** **

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

----

 

**FORM 10-Q**

**(Mark One)**

 

| **ý** |                                     | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934.**  |
|------------|------------------------------------------|-------------------------------------------------------------------------------------------------|
|       |
|       | **FOR THE QUARTER ENDED MARCH 31, 2004** |
|       |
| **or**     |
|       |
| **o**      |                                     | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934.** |

 

**COMMISSION FILE NUMBER: 000-25077**

 

**SEACOAST FINANCIAL SERVICES CORPORATION**

(Exact Name of Registrant as Specified in Its Charter)

 
| **Massachusetts**                                 |   | **04-1659040**                     |
|---------------------------------------------------|--------|------------------------------------|
| (State of Incorporation)                          |   | (IRS Employer  Identification No.) |
|                                              |   |                               |
| **One Compass Place, New Bedford, Massachusetts** |   | **02740**                          |
| (Address of Principal Executive Offices)          |   | (Zip Code)                         |
|                                              |   |                               |
| **(508) 984-6000**                                |
| (Registrant’s Telephone Number               |

 

**N/A**

Former Name, Former Address and Former Fiscal Year if Changed SinceLast Report

 

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

 

Indicate by check mark whether registrant isan accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Actof 1934).                                                                                                                                                                                                       ý Yes  o No

 

| At  May 3, 2004, the Company had 30,213,760 shares of common stock outstanding . |
|----------------------------------------------------------------------------------|

 

 

----

 

## **SEACOASTFINANCIAL SERVICES CORPORATION**

**INDEX**

 
| **PART I - FINANCIAL INFORMATION** |                                                                                                                 |
|------------------------------------|----------------------------------------------------------------------------------------------------------------------|
|                               |                                                                                                                 |   |
| Item  1.                           | Financial  Statements                                                                                                |   |
|                               |                                                                                                                 |   |
|                               | Consolidated Balance Sheets  at March 31, 2004 and December 31, 2003                                                 |   |
|                               |                                                                                                                 |   |
|                               | Consolidated  Statements of Operations for the three months ended March 31, 2004 and 2003                            |   |
|                               |                                                                                                                 |   |
|                               | Consolidated  Statements of Changes in Stockholders’ Equity for the three months ended  March 31, 2004 and 2003 |   |
|                               |                                                                                                                 |   |
|                               | Consolidated  Statements of Cash Flows for the three months ended March 31, 2004 and 2003                            |   |
|                               |                                                                                                                 |   |
|                               | Notes  to Unaudited Consolidated Financial Statements                                                                |   |
|                               |                                                                                                                 |   |
| Item 2.                            | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                          |   |
|                               |                                                                                                                 |   |
| Item 3.                            | Quantitative and Qualitative  Disclosures About Market Risk                                                          |   |
|                               |                                                                                                                 |   |
| Item 4.                            | Controls and Procedures                                                                                              |   |
|                               |                                                                                                                 |   |
| **PART II - OTHER INFORMATION**    |                                                                                                                 |
|                               |                                                                                                                 |   |
| Item 1.                            | Legal Proceedings                                                                                                    |   |
|                               |                                                                                                                 |   |
| Item 2.                            | Changes in Securities  and Use of Proceeds                                                                           |   |
|                               |                                                                                                                 |   |
| Item 3.                            | Defaults upon Senior  Securities                                                                                     |   |
|                               |                                                                                                                 |   |
| Item 4.                            | Submission of Matters  to a Vote of Security Holders                                                                 |   |
|                               |                                                                                                                 |   |
| Item 5.                            | Other Information                                                                                                    |   |
|                               |                                                                                                                 |   |
| Item  6.                           | Exhibits  and Reports on Form 8-K                                                                                    |   |
|                               |                                                                                                                 |   |
| **SIGNATURES**                     |                                                                                                                 |
|                               |                                                                                                                 |   |
| **CERTIFICATIONS**                 |                                                                                                                 |

 

