Financial Condition at June 30, 2008

Total assets were $217,182,773 at June 30, 2008, an increase of $13,389,204 or, 6.8%, from December 31, 2007. The increase resulted from the investment of funds available to us as the result of an increase in deposits. The deposit increase was caused generally by our efforts to grow our franchise and specifically by the deposit increases at our branch offices. We invested these funds primarily in investment securities available for sale and to fund an increase in overnight investments. The net increase in assets can be summarized as follows:

† A $5,310,982 net increase in cash and cash equivalents

† A $7,312,627 net increase in investment securities available for sale and

† An $805,642 net increase in net loans receivable.

In addition, we also experienced changes in other asset categories due to normal fluctuations in operations.

Our deposits (including escrow deposits) were $189,060,535 at June 30, 2008, an increase of $12,726,092, or 7.2%, from December 31, 2007. The increase in deposits resulted from increases of $5,584,881 in time deposits, $3,928,274 in non-interest demand deposits, $2,198,478 in NOW and $1,134,606 in savings accounts, partially offset by a decrease of $120,147 in money market accounts.

Total stockholders' equity was $21,577,685 at June 30, 2008, an increase of $693,880 from December 31, 2007. The increase reflected net income of $788,220 for the six months ended June 30, 2008, increased by a reduction in the net unrealized loss on securities available for sale of $31,993 and increased by a reduction of $84,538 in Unearned ESOP shares reflecting the effect of the gradual payment of the loan we made to fund the ESOP's purchase of our stock. This was partially offset by the use of $228,549, representing the two $0.06 per share cash dividends that we paid in 2008.

The unrealized loss on securities available for sale is excluded from the calculation of regulatory capital. Management does not anticipate selling securities in this portfolio, but changes in market interest rates or in the demand for funds may change management's plans with respect to the securities portfolio. If there is a material increase in interest rates, the market value of the available for sale portfolio may decline. Management believes that the principal and interest payments on this portfolio, combined with the existing liquidity, will be sufficient to fund loan growth and potential deposit outflow.

For financial statement reporting purposes, we record the compensation expense related to the ESOP when shares are committed to be released from the security interest for the loan. The amount of the compensation expense is based upon the fair market value of the shares at that time, not the original purchase price. The initial sale of shares to the ESOP did not increase our capital by the amount of the purchase price because the purchase price was paid by the loan we made to the ESOP. Instead, capital increases as the shares are allocated or committed to be allocated to employee accounts (i.e., as the ESOP loan is gradually repaid), based upon the fair market value of the shares at that time. When we calculate earnings per share, only shares allocated or committed to be allocated to employee accounts are considered to be outstanding. However, all shares that the ESOP owns are legally outstanding, so they have voting rights and, if we pay dividends, dividends will be paid on all ESOP shares.

We do not expect that adverse conditions in the residential mortgage market throughout the United States will have a direct adverse effect on our financial condition or results of operations. We are not a residential mortgage lender. We do not hold any loans in our portfolio of the type that are commonly known as subprime residential mortgage loans. At June 30, 2008, we owned $125.1 million of securities that are either collateralized by residential mortgage loans or that represent shares in pools of such loans. However, 94.7% of those securities are issued or guaranteed by FNMA (Fannie Mae), GNMA (Ginnie Mae) or FHLMC (Freddie Mac). The remainder of the securities portfolio is all investment grade fixed-rate securities rated AAA that are at least five years old. None of those securities have experienced ratings downgrades. Those securities issued or guaranteed by Fannie Mae or Freddie Mac are entirely securities in which we have a relatively senior position in the cash flow received on the underlying mortgages and there is at least one significant class in each security with a lower cash flow priority. As a result, we anticipate that even if here are defaults on the underlying mortgages and even if Fannie Mae or Freddie Mac suffers from economic difficulties, the ultimate recovery of the entire amount owed of the securities we have purchased is reasonably certain.

Many of our customers, both loan and deposit customers, are involved in the residential construction business in Staten Island. We believe that the turmoil in the national housing and residential mortgage markets has had an adverse effect on some of our customers. An apparent slow down in the local housing market and a noticeable reduction in the availability of residential mortgage loans seems to have had an adverse effect on our customers and reduced their business activity. We believe that this, in turn, has caused a reduction in their demand for loans from us, such as construction loans to build new homes. It also appears to have adversely affected the level of deposits they maintain.

The Effect of Declining Market Interest Rates.

Market interest rates, especially short term market interest rates, declined substantially from September 2007 to April 2008 as the Federal Reserve reduced the target federal funds rate, which resulted in an immediate and equal reduction in the prime lending rate. The prime rate and the target overnight federal funds rate both declined by 325 basis points during that period, with the most dramatic decline being a 200 basis point decline in the two months from January 22, 2008 through March 18, 2008. As a result, our loan yields (usually based on the prime rate) and our overnight investment yields (based upon the target federal funds rate) declined as market interest rates decline.

