UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2006

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

(Exact name of registrant as specified in its charter)

FEDERAL
(State or other jurisdiction of		59-3764686
incorporation or organization)		(I.R.S. Employer Identification Number)
505 Haines Avenue
Waycross, Georgia		31501
(Address of principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code (800) 342-2824

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 þ NO o

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

Large Accelerated Filer o		Accelerated Filer o		Non-Accelerated Filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. YES o NO þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.

Class		Outstanding at May 5, 2006
Common Stock, $0.01 Par Value		14,143,850

 

 

ATLANTIC COAST FEDERAL CORPORATION

Form 10-Q Quarterly Report

Table of Contents

				Page Number
		PART I.
Item 1.		Financial Statements			2
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			25
Item 4.		Controls and Procedures			26
		PART II.
Item 1.		Legal Proceedings			27
Item 1A		Risk Factors			27
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			27
Item 3.		Defaults Upon Senior Securities			27
Item 4.		Submission of Matters to a Vote of Security Holders			27
Item 5.		Other Information			27
Item 6.		Exhibits			27
Form 10-Q		Signature Page			28
Ex-31.1		Section 302 Certification of CEO
Ex-31.2		Section 302 Certification of CFO
Ex-32		Section 906 Certification of CEO and CFO
Ex-31.1 Section 302 Certification
Ex-31.2 Section 302 Certification
Ex-32 Section 906 Certification

PART I

ITEM 1- FINANCIAL STATEMENTS

ATLANTIC COAST FEDERAL CORPORATION
CONSOLIDATED BALANCE SHEETS
As of March 31, 2006 (unaudited) and December 31, 2005

		2006				2005
ASSETS
Cash and due from financial institutions		$	12,644,279			$	22,041,346
Short-term interest bearing deposits			34,940,317				15,917,657
Total cash and cash equivalents			47,584,596				37,959,003
Other interest bearing deposits in other financial institutions			1,800,000				1,800,000
Securities available for sale			69,061,342				71,964,998
Real estate mortgages held for sale			55,000				99,853
Loans, net of allowance for loan losses of $4,507,750 at March 31, 2006 and $4,586,736 at December 31, 2005			599,294,769				580,440,609
Federal Home Loan Bank stock			7,302,300				7,074,400
Accrued interest receivable			3,004,071				2,722,398
Land, premises and equipment			14,709,108				14,485,195
Bank owned life insurance			20,730,181				20,526,254
Other real estate owned			132,162				310,000
Goodwill			2,661,190				2,661,190
Other assets			4,184,504				3,804,603
Total assets		$	770,519,223			$	743,848,503
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Non-interest-bearing demand		$	41,584,402			$	38,454,438
Interest-bearing demand			68,537,562				79,738,995
Savings and money market			117,061,274				100,259,277
Time			302,930,047				297,868,790
Total deposits			530,113,285				516,321,500
Securities sold under agreements to repurchase			12,000,000				—
Federal Home Loan Bank advances			129,000,000				129,000,000
Accrued expenses and other liabilities			5,367,429				5,610,335
Total liabilities			676,480,714				650,931,835
Commitments and contingencies			—				—
Preferred stock: $0.01 par value; 2,000,000 shares authorized none issued			—				—
Common stock: $0.01 par value; 18,000,000 shares authorized; shares issued: 14,805,969 at March 31, 2006 and at December 31, 2005; shares outstanding: 14,141,350 at March 31, 2006 and at December 31, 2005			148,060				148,060
Additional paid in capital			57,149,959				56,876,105
Unearned employee stock ownership plan(ESOP) shares of 360,778 at March 31, 2006 and 372,416 at December 31, 2005			(3,607,780	)			(3,724,160	)
Retained earnings			49,842,062				49,193,384
Accumulated other comprehensive income (loss)			109,122				26,193
Treasury stock, at cost, 664,619 shares at March 31, 2006 and at December 31, 2005			(9,602,914	)			(9,602,914	)
Total stockholders’ equity			94,038,509				92,916,668
Total liabilities and stockholders’ equity		$	770,519,223			$	743,848,503

The accompanying notes are an integral part of these unaudited consolidated financial statements.

ATLANTIC COAST FEDERAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)

		Three Months
		Ended March 31,
		2006				2005
Interest and dividend income
Loans, including fees		$	9,407,213			$	7,842,180
Securities and interest-bearing deposits in other financial institutions			1,107,665				528,141
Securities purchased under agreements to resell			—				72,411
Total interest and dividend income			10,514,878				8,442,732
Interest expense
Deposits			3,851,923				2,425,251
Federal Home Loan Bank advances			1,326,949				1,052,350
Securities sold under agreements to repurchase			57,380				—
Total interest expense			5,236,252				3,477,601
Net interest income			5,278,626				4,965,131
Provision for loan losses			76,380				523,240
Net interest income after provision for loan losses			5,202,246				4,441,891
Noninterest income
Service charges and fees			1,341,763				895,733
Net loss on available for sale securities			(176,653	)			—
Gain on sale of real estate mortgages held for sale			3,124				11,399
Gain on sale of foreclosed assets			2,961				852
Commission income			81,147				99,244
Interchange fees			195,414				180,442
Bank owned life insurance earnings			203,927				50,952
Other			(13,451	)			48,014
			1,638,232				1,286,636
Noninterest expense
Compensation and benefits			2,627,017				2,231,464
Occupancy and equipment			507,724				373,612
Data processing			365,423				249,073
Advertising			215,830				106,709
Outside professional services			493,200				605,218
Interchange charges			166,469				147,049
Collection expense and repossessed asset losses			82,673				79,344
Telephone			122,894				116,365
Other			652,632				598,118
			5,233,862				4,506,952
Income before income tax expense			1,606,616				1,221,575
Income tax expense			499,680				439,183
Net income		$	1,106,936			$	782,392
Earnings per common share:
Basic		$	0.08			$	0.06
Diluted		$	0.08			$	0.06
Dividends declared per common share		$	0.09			$	0.05

The accompanying notes are an integral part of these unaudited consolidated financial statements.

