouncements” in the Company’s Consolidated Financial Statements.

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.  The Company manages the interest rate sensitivity of its interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. To reduce the volatility of its earnings, the Company has sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. The Company’s strategy for managing interest rate risk generally is to emphasize the origination of 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 purchases variable-rate loans in the secondary market that are fully guaranteed by the USDA and SBA.  These loans have a significantly shorter duration than fixed-rate mortgage loans. Fixed-rate mortgage loans typically have an adverse effect on interest rate sensitivity compared to adjustable-rate loans. Accordingly, the Company has sold more longer-term fixed-rate mortgage loans in the secondary market in recent periods to manage interest rate risk.  The Company may offer attractive rates for existing certificates of deposit accounts to extend their maturities. The Company also uses shorter-term investment securities and longer-term borrowings from the FHLB to help manage interest rate risk.

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.

On July 1, 2010, the Company entered into an interest rate swap agreement with a third-party financial institution with a notional amount of $8.0 million whereby the counterparty will pay a variable rate equal to three-month LIBOR and the Company will pay a fixed rate of 2.44%. The agreement was effective on December 15, 2010 and terminates on December 15, 2015. This agreement was designated as a cash flow hedge against the trust preferred securities issued by SI Capital Trust II. This effectively fixes the interest rate on the $8.0 million of trust preferred securities at 4.14% for the period December 15, 2010 through December 15, 2015.

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.

Net Interest Income Simulation Analysis

The Company’s goal is to manage asset and liability positions to moderate the effects of interest rate fluctuations on net interest income. Interest income simulations are completed quarterly and presented to the 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 changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities.

- 17 -

The table below sets forth an approximation of the Company’s exposure as a percentage of estimated net interest income for the next 12- and 24-month periods using interest income simulation. The simulation uses projected repricing of assets and liabilities at December 31, 2010 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 large percentage of loans and mortgage-backed securities the Company holds, rising or falling interest rates have a significant impact on the prepayment speeds of the Company’s earning assets that in turn affect the rate sensitivity position. When interest rates rise, prepayments tend to slow. When interest rates fall, prepayments tend to rise. The Company’s asset sensitivity would be reduced if prepayments slow and vice versa. While the Company believes such assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed security and loan repayment activity.

The following table reflects changes in estimated net interest income only for the Company at December 31, 2010.

	Percentage Change in Estimated
	Net Interest Income Over
	12 Months			24 Months
300 basis point increase in rates		1.74	%		0.47	%
Semi-annual 100 basis point increase in rates		3.11			1.98
50 basis point decrease in rates		(1.01	)		(2.22	)

Management believes that under the current rate environment, a change of interest rates downward of 200 basis points is a highly remote interest rate scenario. Therefore, management modified the limit and a 50 basis point decrease in interest rates was used. This limit will be re-evaluated periodically and may be modified as appropriate.

The basis point change in rates in the above table is assumed to occur evenly over the 12- and 24-month periods for both the 300 basis point increase in rates and the 50 basis point decrease in rates.  However, the semi-annual 100 basis point increase in rates over the 12- and 24-month periods represents the most likely scenario based upon the anticipated policy of the Federal Reserve Board. As indicated by the above scenarios, net interest income would be adversely affected (within our internal guidelines) in the 12- and 24-month periods if rates declined by 50 basis points.  Conversely, net interest income would be positively impacted as indicated in the increasing rate scenarios detailed above as a result of the Company’s strategy to better position the balance sheet for the anticipated increase in market interest rates.  The Company’s strategy for mitigating interest rate risk includes the purchase of adjustable-rate investment securities and USDA and SBA loans that will reprice in a rising rate environment, selling longer-term and lower fixed-rate residential mortgage loans in the secondary market and restructuring FHLB borrowings to current lower market interest rates while extending their duration.

- 18 -

Stock Performance Graph

The following graph compares the cumulative total shareholder return on the Company's common stock with the cumulative total return on the Nasdaq Composite (U.S. Companies) and the SNL $500M - $1B Thrift Index.  Total return assumes the reinvestment of all dividends.  The graph assumes $100 was invested at the close of business on December 31, 2005.

- 19 -

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of

SI Financial Group, Inc.

We have audited the accompanying consolidated balance sheets of SI Financial Group, Inc. and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2010.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SI Financial Group, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.

/s/ Wolf & Company, P.C.

Boston, Massachusetts

March 28, 2011

- 20 -

SI FINANCIAL GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Amounts)

	December 31,
	2010			2009
ASSETS:
Cash and due from banks:
Noninterest-bearing	$	11,204		$	12,889
Interest-bearing		2,287			2,350
Federal funds sold		64,830			8,965
Total cash and cash equivalents		78,321			24,204
Trading securities, at fair value		248			-
Available for sale securities, at fair value		180,036			183,562
Loans held for sale		7,371			396
Loans receivable (net of allowance for loan losses of $4,799 and $4,891 at December 31, 2010 and 2009, respectively)		606,214			607,692
Federal Home Loan Bank stock, at cost		8,388			8,388
Bank-owned life insurance		9,024			8,734
Premises and equipment, net		12,123			12,966
Goodwill and other intangibles		4,126			4,195
Accrued interest receivable		3,113			3,341
Deferred tax asset, net		5,729			6,078
Other real estate owned, net		1,285			3,680
Prepaid FDIC deposit insurance assessment		2,576			3,549
Other assets		7,855			5,569
Total assets	$	926,409		$	872,354
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Deposits:
Noninterest-bearing	$	66,845		$	65,407
Interest-bearing		593,869			593,380
Total deposits		660,714			658,787
Mortgagors' and investors' escrow accounts		3,425			3,591
Federal Home Loan Bank advances		114,169			116,100
Junior subordinated debt owed to unconsolidated trust		8,248			8,248
Stock offering escrow		48,325			-
Accrued expenses and other liabilities		10,424			8,166
Total liabilities		845,305			794,892
Commitments and contingencies (Notes 11 and 12)
Shareholders' Equity:
Preferred stock ($.01 par value; 1,000,000 shares authorized; none issued)		-			-
Common stock ($.01 par value; 75,000,000 shares authorized; 12,563,750  shares issued; 11,777,496 and 11,789,202 shares outstanding at December 31, 2010 and 2009, respectively)		126			126
Additional paid-in-capital		52,198			52,230
Unallocated common shares held by ESOP		(2,907	)		(3,230	)
Unearned restricted shares		(25	)		(193	)
Retained earnings		40,859			38,883
Accumulated other comprehensive loss		(1,108	)		(2,389	)
Treasury stock, at cost (786,254 and 774,548 shares at December 31, 2010 and 2009, respectively)		(8,039	)		(7,965	)
Total shareholders' equity		81,104			77,462
Total liabilities and shareholders' equity	$	926,409		$	872,354

See accompanying notes to consolidated financial statements.

- 21 -

SI FINANCIAL GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Amounts)

	Years Ended December 31,
	2010			2009			2008
Interest and dividend income:
Loans, including fees	$	33,381		$	35,440		$	37,192
Securities:
Taxable interest		6,319			7,744			8,516
Tax-exempt interest		38			47			13
Dividends		23			42			412
Other		114			112			366
Total interest and dividend income		39,875			43,385			46,499
Interest expense:
Deposits		9,437			13,183			15,738
Federal Home Loan Bank advances		4,214			5,461			6,324
Subordinated debt		173			217			397
Total interest expense		13,824			18,861			22,459
Net interest income		26,051			24,524			24,040
Provision for loan losses		902			2,830			1,369
Net interest income after provision for loan losses		25,149			21,694			22,671
Noninterest income:
Total other-than-temporary impairment losses on securities		(492	)		(894	)		(7,148	)
Portion of losses recognized in other comprehensive income		-			666			-
Net impairment losses recognized in earnings		(492	)		(228	)		(7,148	)
Service fees		5,093			5,033			5,251
Wealth management fees		4,083			3,912			3,923
Increase in cash surrender value of bank-owned life insurance		290			294			304
Net gain on sale of securities		878			285			463
Mortgage banking fees		1,090			707			202
Net loss in fair value on trading securities and derivatives		(429	)		-			-
Net (loss) gain on disposal of equipment		(5	)		99			-
Other		177			79			141
Total noninterest income		10,685			10,181			3,136
Noninterest expenses:
Salaries and employee benefits		15,487			15,767			16,211
Occupancy and equipment		5,628			5,559			5,733
Computer and electronic banking services		3,785			3,477			3,084
Outside professional services		944			975			842
Marketing and advertising		757			791			800
Supplies		491			524			569
FDIC deposit insurance and regulatory assessments		1,306			1,756			567
Other		3,120			2,556			2,234
Total noninterest expenses		31,518			31,405			30,040
Income (loss) before income tax provision (benefit)		4,316			470			(4,233	)
Income tax provision (benefit)		1,313			35			(1,360	)
Net income (loss)	$	3,003		$	435		$	(2,873	)
Net income (loss) per share:
Basic	$	0.26		$	0.04		$	(0.25	)
Diluted	$	0.26		$	0.04		$	(0.25	)

See accompanying notes to consolidated financial statements.

- 22 -

SI FINANCIAL GROUP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008

(In Thousands, Except Share Amounts)

	Common Stock				Additional Paid-in			Unallocated Common Shares Held			Unearned Restricted			Retained			Accumulated Other Comprehensive			Treasury			Total Shareholders'
	Shares		Dollars		Capital			by ESOP			Shares			Earnings			(Loss) Income			Stock			Equity
Balance at December 31, 2007		12,563,750	$	126	$	51,852		$	(3,876	)	$	(1,181	)	$	39,933		$	504		$	(5,271	)	$	82,087
Cumulative effect adjustment for change in accounting principle for split-dollar life insurance		-		-		-			-			-			(547	)		-			-			(547	)
Comprehensive loss:
Net loss		-		-		-			-			-			(2,873	)		-			-			(2,873	)
Net unrealized loss on available for sale securities, net of reclassification adjustment and tax effects		-		-		-			-			-			-			(3,490	)		-			(3,490	)
Total comprehensive loss																								(6,363	)
Cash dividends declared ($0.16 per share)		-		-		-			-			-			(665	)		-			-			(665	)
Equity incentive plan shares earned		-		-		301			-			467			-			-			-			768
Allocation of 32,295 ESOP shares		-		-		(44	)		323			-			-			-			-			279
Tax deficiency from share-based stock compensation		-		-		(6	)		-			-			-			-			-			(6	)
Treasury stock purchased (270,655 shares)		-		-		-			-			-			-			-			(2,626	)		(2,626	)
Balance at December 31, 2008		12,563,750		126		52,103			(3,553	)		(714	)		35,848			(2,986	)		(7,897	)		72,927
Cumulative effect adjustment for change in accounting  principle for impairment of securities		-		-		-			-			-			2,717			(2,717	)		-			-
Comprehensive income:
Net income		-		-		-			-			-			435			-			-			435
Net unrealized gain on available for sale securities, net of reclassification adjustment and tax effects		-		-		-			-			-			-			3,314			-			3,314
Total comprehensive income																								3,749
Restricted shares activity		-		-		37			-			80			(117	)		-			-			-
Equity incentive plan shares earned		-		-		301			-			441			-			-			-			742
Allocation of 32,295 ESOP shares		-		-		(168	)		323			-			-			-			-			155
Tax deficiency from share-based stock compensation		-		-		(43	)		-			-			-			-			-			(43	)
Treasury stock purchased (11,243 shares)		-		-		-			-			-			-			-			(68	)		(68	)
Balance at December 31, 2009		12,563,750		126		52,230			(3,230	)		(193	)		38,883			(2,389	)		(7,965	)		77,462
Cumulative effect adjustment for change in accounting  principle for embedded credit derivatives		-		-		-			-			-			(652	)		652			-			-
Comprehensive income:
Net income		-		-		-			-			-			3,003			-			-			3,003
Net unrealized gain on available for sale securities, net of reclassification adjustment and tax effects		-		-		-			-			-			-			714			-			714
Net unrealized loss on interest-rate swap derivative		-		-		-			-			-			-			(85	)		-			(85	)
Total comprehensive income																								3,632
Cash dividends declared ($0.09 per share)		-		-		-			-			-			(375	)		-			-			(375	)
Equity incentive plan shares earned		-		-		89			-			168			-			-			-			257
Allocation of 32,295 ESOP shares		-		-		(121	)		323			-			-			-			-			202
Treasury stock purchased (11,706 shares)		-		-		-			-			-			-			-			(74	)		(74	)
Balance at December 31, 2010		12,563,750	$	126	$	52,198		$	(2,907	)	$	(25	)	$	40,859		$	(1,108	)	$	(8,039	)	$	81,104

See accompanying notes to consolidated financial statements.

- 23 -

SI FINANCIAL GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

	Years Ended December 31,
	2010			2009			2008
Cash flows from operating activities:
Net income (loss)	$	3,003		$	435		$	(2,873	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses		902			2,830			1,369
Employee stock ownership plan expense		202			155			279
Equity incentive plan expense		257			742			768
Excess tax expense from share-based compensation		-			43			6
Amortization (accretion) of investment premiums and discounts, net		394			(101	)		(224	)
Amortization of loan premiums and discounts, net		674			282			274
Depreciation and amortization of premises and equipment		1,971			1,926			2,074
Amortization of core deposit intangible		32			42			53
Net gain on sale of securities		(878	)		(285	)		(463	)
Net loss on trading securities		408			-			-
Deferred income tax (benefit) provision		(355	)		275			(2,870	)
Loans originated for sale		(55,634	)		(56,732	)		(13,822	)
Proceeds from sale of loans held for sale		49,107			56,913			14,434
Net gain on sale of loans		(887	)		(577	)		(202	)
Net loss (gain) on disposal of equipment		5			(99	)		-
Net loss (gain) on sales or write-downs of other real estate owned		534			(16	)		(10	)
Increase in cash surrender value of bank-owned life insurance		(290	)		(294	)		(304	)
Gain on bank-owned life insurance		-			(291	)		-
Other-than-temporary impairment losses on securities		492			228			7,148
Change in operating assets and liabilities:
Accrued interest receivable		228			380			(153	)
Other assets		313			(4,480	)		(807	)
Accrued expenses and other liabilities		2,129			52			1,039
Net cash provided by operating activities		2,607			1,428			5,716
Cash flows from investing activities:
Purchases of available for sale securities		(91,716	)		(95,071	)		(100,810	)
Proceeds from sales of available for sale securities		40,144			24,483			19,981
Proceeds from maturities of and principal repayments on available for sale securities		55,515			54,782			47,720
Net decrease (increase) in loans		52,031			41,803			(11,646	)
Purchase of Federal Home Loan Bank stock		-			-			(586	)
Purchases of loans		(53,953	)		(40,876	)		(12,281	)
Proceeds from sale of other real estate owned		3,685			1,865			923
Purchases of premises and equipment		(1,133	)		(3,518	)		(1,808	)
Proceeds from bank-owned life insurance		-			565			-
Net cash (paid) received for branch (sale) acquisitions		-			(619	)		15,805
Net cash provided by (used in) investing activities		4,573			(16,586	)		(42,702	)
Cash flows from financing activities:
Net increase in deposits		1,927			39,804			44,648
Net (decrease) increase  in mortgagors' and investors' escrow accounts		(166	)		(34	)		188
Proceeds from Federal Home Loan Bank advances		23,355			37,300			53,507
Repayments of Federal Home Loan Bank advances		(25,286	)		(60,800	)		(55,526	)
Stock offering escrow, net of expenses		47,556			-			-
Excess tax expense from share-based compensation		-			(43	)		(6	)
Cash dividends on common stock		(375	)		-			(665	)
Treasury stock purchased		(74	)		(68	)		(2,626	)
Net cash provided by financing activities		46,937			16,159			39,520

(continued on next page)

- 24 -

SI FINANCIAL GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(In Thousands)

	Years Ended December 31,
	2010		2009		2008
Net change in cash and cash equivalents		54,117		1,001		2,534
Cash and cash equivalents at beginning of year		24,204		23,203		20,669
Cash and cash equivalents at end of year	$	78,321	$	24,204	$	23,203
Supplemental cash flow information:
Interest paid	$	13,857	$	19,050	$	22,488
Income taxes paid, net		714		731		1,356
Transfer of loans to other real estate owned		1,824		5,529		-

Branch sale and acquisitions:

The Company paid cash of $619,000 for the disposition of net liabilities related to the sale of its branch office located in Gales Ferry, Connecticut in 2009.  In 2008, the Company received cash of $15.8 million for the assumption of net liabilities related to the purchase of branch offices located in Colchester and New London, Connecticut.