2

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## ** **

## **SEACOASTFINANCIAL SERVICES CORPORATION AND SUBSIDIARIES**

## **CONSOLIDATEDBALANCE SHEETS**

**(In thousands)**

** **
|                                                                                                                                                        |   | **March 31,  2004** |      | **December  31,  2003** |   | **March 31,  2003** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------|-------------------------|--------|---------------------|--------|
|                                                                                                                                                        |   | **(unaudited)**     |      |                    |   | **(unaudited)**     |   |
| **ASSETS:**                                                                                                                                                 |   |                |      |                    |   |                |   |
| Cash and due from banks                                                                                                                                     |   | $                   | 123,415   |                    | $      | 134,326             |   | $ | 105,188 |   |
| Federal funds sold                                                                                                                                          |   | 91,256              |      | 21,123                  |   | 45,106              |   |
| Short-term investment                                                                                                                                       |   | —              |      | 10,000                  |   | —              |   |
| Total cash and cash equivalents                                                                                                                             |   | 214,671             |      | 165,449                 |   | 150,294             |   |
| Investment securities                                                                                                                                       |   |                |      |                    |   |                |   |
| Available for sale, at fair value                                                                                                                           |   | 315,070             |      | 358,574                 |   | 397,833             |   |
| Held to maturity, at amortized cost (fair  value $18,520, $18,552 and $19,161)                                                                              |   | 17,956              |      | 18,067                  |   | 18,446              |   |
| Restricted equity securities                                                                                                                                |   | 55,623              |      | 55,623                  |   | 46,136              |   |
| Total investment securities                                                                                                                                 |   | 388,649             |      | 432,264                 |   | 462,415             |   |
| Loans held-for-sale                                                                                                                                         |   | —              |      | 2,624                   |   | 9,587               |   |
| Loans                                                                                                                                                       |   | 3,654,180           |      | 3,591,405               |   | 3,058,271           |   |
| Allowance for loan losses                                                                                                                                   |   | (43,257             | )         | (43,321                 | )      | (34,709             | )      |
| Net loans                                                                                                                                                   |   | 3,610,923           |      | 3,548,084               |   | 3,023,562           |   |
| Banking premises and equipment, net                                                                                                                         |   | 64,462              |      | 64,345                  |   | 54,288              |   |
| Goodwill                                                                                                                                                    |   | 113,051             |      | 113,138                 |   | 33,903              |   |
| Intangible assets                                                                                                                                           |   | 6,569               |      | 7,037                   |   | 1,400               |   |
| Bank owned life insurance                                                                                                                                   |   | 13,554              |      | 13,396                  |   | 3,905               |   |
| Net deferred tax asset                                                                                                                                      |   | 9,860               |      | 9,920                   |   | 10,377              |   |
| Other real estate owned and repossessed  autos                                                                                                              |   | 732                 |      | 266                     |   | 332                 |   |
| Accrued interest receivable                                                                                                                                 |   | 17,157              |      | 17,469                  |   | 16,509              |   |
| Other assets                                                                                                                                                |   | 13,237              |      | 11,144                  |   | 14,919              |   |
| Total assets                                                                                                                                                |   | $                   | 4,452,865 |                    | $      | 4,385,136           |   | $ | 3,781,491 |   |
|                                                                                                                                                        |   |                |      |                    |   |                |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY:**                                                                                                              |   |                |      |                    |   |                |   |
| Deposits                                                                                                                                                    |   | $                   | 2,925,002 |                    | $      | 2,917,361           |   | $ | 2,418,512 |   |
| Short-term borrowings                                                                                                                                       |   | 38,173              |      | 45,727                  |   | 31,843              |   |
| Federal Home Loan Bank advances                                                                                                                             |   | 986,970             |      | 927,162                 |   | 908,463             |   |
| Junior subordinated debentures                                                                                                                              |   | 74,742              |      | 74,742                  |   | 74,742              |   |
| Other borrowings                                                                                                                                            |   | 1,678               |      | 1,697                   |   | 1,754               |   |
| Mortgagors’ escrow payments                                                                                                                            |   | 5,704               |      | 2,911                   |   | 5,761               |   |
| Accrued expenses and other liabilities                                                                                                                      |   | 23,910              |      | 24,679                  |   | 31,438              |   |
| Total liabilities                                                                                                                                           |   | 4,056,179           |      | 3,994,279               |   | 3,472,513           |   |
|                                                                                                                                                        |   |                |      |                    |   |                |   |
| Stockholders’ equity:                                                                                                                                  |   |                |      |                    |   |                |   |
| Preferred stock, par value $.01 per share;  authorized 10,000,000 shares; none issued                                                                       |   | —              |      | —                  |   | —              |   |
| Common stock, par value $.01 per share;  authorized 100,000,000 shares; 30,227,555, 30,227,555 and 26,758,136 shares  issued in 2004 and 2003, respectively |   | 302                 |      | 302                     |   | 268                 |   |
| Additional paid-in capital                                                                                                                                  |   | 228,889             |      | 227,969                 |   | 154,495             |   |
| Retained earnings                                                                                                                                           |   | 237,443             |      | 234,275                 |   | 210,884             |   |
| Treasury stock, at cost, 4,305,625,  4,406,725 and 3,666,362 shares in 2004 and 2003, respectively                                                          |   | (69,446             | )         | (70,516                 | )      | (54,368             | )      |
| Accumulated other comprehensive income                                                                                                                      |   | 8,301               |      | 8,072                   |   | 8,320               |   |
| Unearned compensation - ESOP and restricted  stock                                                                                                          |   | (8,486              | )         | (8,932                  | )      | (10,314             | )      |
| Shares held in employee trust                                                                                                                               |   | (317                | )         | (313                    | )      | (307                | )      |
| Total stockholders’ equity                                                                                                                             |   | 396,686             |      | 390,857                 |   | 308,978             |   |
| Total liabilities and stockholders’ equity                                                                                                             |   | $                   | 4,452,865 |                    | $      | 4,385,136           |   | $ | 3,781,491 |   |