ATLANTIC COAST FEDERAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

																		ACCUMULATED
						ADDITIONAL				UNEARNED								OTHER
		COMMON				PAID IN				ESOP				RETAINED				COMPREHENSIVE				TREASURY				TOTAL
		STOCK				CAPITAL				STOCK				EARNINGS				INCOME(LOSS)				STOCK				EQUITY
For the three months ended March 31, 2006
Balance at January 1, 2006		$	148,060			$	56,876,105			$	(3,724,160	)		$	49,193,384			$	26,193			$	(9,602,914	)		$	92,916,668
ESOP shares earned, 11,638 shares							53,066				116,380																169,446
Management restricted stock expense							145,241																				145,241
Stock options expense							75,547																				75,547
Dividends declared ( $.09 per share)															(458,258	)											(458,258	)
Comprehensive income:
Net income															1,106,936												1,106,936
Other comprehensive income(loss)																			82,929								82,929
Total comprehensive income																											1,189,865
Balance at March 31, 2006 (unaudited)		$	148,060			$	57,149,959			$	(3,607,780	)		$	49,842,062			$	109,122			$	(9,602,914	)		$	94,038,509
For the three months ended March 31, 2005
Balance at January 1, 2005		$	145,475			$	56,332,850			$	(4,189,680	)		$	46,412,522			$	(904	)		$	—			$	98,700,263
ESOP shares earned, 11,638 shares							36,457				116,380																152,837
Dividend declared ($.05 per share)															(290,950	)											(290,950	)
Comprehensive income:
Net income															782,392												782,392
Other comprehensive income(loss)																			174,104								174,104
Total comprehensive income																											956,496
Balance at March 31, 2005 (unaudited)		$	145,475			$	56,369,307			($	4,073,300	)		$	46,903,964			$	173,200			$	—			$	99,518,646

The accompanying notes are an integral part of these unaudited consolidated financial statements.

ATLANTIC COAST FEDERAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

		Three Months
		Ended March 31,
		2006				2005
Cash flows from operating activities
Net income		$	1,106,936			$	782,392
Adjustments to reconcile net income to to net cash from operating activities:
Provision for loan losses			76,380				523,240
Net loss on available for sale securities			176,653				—
Gain on sale of real estate mortgages held for sale			(3,124	)			(11,399	)
Loans originated for sale			(235,000	)			(1,936,921	)
Proceeds from loan sales			282,977				1,259,774
Gain on sale of other real estate owned			(2,961	)			(852	)
Loss on disposal of equipment			30,297				—
ESOP compensation expense			169,446				152,837
Share-based compensation expense			220,788				—
Net depreciation and amortization			487,407				434,232
Net change in accrued interest receivable			(281,673	)			(208,412	)
Increase in bank owned life insurance			(203,927	)			(50,951	)
Net change in other assets			(156,130	)			75,404
Net change in accrued expenses and other liabilities			(287,041	)			350,672
Net cash from operating activites			1,381,028				1,370,016
Cash flows from investing activities
Net change in securities purchased under agreements to resell			—				11,800,000
Proceeds from maturities and payments of securites available for sale			4,605,571				10,948,755
Proceeds from the sales of securities available for sale			—				—
Purchase of securities available for sale			(2,059,437	)			(8,000,000	)
Loans purchased			(7,782,005	)			(17,499,749	)
Net change in loans			(11,420,604	)			(13,465,317	)
Expenditures on premises and equipment			(525,603	)			(1,167,688	)
Proceeds from the sale of other real estate owned			276,879				157,546
Purchase of FHLB stock			(227,900	)			(663,000	)
Purchase of bank owned life insurance			—				(10,000,000	)
Net change in other investments			—				900,000
Net cash from investing activities			(17,133,099	)			(26,989,453	)

(Continued)

ATLANTIC COAST FEDERAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

		Three Months
		Ended March 31,
		2006				2005
Cash flows from financing activities
Net increase in deposits		$	13,791,785			$	25,759,617
FHLB advances			—				10,000,000
Net change in securities sold under agreements to repurchase			12,000,000				—
Repayment of FHLB advances			—				(657,144	)
Dividends paid			(414,123	)			—
Net cash from financing activities			25,377,662				35,102,473
Net change in cash and cash equivalents			9,625,591				9,483,036
Cash and equivalents beginning of period			37,959,003				25,707,885
Cash and equivalents at end of period		$	47,584,594			$	35,190,921
Supplemental information:
Interest paid		$	5,160,967			$	3,407,687
Income taxes paid			765,000				—
Supplemental noncash disclosures:
Loans transferred to other real estate		$	96,080			$	523,959
Other real estate exchanged for loans			—				290,950

The accompanying notes are an integral part of these unaudited consolidated financial statements.

ATLANTIC COAST FEDERAL CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements include the accounts of Atlantic Coast Federal Corporation (or the “Company”) and its wholly owned subsidiary, Atlantic Coast Federal (the “Bank”). Also included in the unaudited consolidated statements is Atlantic Coast Holdings, Inc. (“Holdings”) a wholly owned subsidiary of the Bank, which manages and invests in certain securities, and owns 100% of the common stock and 85% of the Preferred Stock of Coastal Properties, Inc., a real estate investment trust (the “REIT”). All significant inter-company balances and transactions have been eliminated in consolidation.

The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (all of which are normal and recurring in nature) considered necessary for a fair presentation have been included. Operating results for the three-month period ending March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The 2005 Atlantic Coast Federal Corporation consolidated financial statements, as presented in the Company’s Form 10-K, should be read in conjunction with these statements.

Some items in the prior year Form 10-Q were reclassified to conform to the current presentation.

NOTE 2. USE OF ESTIMATES

The preparation of consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of income and expenses during the reported periods. Actual results could differ from current estimates. Estimates associated with the allowance for loan losses, realization of deferred tax assets, valuation of intangible assets, including goodwill and the fair values of securities and other financial instruments are particularly susceptible to material change in the near term.