	Years Ended December 31,
	2010		2009		2008
Assets:
Loans receivable	$	-	$	3	$	7,441
Accrued interest - loans		-		-		40
Core deposit intangible		-		-		159
Fixed assets, net		-		950		685
Goodwill		-		-		3,545
Other assets		-		96		-
Total assets		-		1,049		11,870
Liabilities:
Deposits		-		1,668		27,668
Accrued interest - deposits		-		-		7
Total liabilities		-		1,668		27,675
Net liabilities	$	-	$	619	$	15,805

See accompanying notes to consolidated financial statements.

- 25 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

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 twenty-one offices in eastern Connecticut.  Its 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.  SI Trust Servicing, a third-party provider of trust outsourcing services for community banks, expands the wealth management products offered by the Bank, and offers trust services to other community banks.  The Company does not conduct any material business other than owning all of the stock of the Bank and making payments on the subordinated debentures held by the Company.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank, 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 consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and general practices within the banking industry.  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 balance sheets and reported amounts of revenues and expenses for the years presented.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, other-than-temporary impairment (“OTTI”) of securities, deferred income taxes and the impairment of long-lived assets.

At December 31, 2010, SI Bancorp, MHC (the “MHC”) was the majority shareholder of the Company.  The MHC was a mutual institution whose members were the depositors of the Bank.  The financial statements included in this Annual Report do not include the transactions and balances of the MHC.  On January 12, 2011, the MHC completed its conversion from the mutual holding company structure to a stock holding company structure.  In connection with that transaction, new SI Financial Group, Inc., a newly-formed stock corporation chartered in Maryland offered shares of stock in a public offering and all outstanding shares of the Company’s common stock (other than those owned by the MHC) were converted into the right to receive 0.8981 shares of new SI Financial Group, Inc. common stock.  As part of the transaction, new SI Financial Group, Inc. became the holding company for the Bank, and the MHC and the former SI Financial Group, Inc. ceased to exist.  References to the Company in this document refer to the former SI Financial Group, Inc., the new SI Financial Group, Inc. and the Bank, as the context requires.  See Note 22 for details.

Reclassifications

Certain amounts in the Company’s consolidated financial statements have been reclassified to conform to the 2010 presentation.  On the income statement, $203,000 of loan fees were reclassified to mortgage banking fees and other noninterest income for the year ended December 31, 2009.  Such reclassifications had no effect on net income.

- 26 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Significant Group Concentrations of Credit Risk

Most of the Company’s activities are with customers located within eastern Connecticut.  The Company does not have any significant concentrations in any one industry or customer.  See Notes 3 and 4 for details relating to the Company’s investment and lending activities.

Cash and Cash Equivalents and Statements of Cash Flows

Cash and due from banks, federal funds sold and short-term investments with original maturities of less than 90 days are recognized as cash equivalents in the statements of cash flows.  Federal funds sold generally mature in one day.  For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.  Cash flows from loans and deposits are reported on a net basis.  The Company maintains amounts due from banks and federal funds sold that, at times, may exceed federally insured limits.  The Company has not experienced any losses from such concentrations.

Fair Value Hierarchy

The Company groups its assets and liabilities in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using unobservable inputs to pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

Securities

Management determines the appropriate classification of securities at the date individual securities are acquired, and the appropriateness of such classification is reassessed at each reporting date.

Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost.  Securities that are held principally for the purpose of trading in the near term are classified as “trading securities.”  Trading securities are carried at fair value, with unrealized gains and losses recognized in earnings.  Interest and dividends are included in net interest income.  Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss), net of taxes.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.  Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

At each reporting period, the Company evaluates all securities classified as available for sale or held to maturity with a decline in fair value below the amortized cost of the investment to determine whether or not the impairment is deemed to have OTTI.  The evaluation is based upon factors such as the creditworthiness of the issuers/guarantors, the underlying collateral, if applicable, and the continuing performance of the securities.  Management also evaluates other facts and circumstances that may be indicative of an OTTI condition.  This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost and near-term prospects of the issuers.  OTTI is required to be recognized (1) if the Company intends to sell the security; (2) if it is “more likely than not” that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, if the present value of expected cash flows is not sufficient to recover the entire amortized cost basis.  Marketable equity securities are evaluated for OTTI based on the severity and duration of the impairment and, if deemed to be other-than-temporary, the declines in fair value are reflected in earnings as realized losses.  For all impaired debt securities that the Company intends to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI through earnings.  Credit-related OTTI for all other impaired debt securities is recognized through earnings and noncredit-related OTTI is recognized in other comprehensive income (loss), net of applicable taxes.  See Notes 3 and 15 for more details.

- 27 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Federal Home Loan Bank Stock

The Bank, as a member of the Federal Home Loan Bank of Boston (“FHLB”), is required to maintain an investment in capital stock of the FHLB.  Based on redemption provisions of the FHLB, the stock has no quoted market value and is carried at cost.  At its discretion, the FHLB may declare dividends on its stock.  The stock is redeemable at par by the FHLB and the Company’s ability to redeem the shares owned is dependent on the redemption practices of the FHLB.  The Company reviews its investment in FHLB stock for impairment based on the ultimate recoverability of the cost basis in the FHLB stock.  No impairment charges were recognized for the years ended December 31, 2010, 2009 and 2008.

Loans Held for Sale

Loans originated and intended for sale in the secondary market are carried at the lower of amortized cost or fair value, as determined by aggregate outstanding commitments from investors or current investor yield requirements.  Net unrealized losses, if any, are recognized through a valuation allowance by charges to noninterest income.  Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold on the trade date and reported within mortgage banking fees on the accompanying statements of operations.

Loans Receivable

Loans receivable are stated at current unpaid principal balances, net of the allowance for loan losses and deferred loan origination fees and costs.  Management has the ability and intent to hold its loans receivable for the foreseeable future or until maturity or pay-off.

A loan is impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement.  Impairment is measured on a loan by loan basis for residential and commercial mortgage loans and commercial business loans by either the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent.  Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring agreement.

The Company periodically may agree to modify the contractual terms of loans.  When a loan is modified and concessions have been made to the original contractual terms, such as reductions of interest rates or deferral of interest or principal payments, due to the borrower’s financial condition, the modification is considered a troubled debt restructuring (“TDR”).  All TDRs are initially classified as impaired.

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SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Management considers all nonaccrual loans and TDRs to be impaired.  In most cases, loan payments less than 90 days past due are considered minor collection delays and the related loans are generally not considered impaired.

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.  Loan losses are charged against the allowance for loan losses when management believes that the uncollectibility of the principal loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance for loan losses when received.  In the determination of the allowance for loan losses, management may obtain independent appraisals for significant properties, if necessary.

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 and evaluations of loans and other relevant factors.

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

o Specific allowance for identified impaired loans.  For such loans that are identified as impaired, an allowance is established when the present value of expected cash flows (or collateral value or observable market price if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan.

o General valuation allowance.  The general component represents a valuation allowance on the remainder of the loan portfolio, after excluding impaired loans.  For this portion of the allowance, loans are segregated by category and assigned an allowance percentage based on historical loan loss experience adjusted for qualitative factors stratified by the following loan segments:  residential one- to four-family, multi-family and commercial real estate, construction, commercial business and consumer.   Management uses a rolling average of historical losses based on the time frame appropriate to capture relevant loss data for each loan segment.  This historical loss factor is adjusted for the following qualitative factors:  levels/trends in delinquencies; level of charge-offs and nonperforming loans; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability and depth of lending management and staff and national and local economic trends and conditions.

The qualitative factors are determined based on the various risk characteristics for each loan segment.  Risk characteristics relevant to each portfolio segment are as follows:

Residential – One- to Four-Family – The Company does not originate conventional loans with loan-to-value ratios exceeding 95% and generally originates loans with loan-to-value ratios in excess of 80% only when secured by first liens on owner-occupied one- to four-family residences.  All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower.  The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality of this segment.

- 29 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Multi-family and Commercial Real Estate – Loans in this segment are originated for the purpose of acquiring, developing, improving or refinancing multi-family and commercial real estate where the property is the primary collateral securing the loan, and the income generated from the property is the primary repayment source.  The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment.  Payments on loans secured by income-producing properties often depend on the successful operation and management of the properties.  Management continually monitors the cash flows of these loans.

Construction – This segment includes loans to individuals, and to a lesser extent builders, to finance the construction of residential dwellings.  The Bank also originates construction loans for commercial development projects.  Upon the completion of construction, the loan generally converts to a permanent mortgage loan.  Credit risk is affected by cost overruns, time to sell at an adequate price and market conditions.

Commercial Business – Loans in this segment are made to businesses and are generally secured by assets of the business.  Repayment is expected from the cash flows of the business.  A weakened economy and reduced viability of the industry in which the customer operates will have a negative impact on the credit quality in this segment.

Consumer – Loans in this segment primarily include home equity lines of credit, and, to a lesser extent, loans secured by marketable securities, passbook or certificate accounts, motorcycles, automobiles and recreational vehicles, as well as unsecured loans.  Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
 

o Unallocated allowance.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

In computing the allowance for loan losses, we do not assign a general valuation allowance to the USDA and SBA loans that we purchase as such loans are fully guaranteed.  Such loans account for $116.5 million, or 19.1% of the loan portfolio at December 31, 2010.

The majority of the Company's loans are collateralized by real estate located in eastern Connecticut. Accordingly, the collateral value of a substantial portion of the Company's loan portfolio and real estate acquired through foreclosure is susceptible to changes in market conditions.

Although management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and the Company’s results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations.  Furthermore, while management believes it has established the allowance for loan losses in conformity with U.S. generally accepted accounting principles, the regulatory agencies, in reviewing the loan portfolio, may request us to increase our allowance for loan losses based on judgments different from ours.  In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be adequate or increases may be necessary should the quality of any loans deteriorate as a result of the factors discussed above.  Any material increase in the allowance for loan losses would adversely affect the Company’s financial condition and results of operations.

- 30 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Interest and Fees on Loans

Interest on loans is accrued and included in net interest income based on contractual rates applied to principal amounts outstanding.  Accrual of interest is discontinued when loan payments are 90 days or more past due, based on contractual terms, or when, in the judgment of management, collectibility of the loan or loan interest becomes uncertain.  Subsequent recognition of income occurs only to the extent payment is received subject to management's assessment of the collectibility of the remaining interest and principal.  A nonaccrual loan is restored to accrual status when it is no longer delinquent and collectibility of interest and principal is no longer in doubt.  Interest collected on nonaccrual loans and impaired loans is recognized only to the extent cash payments are received, and may be recorded as a reduction to principal if the collectibility of the principal balance of the loan is unlikely.

Loan origination fees and direct loan origination costs are deferred, and the net amount is recognized as an adjustment of the related loan's yield utilizing the interest method over the contractual life of the loan.

Derivative Financial Instruments

Derivative financial instruments are recognized as assets and liabilities on the consolidated balance sheets and measured at fair value.

Interest Rate Swap Agreement - The Company uses an interest rate swap agreement, as part of its interest rate risk management strategy, to hedge the interest rate of its subordinated debt.  Interest rate swaps are contracts in which a series of interest rate flows are exchanged over a prescribed period.  The notional amount on which the interest payments are based is not exchanged.  The Company’s swap agreement is a derivative instrument and converts a portion of the Company’s variable-rate debt to a fixed-rate.

The Company has characterized its interest rate swap as a cash flow hedge.  Cash flow hedges are used to minimize the variability in cash flows of assets or liabilities, or forecasted transactions caused by interest rate fluctuations, and are recorded at fair value in other assets or liabilities within the Company’s balance sheets.  Changes in the fair value of these cash flow hedges are initially recorded as a component of other comprehensive income and subsequently reclassified into earnings when the hedged transaction affects earnings.  The ineffective portion of the gain or loss on derivative instrument, if any, is recognized in earnings.

Interest rate derivative financial instruments receive hedge accounting treatment only if they are designated as a hedge and are expected to be, and are, effective in substantially reducing interest rate risk arising from the assets and liabilities identified as exposing the Company to risk.  Those derivative financial instruments that do not meet specified hedging criteria would be recorded at fair value with changes in fair value recorded in earnings.  If periodic assessment indicates derivatives no longer provide an effective hedge, the derivative contracts would be closed out and settled, or classified as a trading activity. For cash flow hedges, the net settlement (upon close-out or termination) that offsets changes in the value of the hedged debt is deferred and amortized into net interest income over the life of the hedged debt.  The portion, if any, of the net settlement amount that did not offset changes in the value of the hedged asset or liability is recognized immediately in noninterest income.

Cash flows resulting from the derivative financial instruments that are accounted for as hedges of assets and liabilities are classified in the cash flow statement in the same category as the cash flows of the items being hedged.

- 31 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Derivative Loan Commitments - Mortgage loan commitments are referred to as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding.  Loan commitments that are derivatives are recognized at fair value on the consolidated balance sheets in other assets and other liabilities with changes in their fair values recorded in noninterest income.

Forward Loan Sale Commitments - To protect against the price risk inherent in derivative loan commitments, the Company utilizes “mandatory delivery” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments.  Mandatory delivery contracts are accounted for as derivative instruments.  Mandatory delivery forward loan sale commitments are recognized at fair value on the consolidated balance sheets in other assets and other liabilities with changes in their fair values recorded in noninterest income.  Subsequent to inception, changes in the fair value of the loan commitment are recognized based on changes in fair value of the underlying mortgage loan due to interest rate changes, changes in the probability the derivative loan commitment will be exercised and the passage of time.  In estimating fair value, the Company assigns a probability to a loan commitment based on an expectation that it will be exercised and the loan will be funded.

The Company estimates the fair value of its forward loan sales commitments using a methodology similar to that used for derivative loan commitments.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets and no condition both constrains the transferee from taking advantage of that right and provides more than a trivial benefit for the transferor and (3) the transferor does not maintain effective control over the transferred assets through either (a) an agreement that both entitles and obligates the transferor to repurchase or redeem the assets before maturity or (b) the ability to unilaterally cause the holder to return specific assets.

Effective January 1, 2010, the Company adopted accounting guidance pertaining to transfers of financial assets.  During the normal course of business, the Company may transfer a portion of a financial asset, for example, a participation loan or the government guaranteed portion of a loan.  In order to be eligible for sales treatment, the transfer of the portion of the loan must meet the criteria of a participating interest.  If it does not meet the criteria of a participating interest, the transfer must be accounted for as a secured borrowing.  In order to meet the criteria for a participating interest, all cash flows from the loan must be divided proportionately, the rights of each loan holder must have the same priority, the loan holders must have no recourse to the transferor other than standard representations and warranties and no loan holder has the right to pledge or exchange the entire loan.