 

## **See accompanying notes to theunaudited consolidated financial statements.**

 

3

----

 

**SEACOAST FINANCIAL SERVICES CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**FOR THE THREE MONTHS ENDED**

**(Unaudited)**

**(In thousands, except per share amounts)**

 

 
|                                                                              |   | **Three Months Ended** |   |
|-----------------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                              |   | **March 31,  2004**    |   | **March 31,  2003** | ** ** |
| INTEREST AND DIVIDEND INCOME:                                                     |   |                   |   |   |   |
| Interest on loans                                                                 |   | $                      | 52,304 |   | $ | 48,247 |   |
| Interest and dividends on investment  securities                                  |   | 4,154                  |   | 5,233 |   |
| Interest on federal funds sold and  short-term investments                        |   | 64                     |   | 54 |   |
| Total interest and dividend income                                                |   | 56,522                 |   | 53,534 |   |
|                                                                              |   |                   |   |   |   |
| INTEREST EXPENSE:                                                                 |   |                   |   |   |   |
| Interest on deposits                                                              |   | 10,723                 |   | 10,961 |   |
| Interest on borrowed funds                                                        |   | 11,047                 |   | 11,576 |   |
| Total interest expense                                                            |   | 21,770                 |   | 22,537 |   |
| Net interest income                                                               |   | 34,752                 |   | 30,997 |   |
|                                                                              |   |                   |   |   |   |
| PROVISION FOR LOAN LOSSES                                                         |   | 1,650                  |   | 2,087 |   |
| Net interest income after provision for  loan losses                              |   | 33,102                 |   | 28,910 |   |
|                                                                              |   |                   |   |   |   |
| NONINTEREST INCOME:                                                               |   |                   |   |   |   |
| Deposit and other banking fees                                                    |   | 2,842                  |   | 2,498 |   |
| Loan servicing fees, net                                                          |   | 179                    |   | 173 |   |
| Merchant card fee income, net                                                     |   | 121                    |   | 50 |   |
| Other loan fees                                                                   |   | 578                    |   | 350 |   |
| Gain on sales of investment securities, net                                       |   | 991                    |   | 259 |   |
| Gain on sales of loans, net                                                       |   | 29                     |   | 45 |   |
| Other income                                                                      |   | 501                    |   | 209 |   |
| Total noninterest income                                                          |   | 5,241                  |   | 3,584 |   |
|                                                                              |   |                   |   |   |   |
| NONINTEREST EXPENSE:                                                              |   |                   |   |   |   |
| Salaries and employee benefits                                                    |   | 12,332                 |   | 9,973 |   |
| Occupancy and equipment expenses                                                  |   | 3,600                  |   | 2,717 |   |
| Data processing expenses                                                          |   | 2,195                  |   | 2,088 |   |
| Marketing expenses                                                                |   | 1,218                  |   | 723 |   |
| Professional services expenses                                                    |   | 1,459                  |   | 551 |   |
| Amortization of intangibles                                                       |   | 468                    |   | 164 |   |
| Merger expenses                                                                   |   | 1,843                  |   | — |   |
| Other operating expenses                                                          |   | 2,508                  |   | 4,144 |   |
| Total noninterest expense                                                         |   | 25,623                 |   | 20,360 |   |
| Income before provision for income taxes                                          |   | 12,720                 |   | 12,134 |   |
| PROVISION FOR INCOME TAXES                                                        |   | 6,055                  |   | 15,187 |   |
| Net income (loss)                                                                 |   | $                      | 6,665  |   | $ | (3,053 | ) |
| EARNINGS (LOSS) PER SHARE :                                                       |   |                   |   |   |   |
| Basic                                                                             |   | $                      | 0.27   |   | $ | (0.14 | ) |
| Diluted                                                                           |   | $                      | 0.26   |   | $ | (0.14 | ) |
|                                                                              |   |                   |   |   |   |
| Weighted average common shares outstanding                                        |   | 25,638,144             |   | 23,334,436 |   |
| Weighted average unallocated ESOP shares  and unvested restricted stock           |   | (711,535               | )      | (1,126,360 | ) |
| Weighted average common shares outstanding  - basic                               |   | 24,926,609             |   | 22,208,076 |   |
| Dilutive effect of common stock equivalents                                       |   | 679,441                |   | 490,045 |   |
| Weighted average common and common stock  equivalent shares outstanding - diluted |   | 25,606,050             |   | 22,698,121 |   |