The decline in loan yields and earnings on overnight investments was more rapid than the decline in our cost of funds for a number of reasons. Approximately one-third of our deposits are interest-free checking accounts and the rates on those accounts (already at zero) do not decline as market rates decline. The rates we pay on interest-bearing deposits, because of their lower starting point, cannot be reduced by as much as the basis point decline in market rates because of the need to maintain customer relationships, competitive pressures and the simple fact that if we price our time deposit rate at, hypothetically, 50% of the prime rate, then if the prime rate declines 100 basis points, then deposit rate only declines 50 basis points. In addition, customers have the ability to exercise discretion in moving funds between different types of deposits to maximize their interest earnings.

We have some flexibility in allocating our investment choices between the three categories of earning assets - loans, investment securities and other investments (principally overnight investments). As interest rates declined, we elected to invest more of our available liquid assets into investment securities instead of overnight investments. This shift in the mix of our investments allowed us to reduce the effect of declining interest rates because investment securities tend to have higher yields that overnight investments. We were also able to reinvest the payments we received on existing investment securities in securities with rates comparable to the rates we were earning on the securities being repaid because many of the securities being repaid were purchased a number of years ago before market interest rates reached their recent peak towards the end of 2006.

Our results of operations depend primarily on net interest income, which is the difference between the income we earn on our loan and investment portfolios and our cost of funds, consisting primarily of interest we pay on customer deposits. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional fees, advertising and marketing expenses and other general and administrative expenses. Our results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.

General. We had net income of $426,275 for the quarter ended June 30, 2008, compared to net income of $508,021 for the comparable quarter in 2007. The principal categories which make up the 2008 net income are:

† Interest income of $2,678,831

† Reduced by interest expense of $592,821

† Reduced by a provision for loan losses of $55,000

† Increased by non-interest income of $624,234

† Reduced by non-interest expense of $1,862,177

† Reduced by $366,792 in income tax expense

We discuss each of these categories individually and the reasons for the differences between the quarters ended June 30, 2008 and 2007 in the following paragraphs. In general, the principal reason for the decline in net income when comparing the second quarter of 2008 with the same quarter in 2007 was a reduction in the yield on interest-earning assets, primarily in the loan portfolio and in other-interest earning assets, which reduced interest income. We were able to maintain the yield on our investment security portfolio as we purchase new securities, with the same risk parameters that we have purchased in the past, at yields comparable to the overall portfolio yield.

Interest Income. Interest income was $2,678,831 for the quarter ended June 30, 2008, compared to $3,059,803 for the quarter ended June 30, 2007, a decrease of $380,972, or 12.5%. The principal reasons for this decrease was a 231 basis point decrease in the yield on our loan portfolio, partially mitigated by a $1,775,129 increase in the average loan balance, and a 297 basis point decrease in the yield of other-interest earning assets (principally overnight investments). The decrease in interest income was partially offset by the increase in the investment security portfolio as we reduced other interest-earning assets and reallocated the funds to increase the average balance of investment securities. We also had a slight increase in the overall investment securities portfolio yield. The average balance of overnight investments decreased by $6,476,062 primarily due to the use of excess funds to purchase higher yielding investment securities.

The 6 basis point increase in the average yield on our investment securities portfolio, from 4.69% to 4.75%, was due to the purchase of new investment securities at higher market rates than the yields on the principal paydowns we received. The yield on investment securities did not decrease as the other interest-earning assets because most of the bonds and notes in our investment portfolio have either fixed interest rates or interest rates that react more slowly to changes in market interest rate conditions. The average balance of our investment portfolio increased by $10,561,973, or 9.56%, between the periods. The increase in volume and the increase in yield resulted in an overall $137,664 increase in interest income from investment securities. The investment securities portfolio represented 89.2% of average non-loan interest earning assets in the 2008 period compared to 83.9% in the 2007 period.

Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $2,086,010 for the quarter ended June 30, 2008, a decrease of $104,006, or 4.8% over the $2,190,016 in the comparable 2007 quarter. The decrease resulted principally from a decrease in the yield on our loan portfolio, which was greater than the decrease in our average cost of deposits, including demand deposits. Our net interest spread increased to 3.50% in the second quarter of 2008 from 3.49% in the second quarter of 2007. We were able to main the spread due to the reallocation of overnight investments into investment securities. However, our net interest margin decreased to 4.20% in the second quarter of 2008 from 4.51% in the second quarter of 2007 because the margin takes into account the effect of interest free demand deposits and capital, which are less valuable funding sources when market interest rates are lower as they can be invested only at lower yields.