Other Real Estate Owned

Other real estate owned consists of properties acquired through, or in lieu of, loan foreclosure or other proceedings and is initially recorded at fair value at the date of foreclosure, establishing a new cost basis.  Subsequent to foreclosure, the properties are held for sale and are carried at the lower of cost or fair value less estimated costs of disposal.  Any write-down to fair value at the time of acquisition is charged to the allowance for loan losses.  Properties are evaluated regularly to ensure the recorded amounts are supported by current fair values, and a charge to operations is recorded as necessary to reduce the carrying amount to fair value less estimated costs to dispose.  Revenue and expense from the operation of other real estate owned and the provision to establish and adjust valuation allowances are included in noninterest expenses.  Costs relating to the development and improvement of the property are capitalized, subject to the limit of fair value of the collateral.  Gains or losses are included in noninterest expenses upon disposal.  See Note 5 for additional details related to other real estate owned.

- 32 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Premises and Equipment

Land is carried at cost.  Premises and equipment are stated at cost, net of accumulated depreciation and amortization.  Depreciation is charged to operations using the straight-line method over the estimated useful lives of the related assets.  Leasehold improvements are amortized over the shorter of the estimated economic lives of the improvements or the expected lease terms.  Expected terms include lease option periods to the extent that the exercise of such options is reasonably assured.  The estimated useful lives of the assets are as follows:

Classification	Estimated Useful Lives
Buildings	5 to 40 years
Furniture and equipment	3 to 10 years
Leasehold improvements	5 to 20 years

Gains and losses on dispositions are recognized upon realization.  Maintenance and repairs are expensed as incurred and improvements are capitalized.

Bank-owned Life Insurance

Bank-owned life insurance policies are presented on the consolidated balance sheets at cash surrender value.  Changes in cash surrender value, as well as gains on the surrender of policies, are reflected in noninterest income on the consolidated statements of operations and are not subject to income taxes.  See Note 11 for additional discussion.

Servicing

The Company services mortgage loans for others.  Mortgage servicing assets are recognized as separate assets when rights are acquired through purchase or retained through the sale of financial assets.  For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing right based on fair value.  Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.  The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.  Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to the amortized cost.  Impairment is determined by stratifying rights by predominant risk characteristics, such as interest rate, loan type and investor type.  Impairment is recognized through a valuation allowance for an individual stratum, to the extent that the fair value is less than the capitalized amount for the stratum.  Changes in the valuation allowance are reported in loan servicing fee income.

Servicing fee income is recorded for fees earned for servicing loans.  The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned.  The amortization of the mortgage servicing assets are netted against loan servicing fee income.

Impairment of Long-lived Assets

Long-lived assets, including premises and equipment and certain identifiable intangible assets that are held and used by the Company, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an 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 earnings.

- 33 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Goodwill and other intangibles are evaluated for impairment annually, or more frequently if events or changes in circumstances warrant such evaluation.  Financial information for the Colchester and New London, Connecticut branch locations and SI Trust Servicing, which represent the reporting units, is used for evaluating goodwill for impairment.  In performing the goodwill impairment testing and measurement process to assess potential impairment in accordance with applicable guidance, the Company utilized an income approach to determine the fair value of each of the reporting units.  The income approach was based on discounted cash flows derived from assumptions of balance sheet and income statement activity, using observable market data to the extent available.  For the branch impairment evaluations, the Bank’s management developed a financial forecast considering several long-term key business drivers such as anticipated loan and deposit growth.   Significant assumptions used in deriving the discounted cash flow analyses for the branch impairment evaluations included estimates of deposit and loan growth and weighted-average rates of interest for deposits and loans.  Growth estimates for deposits and loans were based on a combination of historical trends and anticipated growth projections.  Weighted average interest rates were utilized to calculate interest income and interest expense based on an analysis of the (1) average rate of interest for major product types and (2) anticipated run-off of existing accounts and projected interest rates at the time of maturity for certificates of deposit accounts.Significant assumptions used in the preparation of the discounted cash flow analysis for SI Trust Servicing included estimates of revenue and operating costs utilizing the current and projected revenue and cost structure.  The implied fair values based on the discounted cash flows were compared to the carrying balances of goodwill for each of the reporting units to determine impairment.  As a result of the goodwill impairment analyses, the Company reduced the carrying value of goodwill related to its Colchester, Connecticut branch acquisition by $37,000 through a charge to earnings during the year ended December 31, 2010.  For the year ended December 31, 2009, the Company reduced the carrying value of goodwill related to its New London, Connecticut branch acquisition by $57,000 through a charge to earnings as a result of the goodwill impairment analysis.  No reduction in the carrying value of goodwill was recognized for the year ended December 31, 2008.  The impairment charges had no effect on the Company’s cash balances or liquidity.  In addition, as goodwill and other intangible assets are not included in the calculation of regulatory capital, the regulatory ratios of the Bank were not affected by these impairment charges.

Other Investments

The Company is a limited partner in two Small Business Investment Companies (“SBICs”), which are licensed by the Small Business Administration.  They provide mezzanine financing and private equity investments to small companies which may not otherwise qualify for standard bank financing.  The Company records its investment in the SBICs at cost and evaluates its investment for impairment on a quarterly basis.  Impairment that is considered by management to be other-than-temporary, results in a write-down of the investment which is recognized as a charge to earnings.  See Note 12 regarding outstanding capital commitments to the limited partnerships.

Trust Assets

Trust assets held in a fiduciary or agency capacity, other than trust cash on deposit at the Bank, are not included in these consolidated financial statements because they are not assets of the Company.  Trust fees are recognized on the accrual basis of accounting.

Related Party Transactions

Directors, officers and affiliates of the Company and the Bank have been customers of and have had transactions with the Bank, and it is expected that such persons will continue to have such transactions in the future.  Management believes that all deposit accounts, loans, services and commitments comprising such transactions were made in the ordinary course of business, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other customers who were not directors, officers or affiliates.  In the opinion of management, the transactions with related parties did not involve more than the normal risk of collectibility, favored treatment or terms or present other unfavorable features.  See Note 13 for details regarding related party transactions.

- 34 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Employee Stock Ownership Plan

The Company accounts for the Employee Stock Ownership Plan (“ESOP”) in accordance with applicable guidance.  The loan to the ESOP is repaid from the Bank’s contributions to the ESOP and dividends payable on common stock held by the ESOP over a period of 15 years.  Unearned compensation applicable to the ESOP is reflected as a reduction of shareholders’ equity on the consolidated balance sheets.  The difference between the average fair value and the cost of the shares allocated by the ESOP is recorded as an adjustment to additional paid-in capital.  Compensation expense is recognized as ESOP shares are committed to be released.  Unallocated ESOP shares are not considered outstanding for calculating earnings per share.  Dividends paid on allocated ESOP shares are charged to retained earnings and dividends paid on unallocated ESOP shares are used to satisfy debt service.  See Note 11 for additional discussion.

Equity Incentive Plan

The Company measures and recognizes compensation cost relating to share-based compensation based on the grant date fair value of the equity instruments issued.  Share-based compensation is recognized on a straight-line basis over the period the employee is required to provide services for the award.   Reductions in compensation expense associated with forfeited options are estimated at the date of grant, and this estimated forfeiture rate is adjusted based on actual forfeiture experience.  The fair value of each restricted stock allocation, equal to the market price at the date of grant, is recorded as unearned restricted shares.  The fair value of each stock option award is determined on the date of grant using the Black-Scholes option pricing model, which includes several assumptions such as expected volatility, dividends, term and risk-free rate for each stock option award.  See Note 11 for additional discussion.

Income Taxes

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method.  Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The Company exercises significant judgment in evaluating the amount and timing of recognition of the resulting tax assets and liabilities.  These judgments require us to make projections of future taxable income.  These judgments and estimates, which are inherently subjective, are reviewed periodically as regulatory and business factors change.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that all or some portion of the deferred tax assets will not be realized.

The Company does not have any uncertain tax positions which require accrual or disclosure at December 31, 2010 and 2009.  In accordance with the provisions of applicable accounting guidance, in future periods, the Company may record a liability for unrecognized tax benefits related to the recognition, derecognition or change in measurement of a tax position as a result of new tax positions, changes in management’s judgment about the level of uncertainty of existing tax positions, expiration of open income tax returns due to the statutes of limitation, status of examinations and litigation and legislative activity.  The Company has elected to report future interest and penalties related to unrecognized tax benefits, if any, as income tax expense in the Company’s consolidated statements of operations.  No interest or penalties were recorded for the years ended December 31, 2010, 2009 and 2008.

Income tax benefits related to stock compensation in excess of grant date fair value less any proceeds on exercise are recognized as an increase to additional paid-in capital upon vesting or exercising and delivery of the stock.  Any income tax effects related to stock compensation that are less than grant date fair value less any proceeds on exercise would be recognized as a reduction of additional paid-in capital to the extent of previously recognized income tax benefits and then through income tax expense for the remaining amount.

- 35 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Comprehensive Income (Loss)

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income (loss).  Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of shareholders’ equity, such items, along with net income (loss), are components of comprehensive income (loss).  See Note 15 for components of other comprehensive income and the related tax effects.

Treasury Stock

Common stock shares repurchased are recorded as treasury stock at cost.

Net Income (Loss) Per Share

Basic net income (loss) per share is calculated by dividing the net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period.  Unvested restricted shares are considered outstanding in the computation of basic net income (loss) per share since the shares participate in dividends and the rights to the dividends are non-forfeitable.  Diluted net income (loss) per share is computed in a manner similar to basic net income (loss) per 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 options.  Treasury shares and unallocated common shares held by the ESOP are not deemed outstanding for net income (loss) per share calculations.

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 426,750 and 467,877 for the years ended December 31, 2010 and 2009, respectively.  For the years ended December 31, 2009 and 2008, all common stock equivalents were anti-dilutive and were not included in the computation of diluted earnings per share.

The computation of net income (loss) per share is as follows:

	Years Ended December 31,
	2010		2009		2008
	(In Thousands, Except Share Amounts)
Net income (loss)	$	3,003	$	435	$	(2,873	)
Weighted average common shares outstanding:
Basic		11,471,107		11,450,541		11,476,571
Effect of dilutive stock options		7,975		-		-
Diluted		11,479,082		11,450,541		11,476,571
Net income (loss) per share:
Basic	$	0.26	$	0.04	$	(0.25	)
Diluted	$	0.26	$	0.04	$	(0.25	)

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SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Business Segment Reporting

Public companies are required to report (i) certain financial and descriptive information about “reportable operating segments,” as defined, and (ii) certain enterprise-wide financial information about products and services, geographic areas and major customers.  An operating segment is a component of a business for which separate financial information is available and evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and evaluate performance.  The Company’s operations are limited to financial services provided within the framework of a community bank, and decisions are generally based on specific market areas and or product offerings.  Accordingly, based on the financial information presently evaluated by the Company’s chief operating decision-maker, the Company’s operations are aggregated in one reportable operating segment.

Advertising Costs

Advertising costs are expensed as incurred.

Recent Accounting Pronouncements

Transfers of Financial Assets – In June 2009, the Financial Accounting Standards Board (“FASB”) issued new requirements related to the accounting for transfers of financial assets, including securitization transactions.  These requirements: (1) eliminate the concept of a qualifying special-purpose entity, (2) change the requirements for derecognizing financial assets and (3) require additional disclosures to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets and an entity’s continuing involvement in transferred financial assets.  These requirements were effective for a reporting entity’s first annual reporting period that begins after November 15, 2009.  Transfers of financial assets occurring on or after the effective date are subject to the new requirements.  The Company adopted these new requirements effective January 1, 2010, which did not have a material impact on the Company’s consolidated financial statements.

Fair Value Measurement Disclosures – In January 2010, the FASB amended its standards related to the disclosure of fair value measurements to require: (1) separate disclosure of significant amounts transferred in and out of Levels 1 and 2 fair value measurement categories, (2) a reconciliation of activity in the Level 3 fair value measurement category to present separately information relating to purchases, sales, issuances and settlements, (3) greater disaggregation of the assets and liabilities for which fair value measurements are presented and (4) expanded disclosure of the valuation techniques and inputs used to measure assets and liabilities in Levels 2 and 3 fair value measurement categories.  The Company adopted these amendments effective January 1, 2010, with the exception of the requirement related to the reconciliation of activity in Level 3 fair value measurement category, which is effective for fiscal years beginning after December 15, 2010.  The adoption of this amendment did not have a material impact on the Company’s consolidated financial statements.

Scope Exception Related to Embedded Credit Derivatives – In March 2010, the FASB amended its standards related to derivatives and hedging to clarify that the only form of an embedded credit derivative that is exempt from embedded derivative bifurcation requirements are those that relate to the subordination of one financial instrument to another.  As a result, entities that have contracts containing an embedded credit derivative feature in a form other than such subordination may need to separately account for the embedded credit derivative feature.  Upon initially adopting the amendments of this update, an entity may elect the fair value option for any investment in a beneficial interest in a securitized financial asset.  The provisions of the update became effective on July 1, 2010.  The Company recorded a cumulative effect adjustment for a change in accounting principle as a reduction to retained earnings and a decrease in accumulated other comprehensive loss of $652,000 related to the adoption of this update.

- 37 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Credit Quality of Financing Receivables and the Allowance for Credit Losses - In July 2010, the FASB issued guidance requiring additional disclosures that facilitate financial statement users’ evaluation of: (1) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (2) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (3) the changes and reasons for those changes in the allowance for credit losses.  For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010 and the disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  Disclosures related to troubled debt restructurings were deferred and are anticipated to be effective for interim and annual reporting periods after June 15, 2011 to coincide with impending guidance for determining what constitutes a troubled debt restructuring.  The Company has provided the required disclosures as of December 31, 2010 in Note 4.

NOTE 2.  RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS

The Bank is required to maintain cash reserve balances against its respective transaction accounts and non-personal time deposits.  At December 31, 2010 and 2009, the Bank was required to maintain cash and liquid asset reserves of $559,000 and $684,000, respectively, and to maintain $3.0 million in the Federal Reserve Bank for clearing purposes to satisfy such reserve requirements at December 31, 2010 and 2009.

NOTE 3.  SECURITIES

Trading securities:

During the third quarter of 2010, the Company elected to record two collateralized debt obligations at fair value, previously reported as available for sale securities, and reclassified them to trading securities in accordance with applicable guidance.  These securities had amortized costs of $248,000 and $1.7 million and fair values of $248,000 and $739,000 at December 31, 2010 and 2009, respectively.  Cumulative unrealized losses at the date of election totaling $652,000 were reclassified from accumulated other comprehensive loss to retained earnings as a cumulative effect adjustment resulting from a change in accounting principle.  The Company does not purchase securities with the intent of selling them in the near term, thus there are no other securities in the trading portfolio.  For the year ended December 31, 2010, the net loss in fair value on trading securities held at the reporting date was $408,000.

- 38 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Available for sale securities:

The amortized cost, gross unrealized gains and losses and fair values of available for sale securities at December 31, 2010 and 2009 are as follows:

	December 31, 2010
	Amortized Cost (1)		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In Thousands)
Debt securities:
U.S. Government and agency obligations	$	23,399	$	197	$	(13	)	$	23,583
Government-sponsored enterprises		29,912		283		(202	)		29,993
Mortgage-backed securities:(2)
Agency - residential		84,408		3,132		(170	)		87,370
Non-agency - residential		11,039		127		(711	)		10,455
Non-agency - HELOC		3,797		-		(598	)		3,199
Corporate debt securities		14,502		252		(37	)		14,717
Collateralized debt obligations		6,466		-		(3,934	)		2,532
Obligations of state and political subdivisions		6,800		157		(52	)		6,905
Tax-exempt securities		140		4		-			144
Foreign government securities		100		-		-			100
Total debt securities		180,563		4,152		(5,717	)		178,998
Equity securities:
Equity securities - financial services		1,024		27		(13	)		1,038
Total available for sale securities	$	181,587	$	4,179	$	(5,730	)	$	180,036

_______________

(1) Net of OTTI write-downs recognized in earnings.