NOTE 3. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS

Statement of Financial Accounting Standards (SFAS) No. 123, Revised, requires all public companies to record compensation cost for stock or stock options awarded to employees in return for employee service. The cost is measured at the grant-date fair value of the award and recognized as compensation expense over the employee service period, which is normally the vesting period. This SFAS was to apply to awards granted or modified after the first quarter or year beginning after June 15, 2005. However, the Securities and Exchange Commission (“SEC”) has announced that they will allow public companies to delay adoption until the first interim period of 2006. The Company elected to early adopt SFAS No. 123, Revised as of July 1, 2005, to account for awards made during the quarter then ended. The Company’s stockholders approved a stock option plan and a stock award plan for recognition and retention of key employees and directors at the stockholders’ annual meeting on May 27, 2005. Initial awards under the 2005 Recognition and Retention Plan (the “Recognition Plan”) were made on July 1, 2005 and initial awards under our 2005 Stock Option Plan (the “Stock Option Plan”) were made on July 28, 2005.

ATLANTIC COAST FEDERAL CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Unaudited)

NOTE 3. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS (Continued)

The Financial Accounting Standards Board (FASB) has issued FASB Staff Position (FSP) 115-1 and 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. The guidance in this FSP addresses the determination of when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. The FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends SFAS No. 115,”Accounting for Certain Investments in Debt and Equity Securities,” and SFAS No. 124, “Accounting for Certain Investments Held by Not-for-Profit Organizations.” The guidance in this FSP also nullifies certain requirements of EITF No. 03-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”. The guidance in FSP 115-1 and 124-1 is required to be applied to reporting periods beginning after December 15, 2005. Considering the latest guidance in FSP 115-1 and 124-1, management believes the Company’s current accounting for investment securities is appropriate for evaluating and accounting for any impairment of its investment security portfolio.

NOTE 4. AVAILABLE FOR SALE SECURITIES

For purposes of managing the net interest margin, the Company identified certain available for sale securities with an approximate carrying value of $15.8 million at March 31, 2006, for disposal during the second quarter of 2006. The securities, which are FHLB debt securities, have an original purchase cost of $16.0 million and a weighted average yield of 3.84%. Due to the planned sale of the securities, the $177,000 difference between the original acquired cost and the market value at March 31, 2006, was deemed to be an other-than-temporary loss and, accordingly, was charged to earnings as a net loss on securities available for sale for the three months ended March 31, 2006.

The fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income(loss) after reflecting the impairment loss as of March 31, 2006, and as of December 31, 2005 were as follows:

						Gross				Gross
						Unrealized				Unrealized
		Fair Value				Gains				Losses
March 31, 2006
Government-sponsored enterprises		$	31,924,591			$	—			$	(245,225	)
State and municipal			3,995,100				2,700				(30,305	)
Mortgage-backed			33,141,651				485				(529,664	)
		$	69,061,342			$	3,185			$	(805,194	)
December 31, 2005
Government-sponsored enterprises		$	32,078,971			$	405			$	(262,687	)
State and municipal			5,361,261				551				(39,479	)
Mortgage-backed			34,524,766				30,570				(390,525	)
		$	71,964,998			$	31,526			$	(692,691	)

The Company evaluates securities for other-than-temporary impairment, at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its

ATLANTIC COAST FEDERAL CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Unaudited)

NOTE 4. AVAILABLE FOR SALE SECURITIES (Continued)

investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or one of its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The unrealized losses of $805,194 and $692,691 at March 31, 2006 and December 31, 2005, are largely due to the current interest rate environment, relative to the interest rate of the securities, and as the security approaches maturity the fair value will return to par.

NOTE 5. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under agreements to repurchase are secured by mortgage-backed securities with a carrying amount of $13,120,000 at March 31, 2006. The Company had no such agreements as of December 31, 2005.

Securities sold under agreements to repurchase are financing arrangements that mature in February 2011, or, beginning in February 2007, may be terminated by the lender each following quarter. At maturity or termination, the securities underlying the agreements are returned to the Company. Information concerning securities sold under agreements to repurchase as of, and for the three months ended March 31, 2006 is summarized as follows:

Average daily balance		$	5,034,000
Average interest rate			4.53	%
Maximum month-end balance		$	12,000,000
Weighted average interest rate at period end			4.53	%

The interest rate remains fixed at 4.53% until February 2007, at which time it converts to a floating rate of 8.50% minus 3-month LIBOR up to a maximum rate of 5.75%.

NOTE 6. DIVIDENDS

During the first quarter of 2006, the Company’s board of directors declared a regular quarterly cash dividend at a rate of $0.09 per share. The dividend is payable on May 1, 2006 for stockholders of record on April 14, 2006. Atlantic Coast Federal, MHC (MHC) which holds 8,728,500 shares, or 61.7% of the Company’s total outstanding stock has informed the Company that it will waive receipt of the first quarter dividend on their owned shares.

Total dividends charged to retained earnings for the three months ended March 31, 2006 was $458,258.

NOTE 7. EARNINGS PER COMMON SHARE

Basic earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period, reduced for average unallocated ESOP shares and average unearned restricted stock awards. Diluted earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period increased for the dilutive effect of unvested stock options and stock awards. The dilutive effect of the unvested stock options and stock awards is calculated under the treasury stock method utilizing the average market value of the Company’s stock for the period. A reconciliation of the numerator and denominator of the basic and diluted earnings per common share computation for the three months ended March 31, 2006 and 2005, is as follows:

ATLANTIC COAST FEDERAL CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Unaudited)

NOTE 7. EARNINGS PER COMMON SHARE (Continued)

		2006				2005
Basic
Net income		$	1,106,936			$	782,392
Weighted average common shares outstanding			14,141,350				14,547,500
Less: Average unallocated ESOP shares			(372,416	)			(418,968	)
Average unvested restricted stock awards			(258,469	)			—
Average Shares			13,510,465				14,128,532
Basic earnings per common share		$	0.08			$	0.06
Diluted
Net Income		$	1,106,936			$	782,392
Weighted average common shares outstanding per common share			13,510,465				14,128,532
Add: Dilutive effects of full vesting of stock awards			69,686				—
Average shares and dilutive potential common shares			13,580,151				14,128,532
Diluted earnings per common share		$	0.08			$	0.06

Stock options for 534,400 shares of common stock were not considered in computing diluted earnings per common share for the three months ended March 31, 2006. There were no potentially dilutive securities for the three months ended March 31, 2005.