Provision for Loan Losses. We took a provision for loan losses of $55,000 for the quarter ended June 30, 2008 compared to no provision for loan losses for the quarter ended June 30, 2007. The increase in the provision was the result of an increase in loan delinquencies. The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge offs and recoveries. Our allowance for loan losses is based on management's evaluation of the risks inherent in our loan portfolio and the general economy. Management periodically evaluates both broad categories of performing loans and problem loans individually to assess the appropriate level of the allowance.

Although management uses available information to assess the appropriateness of the allowance on a quarterly basis in consultation with outside advisors and the board of directors, changes in national or local economic conditions, the circumstances of individual borrowers, or other factors, may change, increasing the level of problem loans and requiring an increase in the level of the allowance. The allowance for loan losses represented 1.36% of total loans at June 30, 2008, but there can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.

Non-interest Income. Non-interest income was $624,234 for the three months ended June 30, 2008, compared to $535,193 during the same period last year. The $89,041, or 16.6%, increase in non-interest income was a direct result of a $100,411 increase in service charges on deposits (primarily non-sufficient fund fees) and an increase in net rental income of $24,224, partially offset by a decrease of $36,347 in other income. Service fees on deposit accounts, principally non-sufficient funds fees, increased from 2007 to 2008 due to an increase in the number of non-sufficient fund transactions coupled with our decision to increase per item charges for both insufficient fund and bounced check fees and other deposit fees in June of 2008. The increase in net rental income was due to the occupancy of one of the Bank's subleased properties. The decrease in other income was a result of the loss of a check cashing customer and the fee income associated with that business.

Non-interest Expense. Non-interest expense was $1,862,177 for the quarter ended June 30, 2008, compared to $1,773,951 for the quarter ended June 30, 2007. The principal causes of the $88,226 increase were:

† $16,716 increase in occupancy expenses due to higher utility bills;

† $81,860 increase in legal expenses primarily because in 2007 we received a reimbursement from our insurance company of legal fees previously expensed and new collection matters

† $52,932 increase in other expenses due to a $24,304 increase in advertising expenses in connection with the Bank's new advertising campaign, and a $40,110 recovery in 2007 of part of a reserve expensed in 2005 for a legal claim that we settled for less than the reserve in 2007.

† $69,725 decrease in salaries and benefits expense, due in part to the retirement of the former president and reduced incentive and ESOP compensation expense.

Results of Operations for the Six Months Ended June 30, 2008 and June 30, 2007

Our results of operations depend primarily on net interest income, which is the difference between the income we earn on our loan and investment portfolios and our cost of funds, consisting primarily of interest we pay on customer deposits. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional fees, advertising and marketing expenses and other general and administrative expenses. Our results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.

General. We had net income of $788,220 for the six months ended June 30, 2008, compared to net income of $1,037,792 for the comparable period in 2007. The principal categories which make up the 2008 net income are:

† Interest income of $5,409,912

† Reduced by interest expense of $1,348,613

† Reduced by a provision for loan losses of $85,000

† Increased by non-interest income of $1,190,136

† Reduced by non-interest expense of $3,700,327

† Reduced by $677,888 in income tax expense

We discuss each of these categories individually and the reasons for the differences between the six months ended June 30, 2008 and 2007 in the following paragraphs. In general, the principal reason for the decline in net income when comparing the first six months of 2008 with the same period in 2007 was a reduction in the yield on interest-earning assets, primarily in the loan portfolio and in other-interest earning assets, which reduced interest income.

Interest Income. Interest income was $5,409,912 for the six months ended June 30, 2008, compared to $6,179,681 for the six months ended June 30, 2007, a decrease of $769,769, or 12.5%. The principal reasons for this decrease was a 224 basis point decrease in the yield on our loan portfolio and a 251 basis point decrease in the yield of other-interest earning assets (principally overnight investments). The decrease was partially offset by the higher average balance of the investment security portfolio as we reduced other interest earning assets and reallocated the funds to increase the average balance of investment securities. We also had a slight increase in the investment securities portfolio yield. The average balance of overnight investments decreased by $6,404,478, primarily due to the use of excess funds to purchase higher yielding investment securities.

The average yield on our investment securities portfolio increased 4 basis points, from 4.71% to 4.75%, due to the purchase of new investment securities at slightly higher market rates than the yields on the principal paydowns we received. The yield on investment securities did not decrease as the other interest earning assets because most of the bonds and notes in our investment portfolio have either fixed interest rates or interest rates that react more slowly to changes in market interest rate conditions. The average balance of our investment portfolio increased by $8,166,695, or 7.36%, between the periods. The increase in volume and the increase in yield resulted in an overall $221,501 increase in interest income from investment securities. The investment securities portfolio represented 89.4% of average non-loan interest earning assets in the 2008 period compared to 84.3% in the 2007 period.

Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $4,061,299 for the six months ended June 30, 2008, a decrease of $405,352, or 9.1% over the $4,466,651 in the comparable 2007 period. The decrease resulted principally from a decrease in the yield on our loan portfolio, which was greater than the decrease in the average cost of our deposits, including demand deposits, and the yield and average balance of our other interest earning assets partially offset by a decrease in the cost of time deposits and an increase in interest income from our investment security portfolio. Our net interest spread decreased to 3.33% in the first six months of 2008 from 3.61% in the same period of 2007 and our net interest margin, which includes the effect of interest-free demand deposits and capital as funding sources, decreased to 4.15% in the first six months of 2008 from 4.63% in the same period of 2007.

Provision for Loan Losses. We took a provision for loan losses of $85,000 for the six months ended June 30, 2008 compared to a credit to the provision for loan losses of $30,000 for the six months ended June 30, 2007. The increase in the provision was the result of an increase in loan delinquencies. The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge offs and recoveries. Our allowance for loan losses is based on management's evaluation of the risks inherent in our loan portfolio and the general economy. Management periodically evaluates both broad categories of performing loans and problem loans individually to assess the appropriate level of the allowance.

Although management uses available information to assess the appropriateness of the allowance on a quarterly basis in consultation with outside advisors and the board of directors, changes in national or local economic conditions, the circumstances of individual borrowers, or other factors, may change, increasing the level of problem loans and requiring an increase in the level of the allowance. The allowance for loan losses represented 1.36% of total loans at June 30, 2008, but there can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.

Non-interest Income. Non-interest income was $1,190,136 for the six months ended June 30, 2008, compared to $1,076,556 during the same period last year. The $113,580, or 10.6%, increase in non-interest income was a direct result of a $163,118 increase in service charges on deposits (primarily non-sufficient fund fees) and an increase in net rental income of $8,400, partially offset by a decrease of $53,446 in other income. Service fees on deposit accounts, principally non-sufficient funds fees, increased from 2007 to 2008 due to an increase in the number of non-sufficient fund transactions coupled with our decision to increase per item charges for both insufficient fund and bounced check fees and other deposit fees in June of 2008. The increase in net rental income was due to the occupancy of one of the Bank's subleased properties that was previously vacant. The decrease in other income was a result of the loss of a check cashing customer that had previously generated substantial fee income.

Non-interest Expense. Non-interest expense was $3,700,327 for the six months ended June 30, 2008, compared to $3,630,107 for the six months ended June 30, 2007. The principal causes of the $70,220 increase were:

† $36,465 increase in occupancy expenses due to higher utility costs and the operation of our new main office in Great Kills, which opened in February 2007;

† $121,420 increase in legal expenses primarily because in 2007 we received a reimbursement from our insurance company of legal fees previously expensed and new collection matters.

† $79,749 increase in other expenses due to a $39,269 increase in advertising expenses in connection with the Bank's new advertising campaign and a $40,110 recovery in 2007 of part of a reserve expensed in 2005 for a legal claim that we settled for less than the reserve in 2007

† $176,647 decrease in salaries and benefits expense, due in part to the retirement of the former president and reduced incentive and ESOP compensation expense.

Income Tax Expense. Income tax expense was $677,888 for the six months ended June 30, 2008, compared to income tax expense of $905,308 for the six months ended June 30, 2007. The reduction in income tax expense was due to the $476,992 decrease in income before income taxes in the 2008 period. Our effective tax rate for the six months ended June 30, 2008 was 46.2% and for the quarter ended June 30, 2007 was 46.6%.

                               VSB Bancorp, Inc.
                      Consolidated Average Balance Sheets
                                  (unaudited)


                               Three Months Ended June 30, 2008                   Three Months Ended June 30, 2007                     Six Months Ended June 30, 2008                      Six Months Ended June 30, 2007
                        -----------------------------------------------    -----------------------------------------------    ------------------------------------------------    ------------------------------------------------
                        Average Balance      Interest      Yield/ Cost     Average Balance      Interest      Yield/ Cost      Average Balance      Interest      Yield/ Cost      Average Balance      Interest      Yield/ Cost
                        ----------------    -----------   -------------    ----------------    -----------   -------------    -----------------    -----------   -------------    -----------------    -----------   -------------

Assets:
Interest-earning
assets:
Loans receivable        $     62,185,996    $ 1,172,917            7.47 %  $     60,410,867    $ 1,501,344            9.78 %  $      62,584,676    $ 2,417,408            7.70 %  $      61,823,241    $ 3,073,697            9.94 %
Investment
securities, afs              121,089,026      1,431,362            4.75         110,527,053      1,293,698            4.69          119,193,950      2,815,659            4.75          111,027,255      2,594,158            4.71
Other
interest-earning
. . .