 

See accompanying notes to the unauditedconsolidated financial statements.

 

4

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**SEACOAST FINANCIAL SERVICES CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS****’ EQUITY**

## **FORTHE THREE MONTHS ENDED MARCH 31, 2004 AND 2003**

**(Unaudited)**

**(In thousands, except per share amounts)**

 
|                                                                                                      |   | **Common  Stock** |   | **Additional  Paid-In  Capital** |   | **Retained  Earnings** |   | **Treasury  Stock** |    | **Accumulated  Other  Comprehensive  Income** |   | **Unearned  Compensation  ESOP/Restricted  Stock** |   | **Shares  Held  in Employee  Trust** |   | **Total** |   |
|-----------------------------------------------------------------------------------------------------------|--------|-------------------|--------|----------------------------------|--------|------------------------|--------|---------------------|---------|-----------------------------------------------|--------|----------------------------------------------------|--------|--------------------------------------|--------|-----------|--------|
| Balance, December 31, 2002                                                                                |   | $                 | 268    |                             | $      | 154,361                |   | $                   | 216,632 |                                          | $      | (49,033                                            | )      | $                                    | 8,330  |      | $      | (10,766 | ) | $ | (304 | ) | $ | 319,488 |   |
| Exercise of stock options                                                                                 |   | —            |   | 3                                |   | —                 |   | 44                  |    | —                                        |   | —                                             |   | —                               |   | 47        |   |
| Repurchase of common stock                                                                                |   | —            |   | —                           |   | —                 |   | (5,379              | )       | —                                        |   | —                                             |   | —                               |   | (5,379    | )      |
| Net loss                                                                                                  |   | —            |   | —                           |   | (3,053                 | )      | —              |    | —                                        |   | —                                             |   | —                               |   | (3,053    | )      |
| Other comprehensive loss — change in unrealized gain on securities  available for sale, net of taxes |   | —            |   | —                           |   | —                 |   | —              |    | (10                                           | )      | —                                             |   | —                               |   | (10       | )      |
| Comprehensive loss                                                                                        |   |              |   |                             |   |                   |   |                |    |                                          |   |                                               |   |                                 |   | (3,063    | )      |
| Cash dividends - $0.12 per share                                                                          |   | —            |   | —                           |   | (2,695                 | )      | —              |    | —                                        |   | —                                             |   | —                               |   | (2,695    | )      |
| Amortization of unearned compensation                                                                     |   | —            |   | 131                              |   | —                 |   | —              |    | —                                        |   | 452                                                |   | —                               |   | 583       |   |
| Other                                                                                                     |   | —            |   | —                           |   | —                 |   | —              |    | —                                        |   | —                                             |   | (3                                   | )      | (3        | )      |
| Balance, March 31, 2003                                                                                   |   | $                 | 268    |                             | $      | 154,495                |   | $                   | 210,884 |                                          | $      | (54,368                                            | )      | $                                    | 8,320  |      | $      | (10,314 | ) | $ | (307 | ) | $ | 308,978 |   |
|                                                                                                      |   |              |   |                             |   |                   |   |                |    |                                          |   |                                               |   |                                 |   |      |   |
| Balance, December 31, 2003                                                                                |   | $                 | 302    |                             | $      | 227,969                |   | $                   | 234,275 |                                          | $      | (70,516                                            | )      | $                                    | 8,072  |      | $      | (8,932 | ) | $ | (313 | ) | $ | 390,857 |   |
| Exercise of stock options                                                                                 |   | —            |   | 603                              |   | —                 |   | 1,070               |    | —                                        |   | —                                             |   | —                               |   | 1,673     |   |
| Net income                                                                                                |   | —            |   | —                           |   | 6,665                  |   | —              |    | —                                        |   | —                                             |   | —                               |   | 6,665     |   |