ATLANTIC COAST FEDERAL CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Unaudited)

NOTE 8. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) components and related taxes for the three months ended March 31, 2006 and 2005 were as follows:

		2006				2005
Unrealized holding gains and (losses) on securities available for sale		$	(317,496	)		$	(178,619	)
Less reclassification adjustments for (gains) losses recognized in income			176,653				—
Net unrealized gains and (losses)			(140,843	)			(178,619	)
Tax effect			50,719				67,875
Net-of-tax amount			(90,124	)			(110,744	)
Change in fair value of derivatives used for cash flow hedges			279,118				459,433
Tax effect			(106,065	)			(174,585	)
Net-of-tax amount			173,053				284,848
Other comprehensive income (loss)		$	82,929			$	174,104

ATLANTIC COAST FEDERAL CORPORATION

Forward-Looking Statements

     This Form 10-Q contains forward-looking statements that are statements that are not historical or current facts. When used in this filing and in future filings by Atlantic Coast Federal Corporation with the Securities and Exchange Commission, in Atlantic Coast Federal Corporation’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases, “anticipate,” “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” will continue,” “is anticipated,” “estimated,” “projected,” or similar expressions are intended to identify, “forward looking statements.” Such statements are subject to risks and uncertainties, including but not limited to changes in economic conditions in Atlantic Coast Federal Corporation’s market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in Atlantic Coast Federal Corporation’s market area, changes in the position of banking regulators on the adequacy of our allowance for loan losses, and competition, all or some of which could cause actual results to differ materially from historical earnings and those presently anticipated or projected.

     Atlantic Coast Federal Corporation wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and advise readers that various factors, including regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investing activities, and competitive and regulatory factors, could affect Atlantic Coast Federal Corporation’s financial performance and could cause Atlantic Coast Federal Corporation’s actual results for future periods to differ materially from those anticipated or projected.

     Atlantic Coast Federal Corporation does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

Critical Accounting Policies

     Certain of our accounting policies are important to the portrayal of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances that could affect these judgments include, but without limitation, changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses, determining the fair value of securities, accounting for deferred income taxes, and the valuation of intangible assets including goodwill. Atlantic Coast Federal Corporation’s accounting policies are discussed in detail in Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K filed with the Securities and Exchange Commission.

     The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required by considering the past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated value of any underlying collateral, whether the loan was originated through the Company’s retail network or through a broker, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.

     The allowance consists of specific and general components. The specific component relates to loans that are individually evaluated and determined to be impaired. Loans individually evaluated are generally large balance and/or complex loans, such as multi-family and commercial real estate loans. This evaluation is often based on significant estimates and assumptions due to the level of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. The general component relates to large groups of small balance homogeneous loans that are evaluated in the aggregate based on historical loss experience adjusted for current factors.

     We believe that the allowance for loan losses and related provision expense are particularly susceptible to material change in the near term as a result of significant changes in individual borrower circumstances on larger balance loans. The provision for loan loss expense was $76,000 for the three months ended March 31, 2006, and $523,000 for the same period in 2005. This decrease was due to the recording of a $400,000 specific reserve in the first quarter of 2005 on one impaired loan relationship; there were no significant changes to specific reserves in the first quarter of 2006.

     Securities available for sale are carried at fair value, with unrealized holding gains and losses reported separately in accumulated other comprehensive income (loss), net of tax. Atlantic Coast Federal Corporation obtains market values from a third party on a monthly basis in order to adjust the securities to fair value. Other comprehensive income (loss) resulting from changes in the fair market value of Atlantic Coast Federal Corporation’s available for sale securities portfolio totaled $(90,000) and $(111,000) for the three months ended March 31, 2006 and 2005, respectively. Additionally, securities available for sale are required to be written down to fair value when a decline in fair value is not temporary; therefore, future changes in the fair value of securities could have a significant impact on Atlantic Coast Federal Corporation’s operating results. In determining whether a market value decline is other than temporary, management considers the reason for the decline, the extent of the decline and the duration of the decline.

     Atlantic Coast Federal Corporation assesses the carrying value of intangible assets and goodwill at least annually in order to determine if such intangible assets are impaired. In reviewing the carrying value of intangible assets, Atlantic Coast Federal Corporation assesses the recoverability of such assets by evaluating the fair value of Atlantic Coast Federal Corporation’s community banking segment, which is the Company’s only business segment. Any impairment would be required to be recorded during the period identified. Atlantic Coast Federal Corporation’s goodwill totaled $2.7 million as of March 31, 2006; therefore, if Atlantic Coast Federal Corporation’s goodwill was determined to be impaired, Atlantic Coast Federal Corporation’s financial results could be materially impacted.

     After converting to a federally chartered savings association, Atlantic Coast Federal became a taxable organization. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary difference between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Internal Revenue Code and applicable regulations are subject to interpretation with respect to the determination of the tax basis of assets and liabilities for credit unions that convert charters and become a taxable organization. Since Atlantic Coast Federal’s transition to a federally chartered thrift, Atlantic Coast Federal Corporation has recorded income tax expense based upon management’s interpretation of the applicable tax regulations. Positions taken by Atlantic Coast Federal Corporation in preparing our federal and state tax returns are subject to the review of taxing authorities, and the review of the positions we have taken by taxing authorities could result in a material adjustment to our financial statements.

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

     General. Our balance sheet growth for the period ended March 31, 2006 as compared to December 31, 2005 indicates an annualized growth rate of approximately 14%. However, loan and deposit growth has continued to slow compared to recent previous quarters, with excess liquidity from borrowings being invested in shorter term interest-bearing assets.