(2) Agency securities refer to debt obligations issued or guaranteed by government corporations or government-sponsored enterprises (“GSEs”).  Non-agency securities, or private-label securities, are the sole obligation of their issuer and are not guaranteed by one of the GSEs or the U.S. Government.

- 39 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

	December 31, 2009
	Amortized Cost (1)		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In Thousands)
Debt securities:
U.S. Government and agency obligations	$	35,945	$	393	$	(109	)	$	36,229
Government-sponsored enterprises		13,980		137		(82	)		14,035
Mortgage-backed securities:(2)
Agency - residential		89,751		3,467		(119	)		93,099
Non-agency - residential		18,690		-		(2,471	)		16,219
Non-agency - HELOC		4,328		-		(2,132	)		2,196
Corporate debt securities		6,979		355		(13	)		7,321
Collateralized debt obligations		8,153		1		(3,116	)		5,038
Obligations of state and political subdivisions		5,003		145		(17	)		5,131
Tax-exempt securities		3,210		9		-			3,219
Foreign government securities		100		-		-			100
Total debt securities		186,139		4,507		(8,059	)		182,587
Equity securities:
Equity securities - financial services		1,043		19		(87	)		975
Total available for sale securities	$	187,182	$	4,526	$	(8,146	)	$	183,562

_________

(1) Net of OTTI write-downs recognized in earnings, other than such noncredit-related amounts reclassified on January 1, 2009 as a cumulative effect adjustment for a change in accounting principle.

(2) Agency securities refer to debt obligations issued or guaranteed by government corporations or government-sponsored enterprises (“GSEs”).  Non-agency securities, or private-label securities, are the sole obligation of their issuer and are not guaranteed by one of the GSEs or the U.S. Government.

At December 31, 2010 and 2009, government-sponsored enterprise securities with an amortized cost of $4.0 million and a fair value of $4.1 million were pledged to secure public deposits and for other purposes required or permitted by law.

The amortized cost and fair value of debt securities by contractual maturities at December 31, 2010 are presented below.  Actual maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the securities may be called or repaid without any penalties.  Because mortgage-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following maturity summary.

	Amortized Cost		Fair Value
	(In Thousands)
Within 1 year	$	2,615	$	2,648
After 1 but within 5 years		42,513		42,848
After 5 but within 10 years		13,845		13,871
After 10 years		22,346		18,607
		81,319		77,974
Mortgage-backed securities		99,244		101,024
Total debt securities	$	180,563	$	178,998

- 40 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The following is a summary of realized gains and losses on the sale of securities for the years ended December 31, 2010, 2009 and 2008:

	Years Ended December 31,
	2010			2009			2008
	(In Thousands)
Gross gains on sales	$	1,096		$	942		$	463
Gross losses on sales		(218	)		(657	)		-
Net gain on sale of securities	$	878		$	285		$	463

The tax provision applicable to the above net realized gains amounted to $299,000, $97,000 and $157,000 for the years ended December 31, 2010, 2009 and 2008, respectively.   Proceeds from the sale of available for sale securities totaled $40.1 million, $24.5 million and $20.0 million, for the years ended December 31, 2010, 2009 and 2008, respectively.

The following tables present information pertaining to securities with gross unrealized losses at December 31, 2010 and 2009, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position.

	Less Than 12 Months				12 Months or More				Total
December 31, 2010:	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In Thousands)
U.S. Government and agency obligations	$	2,053	$	4	$	858	$	9	$	2,911	$	13
Government-sponsored enterprises		16,636		202		-		-		16,636		202
Mortgage-backed securities:
Agency - residential		15,881		170		-		-		15,881		170
Non-agency - residential		2,805		9		6,512		702		9,317		711
Non-agency - HELOC		-		-		3,198		598		3,198		598
Corporate debt securities		3,667		37		-		-		3,667		37
Collateralized debt obligations		28		60		2,504		3,874		2,532		3,934
Obligations of state and political subdivisions		1,493		52		-		-		1,493		52
Equity securities - financial services		-		-		747		13		747		13
Total	$	42,563	$	534	$	13,819	$	5,196	$	56,382	$	5,730

- 41 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

	Less Than 12 Months				12 Months Or More				Total
December 31, 2009:	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In Thousands)
U.S. Government and agency obligations	$	17,114	$	90	$	1,631	$	19	$	18,745	$	109
Government-sponsored enterprises		5,899		82		-		-		5,899		82
Mortgage-backed securities:
Agency - residential		11,126		119		-		-		11,126		119
Non-agency - residential		5,094		80		11,125		2,391		16,219		2,471
Non-agency - HELOC		-		-		2,196		2,132		2,196		2,132
Corporate debt securities		995		13		-		-		995		13
Collateralized debt obligations		1,337		826		3,613		2,290		4,950		3,116
Obligations of state and political subdivisions		483		17		-		-		483		17
Tax-exempt securities		-		-		-		-		-		-
Equity securities - financial services		201		62		734		25		935		87
Total	$	42,249	$	1,289	$	19,299	$	6,857	$	61,548	$	8,146

The Company adopted the provisions of new authoritative accounting guidance related to OTTI on debt securities for the interim period ended March 31, 2009, which was applied to debt securities held by the Company as of January 1, 2009.  For those debt securities for which the fair value of the security is less than its amortized cost and the Company does not intend to sell such security and it is not more likely than not that it will be required to sell such security prior to the recovery of its amortized cost basis (which may be at maturity) less any credit losses, the authoritative accounting guidance requires that the credit component of the OTTI losses be recognized in earnings while the noncredit component is recognized in other comprehensive income (loss), net of related taxes.  As a result, the Company reclassified the noncredit component of the OTTI losses that were previously recognized in earnings during the year ended December 31, 2008.  The reclassification was reflected as a cumulative effect adjustment of $2.7 million, net of taxes, which increased retained earnings and accumulated other comprehensive loss.  The amortized cost basis of these debt securities for which OTTI losses were recognized during 2008 were adjusted by the amount of the cumulative effect adjustment before taxes.

For debt securities with OTTI losses, the Company estimated the portion of loss attributable to credit using a discounted cash flow model in accordance with applicable guidance.  Significant inputs for the non-agency mortgage-backed securities included the estimated cash flows of the underlying collateral based on key assumptions, such as default rate, loss severity and prepayment rate.  Assumptions used can vary widely from loan to loan, and are influenced by such factors as loan interest rate, geographical location of the borrower, borrower characteristics and collateral type.  Significant inputs for the collateralized debt obligations included estimated cash flows and prospective deferrals, defaults and recoveries based on the underlying seniority status and subordination structure of the pooled trust preferred debt tranche at the time of measurement.  Prospective deferral, default and recovery estimates affecting projected cash flows were based on an analysis of the underlying financial condition of the individual issuers, with consideration of the account’s capital adequacy, credit quality, lending concentrations and other factors.  All cash flow estimates were based on the securities’ tranche structure and contractual rate and maturity terms.  The Company utilized the services of an independent third-party valuation firm to obtain information about the structure in order to determine how the underlying collateral cash flows will be distributed to each security issued from the structure.  The present value of the expected cash flows was compared to the Company’s holdings to determine the credit-related impairment loss, if any.

- 42 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

To the extent that continued changes in interest rates, credit movements and other factors that influence fair value of investments occur, the Company may be required to record additional impairment charges for OTTI in future periods.

At December 31, 2010, forty-six debt securities with gross unrealized losses have aggregate depreciation of approximately 9.3% of the Company’s amortized cost basis.  The majority of the unrealized losses related to the Company’s collateralized debt obligations and non-agency mortgage-backed securities.  For the years ended December 31, 2010, 2009 and 2008, the Company recognized $492,000, $228,000 and $7.1 million, respectively, of net impairment charges on investments deemed other-than-temporarily impaired. The following summarizes, by security type, the basis for management’s determination during the preparation of the financial statements of whether the applicable investments within the Company’s securities portfolio were other-than-temporarily impaired at December 31, 2010.
 

U.S. Government and Agency Obligations and Government–Sponsored Enterprises.  The unrealized losses on the Company’s U.S. Government and agency obligations and government-sponsored enterprises related primarily to a widening of the rate spread to comparable treasury securities.  The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments.  Because the decline in fair value is attributable to changes in interest rates and illiquidity and not credit quality, and because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell the securities before their anticipated recovery, which may be at maturity, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2010.

Mortgage-backed Securities - Agency - Residential. The unrealized losses on the Company’s agency–residential mortgage-backed securities were caused by increases in the rate spread to comparable treasury securities.  The Company does not expect these securities to settle at a price less than the amortized cost basis of the investments.  Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before the recovery of their amortized cost basis, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2010.

Mortgage-backed Securities - Non-agency - Residential.  The unrealized losses on the Company’s non-agency-residential mortgage-backed securities are primarily due to the fact that these securities continue to trade well below historic levels, particularly those backed by jumbo or hybrid loan collateral.  In particular, three non-agency residential mortgage-backed securities displayed market pricing significantly below book value and were rated below investment grade at December 31, 2010.  At December 31, 2010, management evaluated credit rating details for the tranche, as well as credit information on subordinate tranches, potential future credit losses and loss analyses.  Additionally, management reviewed reports prepared by an independent third party for certain non-agency mortgage-backed securities.  The Company previously recorded OTTI losses on one of these non-agency mortgage-backed securities totaling $1.1 million related to credit.  The Company did not record any further impairment losses at December 31, 2010 because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity.   See the following table of non-agency mortgage-backed securities rated below investment grade as of December 31, 2010 for more details.

- 43 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Mortgage-backed Securities - Non-agency - HELOC.  The unrealized loss on the Company’s non-agency - HELOC mortgage-backed security is related to one security whose market has been illiquid.  This security is collateralized by home equity lines of credit secured by first and second liens and insured by Financial Security Assurance.  At December 31, 2010, management evaluated credit rating details, collateral support and loss analyses.  All of the unrealized losses on this security relate to factors other than credit.  Because the Company does not intend to sell this security and it is not more likely than not that the Company will be required to sell this security before the recovery of its amortized cost basis, which may be at maturity, the Company did not record an impairment loss at December 31, 2010.

Collateralized Debt Obligations.  The unrealized losses on the Company’s collateralized debt obligations related to investments in pooled trust preferred securities (“PTPS”).  The PTPS market continues to experience significant declines in market value as a result of market saturation.  Transactions for PTPS have been limited and have occurred primarily as a result of distressed or forced liquidation sales.

Management evaluated current credit ratings, credit support and stress testing for future defaults related to the Company’s PTPS.  Management also reviewed analytics provided by the trustee and independent OTTI review and associated cash flow analyses performed by an independent third party.  The unrealized losses on the Company’s PTPS investments were caused by a lack of liquidity, credit downgrades and decreasing credit support.  The increased number of bank and insurance company failures has decreased the level of credit support for these investments.  A number of lower tranche income issues have foregone payments or have received payment in kind through increased principal allocations.  The Company previously recorded OTTI losses on three PTPS investments totaling $1.2 million related to credit factors.  During the third quarter of 2010, the Company elected to fair value two of these investments, which accounted for nearly all of the previously recorded OTTI.  At December 31, 2010, based on the existing credit profile, management does not believe that these investments will suffer from any further credit-related losses.  Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not record additional impairment losses at December 31, 2010.  See the following table of collateralized debt obligations rated below investment grade as of December 31, 2010 for more details.

Equity Securities.  The Company’s investments in marketable equity securities consist of common and preferred stock of companies in the financial services sector.   Management evaluated the near-term prospects of the issuers and the Company’s ability and intent to hold the investments for a reasonable period of time sufficient for an anticipated recovery of fair value.  Although the issuers have shown declines in earnings as a result of the weakened economy, no credit issues have been identified that cause management to believe that the declines in market value are other-than-temporary at December 31, 2010.

- 44 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The following table details the Company’s non-agency mortgage-backed securities that were rated below investment grade at December 31, 2010 (dollars in thousands).

Security	Class (1)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value		Lowest Credit Rating (2)	Total Credit- Related OTTI (3)		Credit Support Coverage Ratios (4)
MBS 1	SSNR, AS	$	2,926	$	-	$	409	$	2,517	CCC	$	-		0.67
MBS 2	SSUP, AS		327		107		-		434	CC		1,059		0.18
MBS 3	PT, AS		423		12		-		435	CC		-		0.82
		$	3,676	$	119	$	409	$	3,386		$	1,059

_________

(1) Class definitions:  PT - Pass Through, AS - Accelerated, SSNR - Super Senior and SSUP - Senior Support.

(2) The Company utilized credit ratings provided by Moody's, S&P and Fitch in its evaluation of issuers.

(3) The OTTI amounts provided in the table represent cumulative credit loss amounts through December 31, 2010.

(4) The credit support coverage ratio, which is the ratio that determines the multiple of credit support, is based on assumptions for the performance of the loans within the delinquency pipeline.  The assumptions used are: current collateral support/((60 day delinquencies x .60)+(90 day delinquencies x .70)+(foreclosures x 1.00) + (other real estate x 1.00)) x .40 for loss severity.

The following table details the Company’s collateralized debt obligations that were rated below investment grade at December 31, 2010 (dollars in thousands).

Security	Class	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value		Lowest Credit Rating (1)	Total Credit- Related OTTI (2)		% of Current Performing Collateral Coverage
CDO 1	B1	$	1,000	$	-	$	784	$	216	CCC	$	-		110.0
CDO 2	B3		1,000		-		782		218	CCC		-		110.0
CDO 3	MEZ		88		-		60		28	CC		35		123.9
CDO 4 (3)	B		248		-		-		248	CC		376		106.4
CDO 5 (3)	C		-		-		-		-	C		809		76.9
CDO 6	A2		2,634		-		1,577		1,057	CCC		-		108.4
CDO 7	A1		1,744		-		731		1,013	CCC		-		137.0
		$	6,714	$	-	$	3,934	$	2,780		$	1,220

_________

(1) The Company utilized credit ratings provided by Moody's, S&P and Fitch in its evaluation of issuers.

(2) The OTTI amounts provided in the table represent cumulative credit loss amounts through December 31, 2010.

(3) These securities were transferred from available for sale to trading securities during the quarter ended  September 30, 2010.

- 45 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The following table summarizes OTTI losses on available for sale securities for the years ended December 31, 2010 and 2009.

	Year Ended December 31, 2010								Year Ended December 31, 2009
	Pooled Trust Preferred Securities		Non-agency Mortgage- backed Securities			Total			Pooled Trust Preferred Securities			Non-agency Mortgage- backed Securities			Total
	(In Thousands)
OTTI related to credit loss recognized in net income	$	-	$	(492	)	$	(492	)	$	(150	)	$	(78	)	$	(228	)
OTTI related to noncredit gain (loss) recognized in accumulated other comprehensive loss		852		702			1,554			(71	)		(595	)		(666	)
Total OTTI gain (loss) on securities	$	852	$	210		$	1,062		$	(221	)	$	(673	)	$	(894	)

The following table presents a roll-forward of the balance of credit losses on the Company’s debt securities for which a portion of OTTI was recognized in other comprehensive income for the years ended December 31, 2010 and 2009.