| Other comprehensive loss — change in unrealized gain on securities  available for sale, net of taxes |   | —            |   | —                           |   | —                 |   | —              |    | 229                                           |   | —                                             |   | —                               |   | 229       |   |
| Comprehensive income                                                                                      |   | —            |   | —                           |   | —                 |   | —              |    | —                                        |   | —                                             |   | —                               |   | 6,894     |   |
| Cash dividends - $0.14 per share                                                                          |   | —            |   | —                           |   | (3,497                 | )      | —              |    | —                                        |   | —                                             |   | —                               |   | (3,497    | )      |
| Amortization of unearned compensation                                                                     |   | —            |   | 317                              |   | —                 |   | —              |    | —                                        |   | 446                                                |   | —                               |   | 763       |   |
| Other                                                                                                     |   | —            |   | —                           |   | —                 |   | —              |    | —                                        |   | —                                             |   | (4                                   | )      | (4        | )      |
| Balance, March 31, 2004                                                                                   |   | $                 | 302    |                             | $      | 228,889                |   | $                   | 237,443 |                                          | $      | (69,446                                            | )      | $                                    | 8,301  |      | $      | (8,486 | ) | $ | (317 | ) | $ | 396,686 |   |

 

See accompanying notes to the unaudited consolidated financialstatements.

 

5

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## **SEACOASTFINANCIAL SERVICES CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003**

**(Unaudited)**

**(In thousands)**

 
|                                                                                                |   | **2004** |   | **2003** |   |
|-----------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |   |     |   |     |   |
| Net income (loss)                                                                                   |   | $        | 6,665  |     | $      | (3,053 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities —     |   |     |   |     |   |
| Depreciation                                                                                        |   | 1,499    |   | 1,232    |   |
| Amortization and accretion, net                                                                     |   | 405      |   | 383      |   |
| Purchase accounting amortization, net                                                               |   | 874      |   | 103      |   |
| Stock-based compensation                                                                            |   | 763      |   | 583      |   |
| Provision for loan losses                                                                           |   | 1,650    |   | 2,087    |   |
| Gain on sales of investment securities, net                                                         |   | (991     | )      | (259     | )      |
| Gain on sale of fixed assets                                                                        |   | —   |   | (1       | )      |
| Net decrease (increase) in deferred tax  asset                                                      |   | 60       |   | (732     | )      |
| Originations of loans held-for-sale                                                                 |   | (1,817   | )      | (8,715   | )      |
| Proceeds from sales of loans originated for  sale                                                   |   | 4,470    |   | 5,356    |   |
| Gain on sales of loans, net                                                                         |   | (29      | )      | (45      | )      |
| Net decrease (increase) in accrued interest  receivable                                             |   | 312      |   | (454     | )      |
| Net increase in other assets                                                                        |   | (2,251   | )      | (1,618   | )      |
| Net increase (decrease) in accrued expenses  and other liabilities                                  |   | (905     | )      | 9,839    |   |
| Net cash provided by operating activities                                                           |   | 10,705   |   | 4,706    |   |
|                                                                                                |   |     |   |     |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |   |     |   |     |   |
| Purchase of securities classified as  available for sale                                            |   | —   |   | (29,116  | )      |
| Purchase of securities classified as held  to maturity                                              |   | —   |   | —   |   |
| Purchase of restricted equity securities                                                            |   | —   |   | (1,893   | )      |
| Proceeds from sales, calls, paydowns and  maturities of securities classified as available for sale |   | 44,579   |   | 57,648   |   |
| Proceeds from calls, paydowns and  maturities of securities classified as held to maturity          |   | 46       |   | 216      |   |
| Purchase of loans                                                                                   |   | —   |   | (3,295   | )      |
| Net increase in loans                                                                               |   | (67,131  | )      | (65,886  | )      |
| Recoveries of loans previously charged off                                                          |   | 315      |   | 84       |   |
| Proceeds from sales of other real estate  owned and repossessed assets                              |   | 1,306    |   | 1,350    |   |
| Purchase of premises and equipment                                                                  |   | (1,700   | )      | (1,583   | )      |
| Net cash used in investing activities                                                               |   | (22,585  | )      | (42,475  | )      |
|                                                                                                     |        |          |        |          |        |  |  |