     Following is a summarized comparative balance sheet as of March 31, 2006 and December 31, 2005:

		March 31,				December 31,				Increase(decrease)
		2006				2005				Dollars			Percentage
		(Dollars in Thousands)
Assets
Cash and cash equivalents		$	47,585			$	37,959			$	9,626				25.4	%
Other interest bearing investments			1,800				1,800				—				0.0	%
Securitites available for sale			69,061				71,965				(2,904	)			-4.0	%
Loans			603,803				585,028				18,775				3.2	%
Allowance for loan losses			(4,508	)			(4,587	)			79				-1.7	%
Loans, net			599,295				580,441				18,854				3.2	%
Loans held for sale			55				100				(45	)			-45.0	%
Other assets			52,723				51,584				1,139				2.2	%
Total assets		$	770,519			$	743,849			$	26,670				3.6	%
Liabilities and Stockholders’ equity
Deposits
Non-interest bearing		$	41,584			$	38,454			$	3,130				8.1	%
Interest bearing transaction accounts			68,538				79,739				(11,201	)			-14.0	%
Savings and money-market			117,061				100,260				16,801				16.8	%
Time			302,930				297,869				5,061				1.7	%
Total deposits			530,113				516,322				13,791				2.7	%
Securities sold under agreements to repurchase			12,000				—				12,000				100.0	%
Federal Home Loan Bank advances			129,000				129,000				—				0.0	%
Accrued expenses and other liabilities			5,367				5,610				(243	)			-4.3	%
Total liabilities			676,480				650,932				25,548				3.9	%
Stockholders’ equity			94,039				92,917				1,122				1.2	%
Total liabilities and stockholders’ equity		$	770,519			$	743,849			$	26,670				3.6	%

     Cash and cash equivalents. Cash and cash equivalents are comprised principally of interest-earning balances held in other depository institutions. We expect the balances we maintain in cash and cash equivalents will fluctuate as our other interest earning assets mature, or we identify opportunities for longer-term investments that fit the Company’s growth strategy. Approximately $12.0 million of the balance held at March 31, 2006, represents funds obtained from securities sold under agreements to repurchase during the first quarter, the purpose of which is to fund loans planned or committed to in the second quarter of 2006.

     Securities available for sale. Securities available for sale is comprised principally of debt securities of U.S. Government-sponsored organizations that issue mortgages, or mortgage-backed securities. In the near-term we expect the composition of our investment in securities available for sale to continue to be heavily weighted in mortgage-backed securities or the debt of government-sponsored organizations that issue mortgages. The decrease in securities available for sale from December 31, 2005 to March 31, 2006 was due to principal payments and maturities of the investments.

     Loans. Following is a comparative composition of net loans as of March 31, 2006 and December 31, 2005:

		As of								As of
		March				% of total				December				% of total				Increase(decrease)
		31, 2006				loans				31, 2005				loans				Dollars				Percentage
		(Dollars In Thousands)
Commercial non-mortgage		$	9,690				1.6	%		$	8,430				1.5	%		$	1,260				14.9	%
Commercial real estate and multifamily			69,363				11.6	%			66,726				11.5	%			2,637				4.0	%
Construction loans			37,081				6.2	%			26,820				4.6	%			10,261				38.3	%
One- to four- family residential mortgages			326,103				54.3	%			324,681				55.9	%			1,422				0.4	%
Consumer and other loans
Automobile			29,272				4.9	%			31,133				5.4	%			(1,861	)			-6.0	%
Unsecured			17,519				2.9	%			18,188				3.1	%			(669	)			-3.7	%
Home equity			84,193				14.0	%			79,016				13.6	%			5,177				6.6	%
Land			12,619				2.1	%			12,650				2.2	%			(31	)			-0.2	%
Other			14,231				2.4	%			13,525				2.3	%			706				5.2	%
Total loans			600,071								581,169								18,902				3.3	%
Allowance for loan losses			(4,508	)			-0.8	%			(4,587	)			-0.8	%			79				-1.7	%
Net deferred loan (fees) costs			3,185				0.5	%			3,164				0.5	%			21				0.7	%
Premiums on purchased loans			547				0.1	%			695				0.1	%			(148	)			-21.3	%
Loans, net		$	599,295							$	580,441							$	18,854				3.2	%

     The composition of our net loan portfolio is heavily weighted toward loans secured by first mortgages, home equity loans, or second mortgages, all secured by one- to four-family residences, with approximately 68% of our loans invested in those types of loans at March 31, 2006, and 70% at

December 31, 2005. The modest growth during the first quarter of 2006 in our largest loan category, one-to four-family residential mortgages, reflects a change made in the second half of 2005 to reduce our emphasis on this category of loans due to the ongoing flat yield curve, which continued to hold interest rates on longer-term loans low relative to our cost of funds. Until rates on longer-term loans demonstrate more attractive yields relative to our cost of funds, we intend to maintain our current level of this category of loans. During the first quarter of 2006, this objective was achieved by purchasing $7.8 million of variable-rate one- to four-family residential loans, along with our normal retail loan originations. Depending on liquidity, earning needs, and the availability of high quality loans, we expect to continue to purchase adjustable rate one- to four-family residential mortgage loans to supplement our internal loan originations and maintain at least our current level of growth.

     Our loan growth during the three months ended March 31, 2006, was primarily achieved with home equity lending and construction loans, primarily for the construction of one- to four-family residential properties. Interest terms for both loan types are generally indexed to the current prime rate and, as such, have more favorable interest margins relative to our cost of funds. The majority of the construction loan balances at March 31, 2006 and December 31, 2005 are comprised of loans acquired from mortgage brokers under arrangements requiring that at the completion of construction the Company will sell the loan back to the mortgage broker at par, or the balance will be paid off with permanent financing from a third party lender. Given the current interest rate environment the Company expects to continue in the near term to focus its lending efforts on home equity lending products and financing the construction of one- to four-family residences.

     Allowance for loan losses. Our allowance for loan losses was .76% and .78% of total loans outstanding at March 31, 2006 and December 31, 2005. Allowance for loan losses activity for the three months ended March 31, 2006 and 2005 was as follows:

		2006				2005
		(In Thousands)
Beginning balance		$	4,587			$	3,956
Loans charged-off			(373	)			(348	)
Recoveries			218				218
Net charge-offs			(155	)			(130	)
Provision for loan losses			76				523
Ending balance		$	4,508			$	4,349