	Years Ended December 31,
	2010			2009
	(In Thousands)
Balance at beginning of year	$	1,787		$	1,559
Reduction for securities transferred to trading during period		(1,186	)		-
Additional credit losses for which OTTI losses were previously recognized		492			228
Balance at end of year	$	1,093		$	1,787

- 46 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

NOTE 4.  LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loan Portfolio

The composition of the Company's loan portfolio at December 31, 2010 and 2009 is as follows:

	December 31,
	2010			2009
	(In Thousands)
Real estate loans:
Residential - 1 to 4 family	$	270,923		$	306,244
Multi-family and commercial		160,015			159,781
Construction		6,952			11,400
Total real estate loans		437,890			477,425
Commercial business loans:
SBA & USDA guaranteed		116,492			77,310
Other		26,310			30,239
Total commercial business loans		142,802			107,549
Consumer loans:
Home equity		25,533			22,573
Other		3,167			3,513
Total consumer loans		28,700			26,086
Total loans		609,392			611,060
Deferred loan origination costs, net of fees		1,621			1,523
Allowance for loan losses		(4,799	)		(4,891	)
Loans receivable, net	$	606,214		$	607,692

Allowance for Loan Losses

Changes in the allowance for loan losses for the years ended December 31, 2010, 2009 and 2008 are as follows:

	Years Ended December 31,
	2010			2009			2008
	(In Thousands)
Balance at beginning of year	$	4,891		$	6,047		$	5,245
Provision for loan losses		902			2,830			1,369
Loans charged-off		(1,015	)		(4,075	)		(597	)
Recoveries of loans previously charged-off		21			89			30
Balance at end of year	$	4,799		$	4,891		$	6,047

- 47 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Further information pertaining to the allowance for loan losses at December 31, 2010 is as follows:

	Residential 1 to 4 Family		Commercial Real Estate		Construction		Commercial Business		Consumer		Total
	(In Thousands)
Amount of allowance for loan losses for loans deemed to be impaired	$	212	$	290	$	-	$	-	$	-	$	502
Amount of allowance for loan losses for loans not deemed to be impaired		703		2,410		64		790		330		4,297
Total loan loss allowance	$	915	$	2,700	$	64	$	790	$	330	$	4,799
Loans deemed to be impaired	$	3,768	$	6,169	$	990	$	201	$	51	$	11,179
Loans not deemed to be impaired		267,155		153,846		5,962		142,601		28,649		598,213
Total loans	$	270,923	$	160,015	$	6,952	$	142,802	$	28,700	$	609,392

Impaired and Nonaccrual Loans

The following represents an aging of loans at December 31, 2010:

	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total 30 Days or More Past Due		Current		Total Loans		Past Due 90 Days or More and Accruing
	(In Thousands)
Real Estate:
Residential 1 to 4 family	$	2,387	$	1,291	$	2,364	$	6,042	$	264,881	$	270,923	$	-
Multi-family and commercial		597		-		44		641		159,374		160,015		-
Construction		-		-		82		82		6,870		6,952		-
Commercial Business:
SBA & USDA guaranteed		10,718		-		-		10,718		105,774		116,492		-
Other		-		-		46		46		26,264		26,310		-
Consumer:
Home equity		25		50		-		75		25,458		25,533		-
Other		10		1		-		11		3,156		3,167		-
Total	$	13,737	$	1,342	$	2,536	$	17,615	$	591,777	$	609,392	$	-

The following is a summary of information pertaining to impaired loans at December 31, 2010 and 2009.

	December 31,
	2010		2009
	(In Thousands)
Impaired loans without valuation allowance	$	4,974	$	2,107
Impaired loans with valuation allowance		5,212		967
Total impaired loans	$	10,186	$	3,074
Valuation allowance related to impaired loans	$	502	$	267
Nonaccrual loans	$	4,925	$	3,007
Loans past due 90 days or more and still accruing	$	-	$	-

- 48 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The Company reviews and establishes, if necessary, an allowance for certain impaired loans for the amount by which the present value of expected cash flows (or fair value of collateral or observable market value) are lower than the carrying value of the loan.  For the periods presented, the Company concluded that certain impaired loans required no valuation allowance as a result of management’s measurement of impairment. No additional funds are committed to be advanced to those borrowers whose loans are impaired.

The following is a summary of impaired and nonaccrual loans at December 31, 2010:

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Total Nonaccrual Loans
	(In Thousands)
Impaired loans without valuation allowance:
Real Estate:
Residential 1 to 4 family	$	3,212	$	3,212	$	-	$	2,345
Multi-family and commercial		1,513		1,513		-		853
Construction		82		990		-		82
Commercial business		116		201		-		116
Consumer		51		51		-		51
Total		4,974		5,967		-		3,447
Impaired loans with valuation allowance:
Real Estate:
Residential 1 to 4 family		556		556		212		556
Multi-family and commercial		4,656		4,656		290		922
Total		5,212		5,212		502		1,478
Total impaired loans	$	10,186	$	11,179	$	502	$	4,925

Additional information related to impaired loans is as follows:

	Years Ended December 31,
	2010		2009		2008
	(In Thousands)
Average recorded investment in impaired loans	$	6,629	$	7,808	$	9,407
Interest income recognized on impaired loans	$	165	$	65	$	27
Cash interest received on impaired loans	$	295	$	99	$	74

Credit Quality Information

The Company utilizes an eight grade internal loan rating system for all loans in the portfolio, with the exception of its purchased SBA & USDA commercial business loans that are fully guaranteed by the U.S. government, as follows:

o Pass (Ratings 1-4):  Loans in these categories are considered low to average risk.

o Special Mention (Rating 5): Loans in this category are starting to show signs of potential weakness and are being closely monitored by management.

- 49 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

o Substandard (Rating 6): Generally, a loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged.  There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.

o Doubtful (Rating 7):  Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.

o Loss (Rating 8): Loans in this category are considered uncollectible and of such little value that their continuance as loans is not warranted.

Management periodically reviews the ratings described above and the Company’s internal audit function reviews components of the credit files, including the assigned risk ratings, of certain commercial loans as part of its loan review audits.  Management incorporates these results into its review process.

The following table presents the Company’s loans by risk rating at December 31, 2010.

	Real Estate Loans						Consumer				Commercial Business
	Residential 1 to 4 Family		Multi-family Commercial		Construction		Home Equity		Other		SBA & USDA		Other		Total Loans
	(In Thousands)
Not Rated	$	-	$	-	$	-	$	-	$	-	$	116,492	$	-	$	116,492
Pass		267,023		134,484		6,504		25,483		3,166		-		20,105		456,765
Special Mention		834		16,260		366		-		-		-		2,896		20,356
Substandard		3,066		9,271		82		50		1		-		3,239		15,709
Doubtful		-		-		-		-		-		-		70		70
Loss		-		-		-		-		-		-		-		-
Total	$	270,923	$	160,015	$	6,952	$	25,533	$	3,167	$	116,492	$	26,310	$	609,392

Related Party Loans

Related party transactions, including loans with related parties, are discussed in further detail in Note 13.

Loans Held for Sale

Total loans held for sale amounted to $7.4 million and $396,000, consisting of fixed-rate residential mortgage loans, at December 31, 2010 and 2009, respectively.

Loans Serviced for Others

The Company services certain loans that it has sold with and without recourse to third parties and other loans for which the Company acquired the servicing rights.  Loans serviced for others are not included in the Company’s consolidated balance sheets.  At December 31, 2010, 2009 and 2008, the aggregate of loans serviced for others amounted to $148.6 million, $121.1 million and $81.5 million, respectively.

- 50 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The following summarizes mortgage servicing rights capitalized and amortized.

	Years Ended December 31,
	2010			2009			2008
	(In Thousands)
Balance at beginning of year	$	740		$	423		$	421
Additions		439			475			116
Amortization		(202	)		(158	)		(114	)
Balance at end of year	$	977		$	740		$	423
Fair value of mortgage servicing assets	$	1,456		$	1,113		$	700

Contractually specified servicing fees included in loan servicing fee income were $374,000, $286,000 and $224,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

NOTE 5.  OTHER REAL ESTATE OWNED

At December 31, 2010, other real estate owned consisted of four residential and two commercial real estate properties which were held for sale.  Other real estate owned consisted of four residential and four commercial real estate properties which were held for sale at December 31, 2009.   A summary of expenses applicable to other real estate operations for the years ended December 31, 2010, 2009 and 2008, is as follows:

	Years Ended December 31,
	2010		2009			2008
	(In Thousands)
Net loss (gain) from sales or write-downs of other real estate owned, net	$	534	$	(16	)	$	(10	)
Other real estate expense, net of rental income		296		145			113
Expense from other real estate operations, net	$	830	$	129		$	103

NOTE 6.  PREMISES AND EQUIPMENT

Premises and equipment at December 31, 2010 and 2009 are summarized as follows:

	December 31,
	2010			2009
	(In Thousands)
Land	$	2,098		$	2,098
Buildings		6,077			6,043
Leasehold improvements		7,786			7,736
Furniture and equipment		11,388			10,711
Construction in process		21			-
		27,370			26,588
Accumulated depreciation and amortization		(15,247	)		(13,622	)
Premises and equipment, net	$	12,123		$	12,966

- 51 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

At December 31, 2010, construction in process primarily related to incidental branch improvements.  There were no outstanding commitments for the construction of new branches at December 31, 2010 and 2009.

Depreciation and amortization expense was $2.0 million, $1.9 million and $2.1 million for the years ended December 31, 2010, 2009 and 2008, respectively.  See Note 12 for a schedule of future minimum rental commitments pursuant to the terms of noncancelable lease agreements.

NOTE 7.  GOODWILL AND OTHER INTANGIBLES

Goodwill

Goodwill for the years ended December 31, 2010, 2009 and 2008 is summarized as follows:

	Years Ended December 31,
	2010			2009			2008
	(In Thousands)
Balance at beginning of year	$	4,131		$	4,188		$	643
Additions		-			-			3,545
Impairment		(37	)		(57	)		-
Balance at end of year	$	4,094		$	4,131		$	4,188

The Company’s goodwill relates to the acquisition of a third-party provider of trust outsourcing services in Vermont and two branch acquisitions in 2008.  Annually, or more frequently if events or changes in circumstances warrant such evaluation, the Company evaluates its goodwill for impairment.  As a result of the Company’s goodwill impairment evaluation, the Company recorded goodwill impairment of $37,000 relating to the Colchester branch acquisition during the year ended December 31, 2010 and $57,000 relating to the New London branch acquisition during the year ended December 31, 2009.

Based on the continued uncertainties in the financial markets, the Company will continue to perform testing for impairment between annual assessments.  To the extent that additional testing results in the identification of impairment, the Company may be required to record impairment charges related to its goodwill.

Core Deposit Intangibles

In connection with the assumption of $18.4 million of deposit liabilities from the Colchester, Connecticut branch office acquisition in January 2008, the Bank recorded a core deposit premium intangible of $159,000.  The resulting core deposit premium intangible is amortized over five years using the sum-of-the-years-digits method.  Core deposit intangibles are summarized as follows:

	Years Ended December 31,
	2010			2009
	(In Thousands)
Core deposit intangible	$	159		$	159
Accumulated amortization		(127	)		(95	)
Core deposit intangible, net	$	32		$	64

Amortization expense was $32,000, $42,000 and $53,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

- 52 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

NOTE 8.  DEPOSITS

A summary of deposit balances, by type, at December 31, 2010 and 2009 is as follows:

	December 31,
	2010		2009
	(In Thousands)
Noninterest-bearing demand deposits	$	66,845	$	65,407
Interest-bearing accounts:
NOW and money market accounts		247,811		220,759
Savings accounts		56,495		61,312
Certificates of deposit (1)		289,563		311,309
Total interest-bearing accounts		593,869		593,380
Total deposits	$	660,714	$	658,787
_________
(1) Includes brokered deposits of $4.1 million and $1.5 million at December 31, 2010 and 2009, respectively.

Certificates of deposit in denominations of $100,000 or more were $99.5 million and $101.8 million at December 31, 2010 and 2009, respectively.  Effective July 21, 2010, with the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the FDIC permanently raised deposit insurance levels to $250,000 per depositor.  Prior to the increase, deposits in excess of $100,000, with the exception of self-directed retirement accounts which are insured up to $250,000, were not federally insured.

Contractual maturities of certificates of deposit as of December 31, 2010 are summarized below.

	(In Thousands)
2011	$	124,332
2012		67,010
2013		63,674
2014		11,906
2015		19,878
Thereafter		2,763
Total certificates of deposit	$	289,563

- 53 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

A summary of interest expense, by account type, for the years ended December 31, 2010, 2009 and 2008 is as follows:

	Years Ended December 31,
	2010		2009		2008
	(In Thousands)
NOW and money market accounts	$	1,618	$	2,189	$	3,149
Savings accounts (1)		295		408		668
Certificates of deposit (2)		7,524		10,586		11,921
Total	$	9,437	$	13,183	$	15,738

_________

(1) Includes interest expense on mortgagors' and investors' escrow accounts.

(2) Includes interest expense on brokered deposits.

Related Party Deposits

Reference Note 13 for a discussion of related party transactions, including deposits from related parties.

NOTE 9.  BORROWINGS

Federal Home Loan Bank Advances

As a member of the FHLB, the Bank has access to a pre-approved secured line of credit with the FHLB of $10.0 million and the capacity to obtain additional advances up to a certain percentage of the value of its qualified collateral, as defined in the FHLB Statement of Credit Policy.  In accordance with an agreement with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances.  At December 31, 2010 and 2009, there were no advances outstanding under the line of credit.  Other outstanding advances from the FHLB aggregated $114.2 million and $116.1 million at December 31, 2010 and 2009, respectively, at interest rates ranging from 1.56% to 5.02% and 2.39% to 5.02%, respectively.

FHLB advances are secured by the Company’s investment in FHLB stock and other qualified collateral, which is based on a percentage of its outstanding residential first mortgage loans.  The carrying value of Federal Home Loan Bank stock is based on the redemption provisions of the FHLB.

Junior Subordinated Debt Owed to Unconsolidated Trust

SI Capital Trust II (the “Trust”), a wholly-owned subsidiary of the Company, was formed on August 31, 2006.  The Trust had no independent assets or operations, and was formed to issue $8.0 million of trust securities and invest the proceeds thereof in an equivalent amount of junior subordinated debentures issued by the Company.  The trust preferred securities mature in 30 years and bear interest at three-month LIBOR plus 1.70%.  The Company may redeem the trust preferred securities, in whole or in part, on or after September 15, 2011, or earlier under certain conditions.

The Company entered into an interest rate swap agreement on July 1, 2010 to effectively convert the floating rate interest on its junior subordinated debentures to a fixed interest rate.  See Note 17 for a discussion of derivative instruments and hedging activities.

The subordinated debt securities 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 Company has entered into a guarantee, which together with its obligations under the subordinated debt securities and the declaration of trust governing the Trust, including its obligations to pay costs, expenses, debts and liabilities, other than trust securities, provides a full and unconditional guarantee of amounts on the capital securities.  If the Company defers interest payments on the junior subordinated debt securities, or otherwise is in default of the obligations, the Company would be prohibited from making dividend payments to its shareholders.

- 54 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The contractual maturities of borrowings, by year, at December 31, 2010 are as follows:

	FHLB			Subordinated
	Advances			Debt			Total
	(Dollars in Thousands)
2011	$	11,000		$	-		$	11,000
2012		29,100			-			29,100
2013 (1)		23,000			-			23,000
2014 (2)		28,000			-			28,000
2015		16,069			-			16,069
Thereafter (3)		7,000			8,248			15,248
Total	$	114,169		$	8,248		$	122,417
Weighted average rate		3.63	%		4.14	%		3.66	%

_______________

(1) Includes FHLB advance of $2.0 million that is callable during 2011.

(2) Includes FHLB advance of $4.0 million that is puttable during 2012.

(3) Includes FHLB advances of $3.0 million and $2.0 million that are callable during 2011 and 2013, respectively.