The allowance for loan losses consists of general allowance allocations made for pools of homogeneous loans and specific allocations on individual loans for which management has significant concerns regarding the borrowers’ ability to repay the loans in accordance with the terms of the loans. Non-performing loans totaled approximately $3.1 million and $2.6 million at March 31, 2006, and December 31, 2005, respectively, and total impaired loans were approximately $4.5 million at both March 31, 2006, and December 31, 2005. The increase in non-performing loans was the result of classifying an individual commercial real estate loan of $900,000 as non-performing at March 31, 2006, that had been considered performing at December 31, 2005, an increase in other non-performing, non-homogeneous loans of $200,000, and the return to performing status of $600,000 of small balance homogeneous loans. The individual commercial real estate loan, which was considered impaired at both dates, had a specific reserve allocated of $100,000 at March 31, 2006 and December 31, 2005. The total allowance allocated for impaired loans was approximately $1.0 million at both March 31, 2006 and December 31, 2005. As of March 31, 2006, and December 31, 2005, all non-performing loans were classified as non-accrual, and we did not have any restructured loans or loans 90 days past due and accruing interest as of March 31, 2006, and December 31, 2005. Non-performing loans, excluding small balance homogeneous loans, were $2.3 million and $1.2 million at March 31, 2006 and December 31, 2005, respectively, and, all such non-performing loans were also reported as impaired loans. See “Comparision of Results of Operation for the Three Months Ended March 31, 2006 and 2005-Provision for loan losses”, for a discussion regarding the decrease in provision for loan losses in the first quarter of 2006 as compared to the same quarter in 2005.

     Other consumer loans include a non-performing loan representing a pool of leases we purchased in 2001 with a balance of approximately $782,000 as of March 31, 2006. We have $150,000 of our allowance for loan losses allocated for this loan. Collection of the total amount owed on the leases from the surety who had provided payment performance bonds for the leases, continues to be vigorously pursued in court under the terms of the bonds. The balance due is approximately $1.7 million (representing the balance outstanding prior to the charge-offs being taken). Total legal fees incurred on this matter for the three months ended March 31, 2006 and 2005 were $61,000 and $104,000, respectively. Collection of any amount, including the $632,000 net amount included in our consolidated financial statements at March 31, 2006, or the gross amount of $1.7 million, cannot be assured. We believe there is a possibility that no amount will be collected in the future; therefore, we may incur additional losses up to the $632,000 net amount remaining as an asset. Additionally, we anticipate we will incur additional legal costs as we pursue collection on the surety bonds.

     Deposits. Savings and money market deposit account balances grew in the first quarter of 2006, as the Bank increased its interest rates on its money market products during the quarter to meet the rate of competitors in its markets. The increased rates, which are tiered so that the highest rates are only paid on deposits of $50,000 or more, resulted in approximately $7.0 million of new deposit account balances. Approximately $9.0 million, or 82% of the decline in interest-bearing transaction account balances was transferred to money market accounts. Growth in time deposits as of March 31, 2006, as compared to the end of 2005, was moderate, following our general deposit rate increases occurring during 2006 that have tracked rates in our market following the Federal Reserve Bank interest changes. We expect future deposit growth as we expand our products and services in new and existing markets particularly in core deposits, and we also anticipate we will continue to purchase brokered deposits to meet liquidity demands.

     Securities sold under agreements to repurchase. Historically, the Company has only utilized advances from the Federal Home Loan Bank of Atlanta (“FHLB”) as an alternative to deposits for funding its lending and investment activities. While we expect FHLB advances to continue to be a significant source of funds in the future, the Company also initiated its first financing arrangement involving the sale of securities under an agreement to repurchase during the first quarter of 2006 to take advantage of favorable interest rates relative to deposits with comparable maturities.

     Securities sold under agreements to repurchase are secured by mortgage-backed securities with a carrying amount of $13.1 million at March 31, 2006 and mature in February 2011, or, beginning in February 2007, may be terminated in whole by the lender each following quarter. At maturity or termination, the securities underlying the agreements will be returned to the Company. At the date of the transaction, the interest rate was fixed at 4.53% until February 2007, at which time it converts to a floating rate of 8.50% minus 3-month LIBOR up to a maximum rate of 5.75%.

     Depending on the availability of suitable securities and the prevailing interest rates and terms of alternative source of funds, the Company may continue to sell securities under agreements to repurchase in the future.

     Stockholders’ equity. Activity in the Company’s stockholders’ equity for the three months ended March 31, 2006 was as follows (in thousands):

Balance at December 31, 2005		$	92,917
Increases to stockholders’ equity:
Net income for the three months ended March 31, 2006			1,107
Net other comprehensive income			83
ESOP shares allocated to employees			169
Management restricted stock earned under Recognition Plan			145
Stock options earned under Stock Option Plan			76
Total increases to stockholders’ equity			1,580
Decreases to stockholders’ equity:
Dividends			(458	)
Treasury stock purchased at cost			—
Total decreases to stockholders’ equity			(458	)
Balance at March 31, 2006		$	94,039

     Net other comprehensive income for the three months ending March 31, 2006 resulted from an increase in unrealized gains on interest rate swaps of $173,000, offset by additional unrealized losses on AFS securities of $90,000, net of taxes. The interest rate swaps have been designated as cash flow hedges of certain FHLB advances, and were determined to be fully effective during the first three months of 2006. The Company expects the hedges to remain fully effective during the remaining terms of the swaps. The unrealized losses on AFS securities are due to changes in interest rates, and we consider their decline in value below their cost to be temporary. Going forward, we expect changes in interest rates to continue to cause swings in unrealized gains and losses from our interest rate swaps and AFS securities.

     Management restricted stock earned under the Recognition Plan and stock options earned under the Stock Option Plan reflects the recognition of compensation expense under SFAS No.123 Revised. The Company early adopted SFAS No. 123 Revised during the third quarter of 2005 to account for its share based compensation plans. Under this new accounting standard, the cost of awards granted under the Recognition Plan and the Stock Option Plan in the third and fourth quarter of 2005, are being amortized over the vesting period of five years, which began on the grant dates.

     On March 31, 2006, the Company’s board of directors declared a regular quarterly cash dividend at a rate of $0.09 per share. The dividend is payable on May 1, 2006 for stockholders’ of record on April 14, 2006. Atlantic Coast Federal, MHC (MHC) which holds 8,728,500 shares, or 61.7% of the Company’s total outstanding stock has informed the Company that it will waive receipt of the first quarter dividend on their owned shares. Accordingly, stockholders’ equity for the three months ending March 31, 2006, was reduced $458,258 for the declared dividend. We expect the MHC to waive receipt of payment on future dividends for its owned shares.