- 55 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

NOTE 10.  INCOME TAXES

The components of the income tax provision (benefit) for the years ended December 31, 2010, 2009 and 2008 are as follows:

	Years Ended December 31,
	2010			2009			2008
	(In Thousands)
Current income tax provision (benefit):
Federal	$	1,648		$	(252	)	$	1,509
State		20			12			1
Total current income tax provision (benefit)		1,668			(240	)		1,510
Deferred income tax (benefit) provision:
Federal		(355	)		275			(2,870	)
Total deferred income tax (benefit) provision		(355	)		275			(2,870	)
Total income tax provision (benefit)	$	1,313		$	35		$	(1,360	)

A reconciliation of the anticipated income tax provision, based on the statutory tax rate of 34.0%, to the income tax provision as reported in the statements of operations is as follows:

	Years Ended December 31,
	2010			2009			2008
	(Dollars in Thousands)
Income tax provision (benefit) at statutory rate	$	1,467		$	160		$	(1,439	)
Increase (decrease) resulting from:
Dividends received deduction		(3	)		(10	)		(33	)
Bank-owned life insurance		(99	)		(199	)		(103	)
Tax-exempt income		(13	)		(15	)		(7	)
Compensation and employee benefit plans		61			72			72
Nondeductible expenses		6			6			7
Valuation allowance		(90	)		21			118
State taxes, net of federal tax benefit		13			8			-
Other		(29	)		(8	)		25
Total income tax provision (benefit)	$	1,313		$	35		$	(1,360	)
Effective tax rate		30.4	%		7.4	%		32.1	%

- 56 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The tax effects of temporary differences that give rise to significant components of the deferred tax assets and deferred tax liabilities are presented below:

	Years Ended December 31,
	2010			2009
	(In Thousands)
Deferred tax assets:
Allowance for loan losses	$	1,753		$	1,764
Unrealized losses on available for sale securities		1,949			2,770
Unrealized losses on trading securities		475			-
Depreciation of premises and equipment		839			756
Other-than-temporary impairment		820			1,369
Charitable contribution carry-forward		-			93
Deferred compensation		1,775			1,524
Employee benefit plans		322			391
Capital loss carry-forward		30			5
Interest receivable on nonaccrual loans		185			160
Deferred other real estate owned expenses		124			-
Net unrealized loss on derivative instruments		44			-
Other		270			166
Total deferred tax assets		8,586			8,998
Less valuation allowance		(49	)		(139	)
Total deferred tax assets, net of valuation allowance		8,537			8,859
Deferred tax liabilities:
Unrealized gains on available for sale securities		1,421			1,539
Goodwill and other intangibles		201			100
Deferred loan costs		854			890
Mortgage servicing asset		332			252
Total deferred tax liabilities		2,808			2,781
Deferred tax asset, net	$	5,729		$	6,078

Due to the uncertainties of realization, the Company maintains a valuation allowance of $49,000 related to other-than-temporary impairment losses on certain equity securities at December 31, 2010.  At December 31, 2009, the Company’s charitable contribution carry-forward, primarily relates to the contribution of the Company’s common stock to SI Financial Group Foundation, Inc. in 2004.  The utilization of charitable contributions for any tax year is limited to 10% of taxable income without regard to charitable contributions, net operating losses and dividend received deductions.  An organization is permitted to carry over contributions that exceed the annual 10% limitation as a deduction to the five succeeding tax years provided the organization has sufficient earnings.  At December 31, 2010, all remaining charitable contribution carry-forwards expired.

Retained earnings at December 31, 2010 and 2009 includes a contingency reserve for loan losses of $3.7 million, which represents the tax reserve balance existing at December 31, 1987, and is maintained in accordance with provisions of the Internal Revenue Code applicable to savings banks.  Amounts transferred to the reserve have been claimed as deductions from taxable income, and, if the reserve is used for purposes other than to absorb losses on loans, a federal income tax liability could be incurred.  It is not anticipated that the Company will incur a federal income tax liability relating to this reserve balance, and accordingly, deferred income taxes of approximately $1.3 million at December 31, 2010 and 2009 have not been recognized.

- 57 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Financial service companies doing business in Connecticut are permitted to establish a “passive investment company” (“PIC”) to hold and manage loans secured by real property.  PICs are exempt from Connecticut corporation business tax, and dividends received by the financial services companies from PICs are not taxable.  In January 1999, the Bank established a PIC, as a wholly-owned subsidiary, and in June 2000, began to transfer a portion of its residential and commercial mortgage loan portfolios from the Bank to the PIC.  A substantial portion of the Company’s interest income is now derived from the PIC, an entity whose net income is exempt from State of Connecticut taxes, and accordingly, state income taxes are minimal.  The Bank’s ability to continue to realize the tax benefits of the PIC is subject to the PIC continuing to comply with all statutory requirements related to the operations of the PIC.

With limited exception, the Company is no longer subject to United States federal, state and local income tax examinations by the tax authorities for the years prior to 2007.

NOTE 11.  BENEFIT PLANS

Profit Sharing and 401(k) Savings Plan

The Bank’s Profit Sharing and 401(k) Savings Plan (the “Plan”) is a tax-qualified defined contribution plan for the benefit of its eligible employees.  The Bank’s profit sharing contribution to the Plan is a discretionary amount authorized by the Board of Directors, based on the financial results of the Bank.  An employee’s share of the profit sharing contribution represents the ratio of the employee’s salary to the total salary expense of the Bank.  Participants vest in the Bank’s discretionary profit sharing contributions based on years of service, with 100% vesting attained upon five years of service.  There were no profit sharing contributions for the years ended December 31, 2010, 2009 and 2008.

The Plan also includes a 401(k) feature.  Eligible participants may make salary deferral contributions of up to 100% of earnings subject to Internal Revenue Services limitations.  The Bank makes matching contributions equal to 50% of the participants’ contributions up to 6% of the participants’ earnings.  Participants are immediately vested in their salary deferral contributions, employer matching contributions and earnings thereon.  Bank contributions were $263,000,  $255,000 and $236,000 for the years ended December 31, 2010,  2009 and 2008, respectively.

Group Term Replacement Plan

The Bank maintains the Group Term Replacement Plan to provide a death benefit to executives designated by the Compensation Committee of the Board of Directors.  The death benefits are funded through certain insurance policies that are owned by the Bank on the lives of the participating executives.  The Bank pays the life insurance premiums, which fund the death benefits from its general assets, and is the beneficiary of any death benefits exceeding any executive’s maximum dollar amount specified in his or her split-dollar endorsement policy.  The maximum dollar amount of each executive’s split-dollar death benefit equals three times the executive’s annual compensation less $50,000 pre-retirement and three times final annual compensation post-retirement not to exceed a specified dollar amount.  For purposes of the plan, annual compensation includes an executive’s base compensation, commissions and cash bonuses earned under the Bank’s bonus plan.  Participation in the plan ceases if an executive is terminated for cause or the executive terminates employment for reasons other than death, disability or retirement.  If the Bank wishes to maintain the insurance after a participant’s termination in the plan, the Bank will be the direct beneficiary of the entire death proceeds of the insurance policies.

- 58 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

In January 2008, the Company recorded a cumulative effect adjustment for a change in accounting principle as a reduction to retained earnings and an increase in accrued liabilities of $547,000 related to the post-retirement obligation of the Company.  Total expense recognized under this plan was $89,000, $125,000 and $76,000 for the years ended December 31, 2010,  2009 and 2008, respectively.

Executive Supplemental Retirement Agreements – Defined Benefit

The Bank maintains unfunded supplemental defined benefit retirement agreements with its directors and members of senior management.  These agreements provide for supplemental retirement benefits to certain executives based upon average annual compensation and years of service.  Entitlement of benefits commence upon the earlier of the executive’s termination of employment (other than for cause), at or after attaining age 65 or, depending on the executive, on the date when the executive’s years of service and age total 80 or 78.  Total expense incurred under these agreements for the years ended December 31, 2010,  2009 and 2008 was $810,000, $826,000 and $828,000, respectively.

Performance-Based Incentive Plan

The Bank has an incentive plan whereby all employees are eligible to receive a bonus tied to both the Company and individual performance.  Non-discretionary contributions to the plan require the approval of the Board of Directors’ Compensation Committee.  Total expense recognized was $534,000, $194,000 and $266,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

Supplemental Executive Retirement Plan

The Bank maintains the Supplemental Executive Retirement Plan to provide restorative payments to executives, designated by the Board of Directors, who are prevented from receiving the full benefits of the Bank’s Profit Sharing and 401(k) Savings Plan and Employee Stock Ownership Plan.  The supplemental executive retirement plan also provides supplemental benefits to participants upon a change in control prior to the complete scheduled repayment of the ESOP loan.  For the years ended December 31, 2010, 2009 and 2008, the President and Chief Executive Officer was designated by the Board of Directors to participate in the plan.  Total expense incurred under this plan was $11,000, $5,000 and $5,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

Employee Stock Ownership Plan

In September 2004, the Bank established an Employee Stock Ownership Plan for the benefit of its eligible employees.  The Company provided a loan to the Savings Institute Bank and Trust Company Employee Stock Ownership Plan of $4.9 million which was used to purchase 492,499 shares of the Company’s outstanding stock.  The loan bears interest equal to 4.75% and provides for annual payments of interest and principal over the 15-year term of the loan.

At December 31, 2010, the remaining principal balance on the ESOP debt is payable as follows:

	(In Thousands)
2011	$	304
2012		318
2013		333
2014		349
2015		366
Thereafter		1,645
Total	$	3,315

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SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The Bank has committed to make contributions to the ESOP sufficient to support the debt service of the loan.  The loan is secured by the shares purchased, which are held in a suspense account for allocation among participants as the loan is repaid.  Shares held by the ESOP include the following at December 31, 2010 and 2009:

	December 31,
	2010		2009
	(Dollars In Thousands)
Allocated		155,306		133,485
Committed to be allocated		32,295		32,295
Unallocated		290,660		322,955
Total shares		478,261		488,735
Fair value of unallocated shares	$	2,567	$	1,696

Total compensation expense recognized in connection with the ESOP was $202,000, $155,000 and $279,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

Equity Incentive Plan

The 2005 Equity Incentive Plan (the “Incentive Plan”) allows the Company to 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.  All options have a contractual life of ten years and vest equally over a period of five years beginning on the first anniversary of the date of grant.  At December 31, 2010, a total of 118,873 stock options were available for future grants.  For the years ended December 31, 2010, 2009 and 2008, the Company recognized share-based compensation expense related to the stock option and restricted stock awards of $257,000, $742,000 and $768,000, respectively.

There were 70,000 stock options granted during the year ended December 31, 2010 and no stock option grants during the year ended December 31, 2009.  The fair value of each option granted in 2010 was determined at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:

Expected term (years)		10.00
Expected dividend yield		1.50	%
Expected volatility		38.98	%
Risk-free interest rate		3.70	%
Fair value of options granted	$	2.29

The expected term was based on the estimated life of the stock options.  The dividend yield assumption was based on the Company’s historical and expected dividend pay-outs.  The expected volatility represents the Company’s historical volatility.  The risk-free interest rate was based on the implied yields of U.S. Treasury zero-coupon issues for periods within the contractual life of the awards in effect at the time of the stock option grants.

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SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The following is a summary of activity for the Company’s stock options for the year ended December 31, 2010:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)
Options outstanding at beginning of year		447,750		$	10.34
Options granted		70,000			5.10
Options forfeited		(21,000	)		11.62
Options outstanding at end of year		496,750		$	9.55		5.18
Options exercisable at end of year		414,150		$	10.21		4.47

There were no options exercised for each of the years ended December 31, 2010 and 2009.  The intrinsic value of stock options outstanding and exercisable at December 31, 2010 was $261,000 and $0, respectively.  At December 31, 2010, there was $155,000 of total unrecognized compensation costs related to outstanding stock options, which is expected to be recognized over a weighted average period of 1.9 years.

The following table presents the summary of activity for the Company’s unvested restricted shares for the year ended December 31, 2010.

	Shares			Weighted Average Grant Date Fair Value
Unvested restricted shares at beginning of year		51,449		$	9.06
Restricted shares granted		-			-
Restricted shares vested		(44,249	)		9.86
Restricted shares forfeited		-			-
Unvested restricted shares at end of year		7,200		$	4.17

At December 31, 2010, a total of 2,600 shares were available for future grants.  The aggregate fair value of restricted stock awards that vested during the years ended December 31, 2010, 2009 and 2008 was $281,000, $267,000 and $480,000, respectively.  At December 31, 2010, there was $25,000 of total unrecognized compensation costs related to unvested restricted stock awards granted under the Incentive Plan, which is expected to be recognized over a weighted average period of 1.8 years.

Bank-Owned Life Insurance

The Company has an investment in, and is the beneficiary of, life insurance policies on the lives of certain officers.  The purpose of these life insurance investments is to provide income through the appreciation in cash surrender value of the policies, which is used to offset the costs of various benefit and retirement plans.  The Company’s investment in bank-owned life insurance does not exceed the regulatory limitation of 25 percent of Tier 1 capital plus the allowance for loan and lease losses.  The aggregate cash surrender value of all policies owned by the Company amounted to $9.0 million and $8.7 million at December 31, 2010 and 2009, respectively.  Income earned on these life insurance policies aggregated $290,000, $294,000 and $304,000 for the years ended December 31, 2010, 2009 and 2008, respectively.The Company recognized a gain of $291,000 on death benefit proceeds received from a bank-owned life insurance policy during the year ended December 31, 2009.

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SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

NOTE 12.  OTHER COMMITMENTS AND CONTINGENCIES

In the normal course of business, there are outstanding commitments and contingencies that are not reflected in the accompanying consolidated financial statements.  The Company is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the balance sheets.  The contractual amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

Loan Commitments and Letters of Credit

The contractual amounts of commitments to extend credit represent the amount of potential loss should the contract be fully drawn upon, the customer defaults and the value of any existing collateral be determined as 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 December 31, 2010 and 2009 were as follows:

	December 31,
	2010		2009
	(In Thousands)
Commitments to extend credit:
Future loan commitments	$	10,166	$	8,648
Undisbursed construction loans		6,708		9,843
Undisbursed home equity lines of credit		21,106		18,733
Undisbursed commercial lines of credit		12,239		12,390
Overdraft protection lines		1,311		1,425
Standby letters of credit		115		784
Total commitments	$	51,645	$	51,823

Future loan commitments at December 31, 2010 and 2009 included fixed rate loan commitments of $6.1million and $5.1 million, respectively, at interest rates ranging from 3.500% to 5.750% and 4.375% to 7.000%, respectively.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  The Company evaluates each customer's creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty.  Collateral held varies but may include residential and commercial property, accounts receivable, inventory, property, plant and equipment, deposits and securities.

Undisbursed commitments under construction, home equity or commercial lines of credit are commitments for future extensions of credit to existing customers.  Total undisbursed amounts on lines of credit may expire without being fully drawn upon and therefore, do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Letters of credit are primarily issued to support public or private borrowing arrangements.  Essentially all letters of credit issued have expiration dates within one year.

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SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Loans Sold with Recourse

At December 31, 2010 and 2009, the outstanding balance of loans sold with recourse was $19,000 and $32,000, respectively.  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.  The Company determined that losses relating to loans sold with recourse were not probable and therefore, a liability was not recorded on the consolidated balance sheets at December 31, 2010 and 2009.

Operating Lease Commitments

The Company leases certain of its branch offices and equipment under operating lease agreements that expire at various dates through 2028.  At December 31, 2010, future minimum rental commitments pursuant to the terms of noncancelable lease agreements, by year and in the aggregate, are as follows:

	(In Thousands)
2011	$	1,381
2012		1,280
2013		1,063
2014		994
2015		835
Thereafter		6,178
Total	$	11,731

Certain leases contain options to extend for periods of 5 to 20 years.  The cost of such extensions is not included in the above amounts.  Rental expense charged to operations for cancelable and noncancelable operating leases was $1.3 million, $1.4 million and $1.5 million for the years ended December 31, 2010, 2009 and 2008, respectively.