     During the three months ended March 31, 2006, the Company did not repurchase any stock under the stock repurchase plan that began in early November 2005. Under that plan the Company is permitted to purchase, over a 12-month period, up to 10%, or 579,520 shares of its outstanding common stock. As of March 31, 2006, approximately 200,000 shares of common stock remained to be repurchased under this plan although no assurances can be made about the number of shares, if any, that will actually be purchased, or the price that will be paid for such shares.

     The equity to assets ratio decreased to 12.20% at March 31, 2006, from 12.49% at December 31, 2005. The decrease was primarily due to the rate of asset growth through March 31, 2006. Despite this decrease, we continued to be well in excess of all minimum regulatory capital requirements, and are considered “well capitalized” under those formulas. Total risk-based capital to risk-weighted assets was 14.62%, Tier 1 capital to risk-weighted assets was 13.83%, and Tier 1 capital to total adjusted total assets was 9.79% at March 31, 2006. These ratios as of December 31, 2005 were 15.90%, 15.00% and 10.00%, respectively.

Comparison of Results of Operation for the Three Months Ended March 31, 2006 and 2005.

     General. Our net income for the three months ended March 31, 2006, was $1.1 million, which was $325,000 more than for the same period in 2005, primarily due to reduced provision for loan losses of $447,000 on the basis of improved credit quality. Net interest income increased 6.3%, or $314,000 in the first quarter of 2006 compared to the same quarter in 2005, as growth in interest earning assets, combined with an increase in the interest yield on such assets, offset the rising cost of deposits. Non-interest income for the first quarter of 2006 grew by 27.4% to $1.6 million as compared to $1.3 million for the same quarter in 2005, due to increased service charges and fees. The increase in non-interest income was offset by increased non-interest expense which grew $727,000, or 16.1%, to $5.2 million for the three months ended March 31, 2006, from $4.5 million for the same period in 2005 due to increased compensation and benefit costs and other operating costs.

     Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following table sets forth certain information for the three months ended March 31, 2006 and 2005. The average yields and costs are derived by dividing income or expense by the average balance or liabilities, respectively, for the periods presented.

		For the three months ended March 31,
		2006												2005
		(Dollars in Thousands)
		Average Balance				Interest				Average Yield /Cost				Average Balance				Interest				Average Yield /Cost
INTEREST-EARNING ASSETS
Loans receivable( 1)		$	590,299			$	9,407				6.37	%		$	531,441			$	7,842				5.90	%
Securites (2)			71,445				737				4.13	%			52,479				345				2.63	%
Other interest-earning assets (3)			31,754				371				4.67	%			35,752				256				2.86	%
Total interest-earning assets			693,498				10,515				6.07	%			619,672				8,443				5.45	%
Non-interest earning assets			57,911												33,993
Total assets		$	751,409											$	653,665
INTEREST-BEARING LIABILITIES
Savings deposits		$	53,120			$	53				0.40	%		$	66,760			$	74				0.44	%
Interest bearing demand accounts			75,433				459				2.43	%			34,979				104				1.19	%
Money market accounts			49,702				384				3.09	%			57,241				338				2.36	%
Time deposits			301,154				2,956				3.93	%			251,059				1,910				3.04	%
Federal Home Loan Bank advances			129,000				1,327				4.11	%			101,874				1,052				4.13	%
Securities sold under agreements to repurchase			5,034				57				4.53	%			—				—				—
Total interest-bearing liabilities			613,443				5,236				3.41	%			511,913				3,478				2.72	%
Non-interest bearing liabilities			45,361												42,123
Total liabilities			658,804												554,036
Stockholders’ equity			92,605												99,629
Total liabilities and stockholders’ equity		$	751,409											$	653,665
Net interest income						$	5,279											$	4,965
Net interest spread											2.66	%											2.73	%
Net earning assets		$	80,055											$	107,759
Net interest margin (4)											3.04	%											3.21	%
Average interest-earning assets to average interest-bearing liabilities							113.05	%											121.05	%

     Rate/Volume Analysis. The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities as of and for the three months ended March 31, 2006 as compared to the same period in 2005. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume multiplied by the old rate; and (2) changes in rate, which are changes in rate multiplied by the old volume; and (3) changes not solely attributable to rate or volume have been allocated proportionately the change due to volume and the change due to rate.

		Increase/(Decrease)								Total
		Due to								Increase
		Volume				Rate				(Decrease)
		(In Thousands)
INTEREST-EARNING ASSETS
Loans receivable		$	909			$	656			$	1,565
Securites			152				240				392
Other interest-earning assets			(31	)			146				115
Total interest-earning assets			1,030				1,042				2,072
INTEREST-BEARING LIABILITIES
Savings deposits			(14	)			(7	)			(21	)
Interest bearing demand accounts			186				169				355
Money market accounts			(48	)			94				46
Time deposits			426				620				1,046
Federal Home Loan Bank advances			279				(4	)			275
Securities sold under agreements to repurchase			57				—				57
Total interest-bearing liabilities			886				872				1,758
Net interest income		$	144			$	170			$	314

     Interest income. As shown in the table above the increase in interest income for the three months ended March 31, 2006, as compared to the same period in 2005, is attributed almost equally to growth in average outstanding interest-earning assets, and the rate of interest earned on those assets. Loans accounted for approximately 76% of the interest income growth, or $2.1 million for the quarter ended March 31, 2006, as compared to for the same quarter in 2005. While the majority of the increased interest income is a result of increased outstanding balances, the Company also increased its yield on average outstanding loan balances as a result of growth in prime interest rate-based loans. As discussed above in “Comparison of Financial Condition at March 31, 2006 and December 31, 2005-Loans,” the flat yield curve over the last 12 months led the Company to increase its emphasis on prime rate interest-based loans, such as home equity lending and construction loans and reduce our focus on growing one- to four-family loans that had interest rates which lagged increases in the interest rate environment. The average outstanding balances of home equity loans and construction loans for the three months ended March 31, 2006, as compared to the same period in 2005, accounted for approximately 55%, or $32.1 million of the total $59.0 million in average loan growth. During these same periods, the average prime rate increased 190 basis-points from 5.44% to 7.34%.

     Approximately 24% of the growth in interest income for the quarter ended March 31, 2006, as compared to the same quarter in 2005 is from investment securities and other interest-earning assets. Yields on these assets have tracked upward consistent with increases to short-term interest rates.

     We expect our interest income will increase as average interest earning assets and interest rates on such assets increase. Growth in interest earnings assets is anticipated from deposit growth in existing markets and the opening of new branches in the second-half of 2006. Our interest income could be adversely impacted by continued low interest rates on longer term loans, such as one- to four-family residential loans and the availability of the type of interest earning-assets desired for investment by the Company.

     Interest expense. The increase in interest expense for the three months ended March 31, 2006, as compared to the same period in 2005, is primarily due to growth in average outstanding balances of interest-bearing deposit accounts, and the increases to interest rates paid on those accounts. During the period of time from the end of the first quarter of 2005, until the beginning of the first quarter of 2006, the Federal Reserve Board increased the target rate for Federal Funds borrowings by 200 basis points, from 2.75% to 4.75%. In general, this has led to comparable rate increases to interest-bearing deposit accounts in our market. In order to fund loan growth and maintain deposit market share, the Company has increased interest rates on its money-market accounts, interest bearing demand accounts and time deposits. The rate of interest expense on our FHLB advances has remained relatively flat for the first quarter of 2006 as compared to the first quarter of 2005, as the average interest rate on new advances have been slightly lower than the average rate of the total outstanding FHLB advances. We expect interest rates on deposits will continue to increase over the near term as market rates for deposits increase.

     Net interest income. Net interest income increased during the three months ended March 31, 2006, as compared to the same period in 2005, as the growth in interest income outpaced the growth in interest expense. As discussed above, increases in prime rate based loans has, in part, enabled the Company to increase the overall yield of the loan portfolio, in addition to strong growth in average outstanding balances. Our net interest spread, which is the difference between the interest yield earned on interest earning assets and the interest rate paid on interest bearing liabilities, declined 7 basis points for the first quarter of 2006 as compared to the same quarter in 2005. For the same comparative periods, our net interest margin, which is net interest income expressed as a percentage of our average interest earning assets declined 17 basis points. The rate of decline in net interest spread and net interest margin has slowed considerably compared to the recent previous four quarters as shown below:

		Net Interest				Net Interest
Comparative Quarters		Spread				Margin
1st quarter-2006			2.66	%			3.04	%
2005			2.73	%			3.21	%
decline			0.07	%			0.17	%
4th quarter-2005			2.65	%			3.06	%
2004			2.80	%			3.34	%
decline			0.15	%			0.28	%
3rd quarter-2005			2.42	%			2.86	%
2004			3.12	%			3.50	%
decline			0.70	%			0.64	%
2nd quarter-2005			2.66	%			3.11	%
2004			3.48	%			3.71	%
decline			0.82	%			0.60	%
1st quarter-2005			2.73	%			3.21	%
2004			3.62	%			3.87	%
decline			0.89	%			0.66	%

     Our rapid loan growth during 2004, primarily in adjustable rate one- to four-family residential mortgages (ARMs), as well as the near-complete refinancing of our existing residential mortgage portfolio, occurred during a period of unprecedented low interest rates. Due to the various interest rate reset terms of our ARM products, recent increases in market interest rates have not generally, resulted in immediate increase in interest rate yields. Due to the fact that one- to four-family residential loans comprise over 50% of our total loan portfolio we do not expect our net interest spread or net interest margin to increase in the near term. However, we believe our recent growth in prime rate based loans, along with limited repricing of our hybrid ARM loans will allow us to us to keep pace with future increases to cost of funds and limit the compression to interest margins. Management does expect net interest income to continue to grow as the Company utilizes deposit growth to expand its business and continues to emphasize loan growth in home equity, construction and commercial loans.

     Provision for loan losses. We establish provisions for loan losses, which are charged to operations, at a level required to reflect probable incurred credit losses in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, the source of origination of those loans, adverse situations that may affect borrowers’ ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. Large groups of smaller balance homogeneous loans, such as residential real estate, small commercial real estate, home equity and consumer loans, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions, source of loan origination, and other relevant data. Larger non-homogeneous loans, such as commercial loans for which management has concerns about the borrowers’ ability to repay, are evaluated individually, and specific allowance allocations are provided for such loans when necessary.

     Based on management’s evaluation of these factors, provisions of $76,000 and $523,000 were made during the three months ended March 31, 2006 and 2005, respectively. Comparatively, the provision for loan losses in the first quarter of 2006, was reduced over same quarter in 2005, because a specific allowance of $400,000 was provided in the first quarter of 2005 for a single commercial real estate loan. This loan was paid off entirely in the third quarter of 2005 and the specific allowance allocation was reversed. There were no significant changes required for the specific allowance allocation in the first quarter of 2006.

     Management assesses the allowance for loan losses on a quarterly basis and makes provisions for loan losses as necessary in order to maintain the allowance for loan losses based on all known and inherent losses that are both probable and can be reasonably estimated. While management uses available information to recognize losses on loans, future loan loss provisions may be necessary based on changes in economic conditions and changes in borrower situations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require us to recognize additional provisions based on their judgment of information available to them at the time of their examination. The allowance for loan losses as of March 31, 2006, is maintained at a level that represents management’s best estimate of probable incurred losses in the loan portfolio.

     Non-interest income. The components of non-interest income for the three months ended March 31, 2006 and 2005 were as follows:

										Increase(decrease)
		2006				2005				Dollars				Percentage
		(Dollars in Thousands)
Service charges and fees		$	1,342			$	896			$	446				49.8	%
Net loss on available for sale securities		$	(177	)			—				(177	)			-100.0	%
Gain on sale of real estate mortgages held for sale			3				11				(8	)			-72.7	%
Gain on sale of foreclosed assets			3				1				2				200.0	%
Commission income			81				99				(18	)			-18.2	%
Interchange fees			195				181				14				7.7	%
Bank owned life insurance earnings			204				51				153				300.0	%
Other			(13	)			48				(61	)			-127.1	%
		$	1,638			$	1,287			$	351				27.3	%