Rental Income Under Subleases

The Company subleases excess office space under noncancelable operating lease agreements that expire at various dates through 2013.  At December 31, 2010, future minimum lease payments receivable for the noncancelable lease agreements is as follows:

	(In Thousands)
2011	$	44
2012		19
2013		10
Total	$	73

Rental income under the noncancelable lease agreements was $52,000, $45,000 and $14,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

Legal Matters

Various legal claims arise from time to time in the normal course of business.  Management believes that the resolution of these matters will not have a material effect on the Company’s financial condition or results of operations.

- 63 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Investment Commitments

The Bank is a limited partner in two SBICs.  In 1998, the Bank became a limited partner in an SBIC and committed to contribute capital of $1.0 million to the limited partnership.  In 2007, the Bank became a limited partner in a second SBIC and committed to contribute capital of $1.0 million to the limited partnership.  The Bank recognized write-downs totaling $12,000 and $383,000 on its investment in the two SBICs during the years ended December 31, 2010 and 2009, respectively.  The SBICs, with a combined net book value of $793,000 and $513,000 at December 31, 2010 and 2009, respectively, are included in other assets.  At December 31, 2010, the Bank’s remaining off-balance sheet commitment for capital investment in the SBICs was $465,000.

NOTE 13.  RELATED PARTY TRANSACTIONS

Loans Receivable

In the normal course of business, the Bank grants loans to related parties.  Related parties include directors and certain officers of the Company and its subsidiaries and their immediate family members and respective affiliates in which they have a controlling interest.  These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with customers, and did not involve more than the normal risk of collectibility.  At December 31, 2010 and 2009, all related party loans were performing in accordance with their terms.

Changes in loans outstanding to such related parties during the years ended December 31, 2010 and 2009 are as follows:

	Years Ended December 31,
	2010			2009
	(In Thousands)
Balance at beginning of year	$	2,148		$	1,983
Additions		125			613
Repayments		(235	)		(448	)
Balance at end of year	$	2,038		$	2,148

Deposits

Deposit accounts of directors, certain officers and other related parties aggregated $1.0 million and $1.1 million at December 31, 2010 and 2009, respectively.

NOTE 14.  REGULATORY CAPITAL

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to total assets (as defined).  As of December 31, 2010 and 2009, the Bank met the conditions to be classified as “well capitalized” under the regulatory framework for prompt corrective action.  There are no conditions or events since then that management believes have changed the Bank’s regulatory category.  As a savings and loan holding company regulated by the OTS, the Company is not subject to any separate regulatory capital requirements.

- 64 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The Bank's actual capital amounts and ratios at December 31, 2010 and 2009 were as follows:

						For Capital Adequacy					To Be Well Capitalized Under Prompt Corrective
December 31, 2010	Actual					Purposes					Action Provisions
(Dollars in Thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Risk-based Capital Ratio	$	75,823		15.34	%	$	39,543		8.00	%	$	49,428		10.00	%
Tier I Risk-based Capital Ratio		71,173		14.40			19,770		4.00			29,655		6.00
Tier I Capital Ratio		71,173		7.81			36,452		4.00			45,565		5.00
Tangible Equity Ratio		71,173		7.81			13,670		1.50			N/A		N/A

December 31, 2009	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
(Dollars in Thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Risk-based Capital Ratio	$	74,095		14.30	%	$	41,452		8.00	%	$	51,815		10.00	%
Tier I Risk-based Capital Ratio		69,201		13.36			20,719		4.00			31,078		6.00
Tier I Capital Ratio		69,201		8.02			34,514		4.00			43,143		5.00
Tangible Equity Ratio		69,201		8.02			12,943		1.50			N/A		N/A

Reconciliations of the Company’s total capital to the Bank’s regulatory capital are as follows:

	December 31,
	2010			2009
	(In Thousands)
Total capital per consolidated financial statements	$	81,104		$	77,462
Holding company equity not available for regulatory capital		(5,313	)		(5,468	)
Accumulated losses on available for sale securities		1,057			2,295
Intangible assets		(3,853	)		(3,997	)
Disallowed deferred tax asset		(1,822	)		(1,091	)
Total tier 1 capital		71,173			69,201
Adjustments for total capital:
Allowance for loan and credit losses		4,650			4,894
Total capital per regulatory reporting	$	75,823		$	74,095

- 65 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

NOTE 15.  OTHER COMPREHENSIVE INCOME

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income.  Although certain changes in assets and liabilities are reported as a separate component of the equity section of the balance sheet, such items along with net income are components of comprehensive income.

Components of other comprehensive income and related tax effects for the years ended December 31, 2010 and 2009 are as follows:

	December 31, 2010
	Before Tax			Tax			Net of Tax
	Amount			Effects			Amount
	(In Thousands)
Securities:
Unrealized holding losses on available for sale securities	$	(87	)	$	29		$	(58	)
Credit portion of OTTI losses recognized in net income		492			(167	)		325
Noncredit portion of OTTI losses on available for sale securities		1,554			(528	)		1,026
Reclassification adjustment for gains realized in net income		(878	)		299			(579	)
Unrealized holding gains on available for sale securities,  net of taxes		1,081			(367	)		714
Derivative instrument:
Change in fair value of effective cash flow hedging derivative		(129	)		44			(85	)
Other comprehensive income	$	952		$	(323	)	$	629

	December 31, 2009
	Before Tax			Tax			Net of Tax
	Amount			Effects			Amount
	(In Thousands)
Securities:
Unrealized holding gains on available for sale securities	$	5,622		$	(1,831	)	$	3,791
Credit portion of OTTI losses recognized in net income		228			(77	)		151
Noncredit portion of OTTI losses on available for sale securities		(666	)		226			(440	)
Reclassification adjustment for gains realized in net income		(285	)		97			(188	)
Unrealized holding gains on available for sale securities,  net of taxes	$	4,899		$	(1,585	)	$	3,314

- 66 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The components of accumulated other comprehensive loss included in shareholders’ equity are as follows:

	December 31, 2010
	Before Tax			Tax			Net of Tax
	Amount			Effects			Amount
	(In Thousands)
Net unrealized losses on securities	$	(1,599	)	$	544		$	(1,055	)
Noncredit portion of OTTI losses on available for sale securities		48			(16	)		32
Net unrealized loss on effective cash flow hedging derivative		(129	)		44			(85	)
Accumulated other comprehensive loss	$	(1,680	)	$	572		$	(1,108	)

	December 31, 2009
	Before Tax			Tax		Net of Tax
	Amount			Effects		Amount
	(In Thousands)
Net unrealized losses on securities	$	(1,992	)	$	597	$	(1,395	)
Noncredit portion of OTTI losses on available for sale securities		(1,506	)		512		(994	)
Accumulated other comprehensive loss	$	(3,498	)	$	1,109	$	(2,389	)

NOTE 16.  FAIR VALUE OF ASSETS AND LIABILITIES

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The following methods and assumptions were used by the Company in estimating fair value disclosures of its financial instruments:

o Cash and cash equivalents.The carrying amounts of cash and short-term instruments approximate the fair values based on the short-term nature of the assets.

o Trading securities.  The Company holds two securities designated as trading securities.  The determination of the fair value for these securities is determined based on a discounted cash flow methodology.  Certain inputs to the fair value calculation are unobservable and management determined that since an orderly and active market for these securities did not exist, the securities meet the definition of Level 3 securities.

- 67 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

o Securities available for sale. Included in the available for sale category are both debt and equity securities.  The securities measured at fair value in Level 1 are based on quoted market prices in an active exchange market.  Securities measured at fair value in Level 2 are based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data. The Company utilizes Interactive Date Corporation (“IDC”), a third-party, nationally-recognized pricing service to estimate fair value measurements for the majority of its portfolio.  The pricing service evaluates each asset class based on relevant market information considering observable data, but these prices do not represent binding quotes.  The fair value prices on all investments are reviewed for reasonableness by management.  Securities measured at fair value in Level 3 include collateralized debt obligations that are backed by trust preferred securities issued by banks, thrifts and insurance companies. Management determined that an orderly and active market for these securities and similar securities did not exist based on a significant reduction in trading volume and widening spreads relative to historical levels. The Company estimates future cash flows discounted using a rate management believes is representative of current market conditions.  Factors in determining the discount rate include the current level of deferrals and/or defaults, changes in credit rating and the financial condition of the debtors within the underlying securities, broker quotes for securities with similar structure and credit risk, interest rate movements and pricing for new issuances.

o Federal Home Loan Bank stock.  The carrying value of FHLB stock approximates fair value based on the redemption provisions of the FHLB.

o Loans held for sale.  The fair value of loans held for sale is estimated using quoted market prices.

o Loans receivable.  For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values.  The fair value of fixed-rate loans are estimated by discounting the future cash flows using the rates at the end of the period in which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

o Accrued interest receivable.  The carrying amount of accrued interest approximates fair value.

o Deposits.  The fair value of demand deposits, negotiable orders of withdrawal, regular savings, certain money market deposits and mortgagors’ and investors’ escrow accounts is the amount payable on demand at the reporting date.  The fair value of certificates of deposit and other time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities to a schedule of aggregated expected maturities on such deposits.

o Federal Home Loan Bank advances.  The fair value of the advances is estimated using a discounted cash flow calculation that applies current FHLB interest rates for advances of similar maturity to a schedule of maturities of such advances.

o Junior subordinated debt owed to unconsolidated trust.  Rates currently available for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.

o Interest rate swap agreement.  The fair value of the Company’s interest rate swap is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of the derivative.  The pricing analysis is based on observable inputs for the contractual term of the derivative, including the period to maturity and interest rate curves.

- 68 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

o Forward loan sale commitments and derivative loan commitments.  Forward loan sale commitments and derivative loan commitments are based on the fair values of the underlying mortgage loans and the probability of such commitments being exercised.  Significant management judgment and estimation is required in determining these fair value measurements.

o Off-balance sheet instruments.  Fair values for off-balance sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standings.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 and assets measured at fair value on a recurring basis at December 31, 2009.  There were no liabilities measured at fair value on a recurring basis as of December 31, 2009.

	December 31, 2010
	Level 1		Level 2		Level 3		Total
	(In Thousands)
Assets:
Trading securities	$	-	$	-	$	248	$	248
U.S. Government and agency obligations		1,025		22,558		-		23,583
Government-sponsored enterprises		-		29,993		-		29,993
Mortgage-backed securities		-		101,024		-		101,024
Corporate debt securities		-		14,717		-		14,717
Collateralized debt obligations		-		-		2,532		2,532
Obligations of state and political subdivisions		-		6,905		-		6,905
Tax-exempt securities		-		144		-		144
Foreign government securities		-		100		-		100
Equity securities		299		739		-		1,038
Forward loan sale commitments and derivative loan commitments		-		-		163		163
Total assets	$	1,324	$	176,180	$	2,943	$	180,447
Liabilities:
Forward loan sale commitments and derivative loan commitments	$	-	$	-	$	184	$	184
Interest rate swap agreement		-		129		-		129
Total liabilities	$	-	$	129	$	184	$	313

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SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

	December 31, 2009
	Level 1		Level 2		Level 3		Total
	(In Thousands)
U.S. Government and agency obligations	$	1,939	$	34,290	$	-	$	36,229
Government-sponsored enterprises		-		14,035		-		14,035
Mortgage-backed securities		-		111,514		-		111,514
Corporate debt securities		-		7,321		-		7,321
Collateralized debt obligations		-		-		5,038		5,038
Obligations of state and political subdivisions		-		5,131		-		5,131
Tax-exempt securities		-		3,219		-		3,219
Foreign government securities		-		100		-		100
Equity securities		247		728		-		975
Total assets	$	2,186	$	176,338	$	5,038	$	183,562

The following table shows a reconciliation of the beginning and ending balances for Level 3 assets and liabilities:

	Assets			Liabilities
	Collateralized Debt Obligations			Derivatives and Forward Loan Sale Commitments, Net
	(In Thousands)
Balance at January 1, 2009	$	5,392		$	-
Transfers to/from Level 3		-			-
Impairment charges included in net income		(150	)		-
Decrease in fair value of securities included in other comprehensive income		(204	)		-
Balance at December 31, 2009		5,038			-
Transfers to/from Level 3		-			21
Decrease in fair value of securities included in net income		(408	)		-
Decrease in fair value of securities included in other comprehensive income		(1,850	)		-
Balance at December 31, 2010	$	2,780		$	21

- 70 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company may also be required, from time to time, to measure certain other financial assets on a nonrecurring basis in accordance with generally accepted accounting principles.  These adjustments to fair value usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.  The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related individual assets as of December 31, 2010 and 2009.  There were no liabilities measured at fair value on a nonrecurring basis as of December 31, 2010 and 2009.

	At December 31, 2010						Year Ended December 31, 2010
	Level 1		Level 2		Level 3		Total Losses
	(In Thousands)
Impaired loans	$	-	$	-	$	1,198	$	800
Other real estate owned		-		-		1,285		326
Goodwill		-		-		2,540		37
Total assets	$	-	$	-	$	5,023	$	1,163

	At December 31, 2009						Year Ended December 31, 2009
	Level 1		Level 2		Level 3		Total Losses
	(In Thousands)
Impaired loans	$	-	$	-	$	700	$	267
Other real estate owned		-		-		3,680		-
Goodwill		-		-		910		57
Total assets	$	-	$	-	$	5,290	$	324

The Company measures the impairment of loans that are collateral dependent based on the fair value of the collateral (Level 3).  The fair value of collateral used by the Company represents the amount expected to be received from the sale of the property, net of selling costs, as determined by an independent, licensed or certified appraiser using observable market data.  This data includes information such as selling price of similar properties, expected future cash flows or earnings of the subject property based on current market expectations and relevant legal, physical and economic factors.  Losses applicable to write-downs of impaired loans are based on the appraised market value of the underlying collateral, assuming foreclosure of these loans is imminent.

The amount of other real estate owned represents the carrying value of the collateral based on the appraised value of the underlying collateral less estimated selling costs.  The loss on foreclosed assets represents adjustments in the valuation recorded during the time period indicated and not for losses incurred on sales.

In accordance with applicable accounting guidance, the Company evaluates its goodwill for impairment.  As a result of this evaluation, goodwill related to the Company’s Colchester and New London, Connecticut branch acquisitions was written down $37,000 and $57,000, respectively, to its implied fair value during the years ended December 31, 2010 and 2009, respectively.

Summary of Fair Values of Financial Instruments

The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are presented in the following table.  Certain financial instruments and all nonfinancial instruments are exempt from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

- 71 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Management uses its best judgment in estimating the fair value of the Company's financial instruments; however, there are inherent weaknesses in any estimation technique.  Therefore, for substantially all financial instruments, the fair value estimates presented herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction at December 31, 2010 or 2009.  The estimated fair value amounts for 2010 and 2009 have been measured as of their respective year-ends, and have not been re-evaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates.  As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year-end.  The information presented should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only required for a limited portion of the Company's assets.  Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimate, comparisons between the Company's disclosures and those of other banks may not be meaningful.

As of December 31, 2010 and 2009, the recorded carrying amounts and estimated fair values of the Company's financial instruments are as follows:

	December 31, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
	(In Thousands)
Financial Assets:
Noninterest-bearing deposits	$	11,204	$	11,204	$	12,889	$	12,889
Interest-bearing deposits		2,287		2,287		2,350		2,350
Federal funds sold		64,830		64,830		8,965		8,965
Trading securities		248		248		-		-
Available for sale securities		180,036		180,036		183,562		183,562
Loans held for sale		7,371		7,460		396		396
Loans receivable, net		606,214		608,935		607,692		609,155
Federal Home Loan Bank stock		8,388		8,388		8,388		8,388
Accrued interest receivable		3,113		3,113		3,341		3,341
Forward loan sale commitments and derivative loan commitments		163		163		-		-
Financial Liabilities:
Savings deposits		56,495		56,495		61,312		61,312
Demand deposits, negotiable orders of withdrawal and money market accounts		314,656		314,656		286,166		286,166
Certificates of deposit		289,563		293,035		311,309		315,777
Mortgagors' and investors' escrow accounts		3,425		3,425		3,591		3,591
Federal Home Loan Bank advances		114,169		118,799		116,100		118,693
Junior subordinated debt owed to unconsolidated trust		8,248		6,115		8,248		5,734
Forward loan sale commitments and derivative loan commitments		184		184		-		-
Interest rate swap agreement		129		129		-		-

- 72 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Off-Balance Sheet Instruments

The Company assumes interest rate risk, which represents the risk that general interest rate levels will change, as a result of its normal operations.  As a result, the fair values of the Company's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company.  Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk.  However, borrowers with fixed-rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment.  Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment.  Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company's overall interest rate risk.

NOTE 17.  DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Derivative Financial Instruments

The Company has a stand-alone derivative financial instrument in the form of an interest rate swap agreement, which derives its value from underlying interest rates.  These transactions involve both credit and market risk.  The notional amounts are amounts on which calculations, payments and the value of the derivative are based.  Notional amounts do not represent direct credit exposures.  Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any.  Such difference, which represents the fair value of the derivative instruments, is reflected on the Company’s balance sheets as other assets and other liabilities.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements.  The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures and does not expect any counterparties to fail their obligations.

Derivative instruments are generally either negotiated over-the-counter contracts or standardized contracts executed on a recognized exchange.  Negotiated over-the-counter derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise prices and maturity.

Derivative Instruments Designated As Hedging Instruments

The Company uses long-term variable rate debt as a source of funds for use in the Company’s lending and investment activities and other general business purposes.  These debt obligations expose the Company to variability in interest payments due to changes in interest rates.  If interest rates increase, interest expense increases.  Conversely, if interest rates decrease, interest expense decreases.  Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore, generally hedges a portion of its variable-rate interest payments.  To meet this objective, management entered into an interest rate swap agreement, characterized as a cash flow hedge, whereby the Company receives variable interest rate payments determined by three-month LIBOR in exchange for making payments at a fixed interest rate.

- 73 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

At December 31, 2010, the information pertaining to outstanding interest rate swap agreement used to hedge variable rate debt is as follows:

	(Dollars in Thousands)
Notional amount	$	8,000
Weighted average fixed pay rate		2.44	%
Weighted average variable receive rate		0.30	%
Weighted average maturity in years		5.0
Unrealized loss relating to interest rate swap	$	129

No interest rate swap agreements existed at December 31, 2009.

Risk management results for the year ended December 31, 2010 related to the balance sheet hedging of long-term debt indicate that the hedge was 100% effective and that there was no component of the derivative instrument’s loss which was excluded from the assessment of hedge effectiveness.

Derivative Instruments Not Designated As Hedging Instruments

Certain derivative instruments do not meet the requirements to be accounted for as hedging instruments.  These undesignated derivative instruments are recognized on the consolidated balance sheets at fair value, with changes in fair value recorded in other noninterest income.

Derivative Loan Commitments

Mortgage loan commitments are referred to as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding.  The Company enters into commitments to fund residential mortgage loans at specified times in the future, with the intention that these loans will subsequently be sold in the secondary market.  A mortgage loan commitment binds the Company to lend funds to a potential borrower at a specified interest rate and within a specified period of time, generally up to 60 days after inception of the rate lock.

Outstanding derivative loan commitments expose the Company to the risk that the price of the loans arising from exercise of the loan commitment might decline from inception of the rate lock to funding of the loan due to increases in mortgage interest rates.  If interest rates increase, the value of these loan commitments decreases.  Conversely, if interest rates decrease, the value of these loan commitments increases.  The notional amount of undesignated mortgage loan commitments was $13.5 million at December 31, 2010.  The loss in fair value of such commitments, which totaled $162,000, was recorded in other liabilities on the balance sheet and noninterest income on the income statement.

Forward Loan Sale Commitments

To protect against the price risk inherent in derivative loan commitments, the Company utilizes “mandatory delivery” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments.

With a “mandatory delivery” contract, the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date.  If the Company fails to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, it is obligated to pay a “pair-off” fee, based on then-current market prices, to the investor to compensate the investor for the shortfall.

- 74 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The Company expects that these forward loan sale commitments will experience changes in fair value opposite to the change in fair value of derivative loan commitments.  The notional amount of undesignated forward loan sale commitments was $8.0 million at December 31, 2010.  The gain in fair value of such commitments, which totaled $141,000, was recorded in other assets on the balance sheets and noninterest income on the income statement.

NOTE 18.  RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES

Federal regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company.  The total amount of dividends which may be declared in a given calendar year is generally limited to the net income of the Bank for that year plus retained net income for the preceding two years.

At December 31, 2010, the Bank’s retained earnings available for payment of dividends was $700,000.  At December 31, 2009, there were no retained earnings available for payment of dividends.  Accordingly, $75.1 million and $72.1 million of the Company’s equity in the net assets of the Bank were restricted at December 31, 2010 and 2009, respectively.

In addition, the Company is further restricted, under its junior subordinated debt obligation, from paying dividends to its shareholders if the Company has deferred interest payments or has otherwise defaulted on its junior subordinated debt obligation.

Under federal regulation, the Bank is also limited to the amount it may loan to the Company, unless such loans are collateralized by specific obligations.  Loans or advances to the Company by the Bank are limited to 10% of the Bank’s capital stock and surplus on a secured basis.  In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof, would cause the Bank’s capital to be reduced below applicable minimum capital requirements.

NOTE 19.  COMMON STOCK REPURCHASE PROGRAM

In November 2005, the Board of Directors approved a plan to repurchase up to 5%, or approximately 628,000 shares, of the Company’s common stock through open market purchases or privately negotiated transactions.  Stock repurchases under the program are accounted for as treasury stock, carried at cost, and reflected as a reduction in shareholders’ equity.  During the first quarter of 2008, the Company completed its repurchase of all 628,000 shares under this plan.  In February 2008, the Company’s Board of Directors approved the repurchase of up to 5% of the Company’s outstanding common stock, or approximately 596,000 shares.  As a result of the Company’s stock conversion on January 12, 2011, no additional shares will be repurchased under this plan.

The Company repurchased stock primarily to create economic value for its shareholders and to provide additional liquidity to the stock.

- 75 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

NOTE 20.  CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY

Condensed financial information pertaining only to the parent company, SI Financial Group, Inc., is as follows:

Condensed Balance Sheets	December 31,
(In Thousands)	2010		2009
Assets:
Cash and cash equivalents	$	2,315	$	3,583
Available for sale securities		6,430		5,378
Investment in Savings Institute Bank and Trust Company		75,791		71,994
Other assets		5,114		4,768
Total assets	$	89,650	$	85,723
Liabilities and Shareholders' Equity:
Liabilities	$	8,546	$	8,261
Shareholders' equity		81,104		77,462
Total liabilities and shareholders' equity	$	89,650	$	85,723

Condensed Statements of Operations	Years Ended December 31,
(In Thousands)	2010			2009		2008
Interest and dividends on investments	$	128		$	203	$	432
Other income		223			365		188
Total income		351			568		620
Operating expenses		492			532		728
(Loss) income before income taxes and equity in undistributed net income (loss)		(141	)		36		(108	)
Income tax (benefit) provision		(136	)		10		(35	)
(Loss) income before equity in indistributed net income (loss) of subsidiary		(5	)		26		(73	)
Equity in undistributed net income (loss) of subsidiary		3,008			409		(2,800	)
Net income (loss)	$	3,003		$	435	$	(2,873	)

- 76 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

Condensed Statements of Cash Flows	Years Ended December 31,
(In Thousands)	2010			2009			2008
Cash flows from operating activities:
Net income (loss)	$	3,003		$	435		$	(2,873	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Equity in undistributed (income) loss of subsidiary		(3,008	)		(409	)		2,800
Excess tax expense from share-based payment arrangements		-			43			6
Deferred income taxes		72			624			1,685
Other, net		(10	)		(692	)		(707	)
Cash provided by operating activities		57			1			911
Cash flows from investing activities:
Purchase of available for sale securities		(4,900	)		(3,013	)		(5,995	)
Proceeds from maturities of available for sale securities		4,000			2,388			6,700
Proceeds from sale of available for sale securities		10			2,000			2,036
Other, net		783			(937	)		(1,985	)
Cash (used in) provided by investing activities		(107	)		438			756
Cash flows from financing activities:
Treasury stock purchased		(74	)		(68	)		(2,626	)
Cash dividends on common stock		(375	)		-			(665	)
Excess tax expense from share-based payment arrangements		-			(43	)		(6	)
Stock offering costs		(769	)		-			-
Other, net		-			(122	)		(6	)
Cash used in financing activities		(1,218	)		(233	)		(3,303	)
Net change in cash and cash equivalents		(1,268	)		206			(1,636	)
Cash and cash equivalents at beginning of year		3,583			3,377			5,013
Cash and cash equivalents at end of year	$	2,315		$	3,583		$	3,377

- 77 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

NOTE 21.  QUARTERLY DATA (UNAUDITED)

Quarterly results of operations for the years ended December 31, 2010 and 2009 are as follows:

	Year Ended December 31, 2010								Year Ended December 31, 2009
	Fourth		Third		Second		First		Fourth		Third		Second			First
	Quarter		Quarter		Quarter		Quarter		Quarter		Quarter		Quarter			Quarter
	(In Thousands, Except Share Amounts)
Interest and dividend income	$	9,732	$	9,876	$	10,058	$	10,209	$	10,458	$	10,723	$	11,176		$	11,028
Interest expense		3,158		3,357		3,530		3,779		4,298		4,681		4,876			5,006
Net interest and dividend income		6,574		6,519		6,528		6,430		6,160		6,042		6,300			6,022
Provision for loan losses		210		270		252		170		200		700		1,440			490
Net interest and dividend income after provision for loan losses		6,364		6,249		6,276		6,260		5,960		5,342		4,860			5,532
Noninterest income		2,610		2,525		2,937		2,613		2,682		2,684		2,671			2,144
Noninterest expenses		7,542		7,674		8,165		8,137		7,759		7,607		8,445			7,594
Income (loss) before income taxes		1,432		1,100		1,048		736		883		419		(914	)		82
Income tax provision (benefit)		473		262		335		243		263		41		(295	)		26
Net income (loss)	$	959	$	838	$	713	$	493	$	620	$	378	$	(619	)	$	56
Net income (loss) per common share:
Basic	$	0.08	$	0.07	$	0.06	$	0.04	$	0.05	$	0.03	$	(0.05	)	$	-
Diluted	$	0.08	$	0.07	$	0.06	$	0.04	$	0.05	$	0.03	$	(0.05	)	$	-

__________

Quarterly per share data may not add to annual data due to rounding.

NOTE 22.  SECOND STEP CONVERSION

Effective January 12, 2011, the Company completed its public stock offering and the concurrent conversion of Savings Institute Bank and Trust Company from the mutual holding company form of organization to the stock form of organization.  A total of 6,544,493 shares of common stock were sold in the subscription and community offerings at $8.00 per share, including 392,670 shares purchased by the Savings Institute Bank & Trust Company Employee Stock Ownership Plan.  Additional shares totaling 4,032,356 were issued in exchange for shares of the former SI Financial Group, Inc., at an exchange ratio of 0.8981.  Shares outstanding after the stock offering and the exchange total 10,576,849.  Shares of the new SI Financial Group, Inc. common stock began trading on January 13, 2011 on the Nasdaq Global Market under the trading symbol SIFID for a period of 20 trading days.  Thereafter, the trading symbol is SIFI.  As of December 31, 2010, reorganization and offering costs totaling  $769,000 were deferred and will be deducted from the proceeds of the stock offering.  The Company estimates an additional $1.2 million in reorganization costs that had not yet been recorded as of December 31, 2010.  At December 31, 2010, subscriptions received from the stock offering totaled $48.3 million and were held in escrow.

- 78 -

SI FINANCIAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010, 2009 AND 2008

The new SI Financial Group, Inc. retained 40% of the net proceeds and 60% of the net proceeds were distributed to the Bank.  New SI Financial Group, Inc. may use the proceeds it retains from the offering to pay cash dividends to shareholders; invest in securities; finance potential acquisitions of financial institutions or other businesses that are related to banking; and for other general corporate purposes, including contributing additional capital to the Bank.  Additionally, in connection with this transaction, a cash contribution of $500,000 was made to SI Financial Group Foundation, a charitable foundation dedicated to providing assistance with charitable causes to communities within our market area.  Under current OTS regulations, new SI Financial Group, Inc. may not repurchase shares of its common stock during the first year following the completion of the conversion and offering, except to fund equity benefit plans other than stock options, or, with prior regulatory approval, when extraordinary circumstances exist.

The Bank may use its net proceeds it receives from the offering to support internal growth through lending in the communities it serves; invest in securities; finance the possible expansion of its business activities; and for other general corporate purposes.  The Bank does not currently have any agreements or understandings regarding any specific acquisition transactions.

In future filings, prior period and per share amounts will be adjusted to give retroactive recognition of the share exchange ratio applied in the conversion.

- 79 -

EX-21.0

Exhibit 21.0

LIST OF SUBSIDIARIES

Registrant: SI Financial Group, Inc.

Subsidiaries	Percentage Ownership			Jurisdiction or State of Incorporation
Savings Institute Bank and Trust Company		100	%	United States
SI Capital Trust II(1)		100	%	Delaware
803 Financial Corp.(2)		100	%	Connecticut
SI Realty Company, Inc.(2)		100	%	Connecticut
SI Mortgage Company(2)		100	%	Connecticut

(1) In accordance with authoritative guidance on the consolidation of variable interest entities, SI Capital Trust II is not included in the Company’s consolidated financial statements.

(2) Wholly-owned subsidiary of Savings Institute Bank and Trust Company.

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in SI Financial Group, Inc.’s Registration Statement Nos. 333-171879 and 333-171880 on Forms S-8 of our report dated March 28, 2011 relating to our audit of the consolidated financial statements of SI Financial Group, Inc. and subsidiaries as of December 31, 2010 appearing in this Annual Report on Form 10-K.

/s/ Wolf & Company, P.C.

Boston, Massachusetts

March 28, 2011

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Rheo A. Brouillard, certify that:

1. I have reviewed this report on Form 10-K of SI Financial Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))  and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)      Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)      Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)      Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)      Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)      All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)      Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ Rheo A. Brouillard

Rheo A. Brouillard

President and Chief Executive Officer

March 28, 2011

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Brian J. Hull, certify that:

1. I have reviewed this annual report on Form 10-K of SI Financial Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have:

(a)     Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)     Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)      Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)     Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)     All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)     Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ Brian J. Hull

Brian J. Hull

Executive Vice President, Treasurer and Chief Financial Officer

March 28, 2011

EX-32.0

Exhibit 32.0

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADDED BY

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of SI Financial Group, Inc. (the “Company”) on Form 10-K for the fiscal year ended December 31, 2010, as filed with the Securities and Exchange Commission (the “Report”), the undersigned hereby certify pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in this Report fairly presents, in all material respects, the consolidated financial condition and results of operations of the Company as of and for the period covered by this Report.

By: /s/ Rheo A. Brouillard

Rheo A. Brouillard

President and Chief Executive Officer

March 28, 2011

By:  /s/ Brian J. Hull

Brian J. Hull

Executive Vice President, Treasurer and Chief Financial Officer

March 28, 2011