 

Statementcontinued on next page.

 

6

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** **
|                                                                              |   | **2004** |    | **2003** |   |
|-----------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| CASH FLOWS FROM FINANCING ACTIVITIES:                                             |   |     |    |     |   |
| Net increase (decrease) in NOW, money  market deposit and demand deposit accounts |   | (2,103   | )       | $        | 6,744  |   |
| Net increase (decrease) in passbook and  other savings accounts                   |   | (14,036  | )       | 13,191   |   |
| Net increase (decrease) in certificates of  deposit                               |   | 23,981   |    | (5,272   | )      |
| Advances from Federal Home Loan Bank                                              |   | 175,361  |    | 83,000   |   |
| Repayments of Federal Home Loan Bank  advances                                    |   | (115,497 | )       | (33,341  | )      |
| Net proceeds from issuance of junior  subordinated debentures                     |   | —   |    | 14,520   |   |
| Net decrease in short-term and other  borrowings                                  |   | (7,573   | )       | (4,303   | )      |
| Net increase in mortgagors’ escrow payments                                  |   | 2,793    |    | 1,272    |   |
| Repurchase of common stock                                                        |   | —   |    | (5,379   | )      |
| Cash dividends                                                                    |   | (3,497   | )       | (2,695   | )      |
| Exercise of stock options                                                         |   | 1,070    |    | 44       |   |
| Tax benefits of stock option and award  transactions, net                         |   | 603      |    | 3        |   |
| Net cash provided by financing activities                                         |   | 61,102   |    | 67,784   |   |
|                                                                              |   |     |    |     |   |
| Net increase in cash and cash equivalents                                         |   | 49,222   |    | 30,015   |   |
| Cash and cash equivalents, beginning of  year                                     |   | 165,449  |    | 120,279  |   |
| Cash and cash equivalents, end of period                                          |   | $        | 214,671 |     | $      | 150,294 |   |
|                                                                              |   |     |    |     |   |
| Supplemental disclosure of cash flow  information:                                |   |     |    |     |   |
| Interest paid on deposits and borrowed  funds                                     |   | $        | 22,072  |     | $      | 22,466 |   |
| Income taxes paid                                                                 |   | 8,849    |    | 6,166    |   |
| Supplemental disclosure of noncash  transactions:                                 |   |     |    |     |   |
| Transfers from loans to repossessed assets                                        |   | 1,772    |    | 332      |   |

 

See accompanying notes to the unaudited consolidated financialstatements.

 

7

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**SEACOASTFINANCIAL SERVICES CORPORATION AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

**MARCH 31, 2004**

**(In thousands, except per share data, unaudited)**

 

**(1)  BASIS OF PRESENTATION AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

##### **Basisof Presentation**

 

The unaudited consolidated financial statements of Seacoast FinancialServices Corporation (the Company or Seacoast) and its wholly-ownedsubsidiaries, Compass Bank for Savings (Compass), Nantucket Bank (together withCompass, the “Banks”) and Lighthouse Securities Corporation, presented hereinshould be read in conjunction with the Consolidated Financial Statements of theCompany as of and for the year ended December 31, 2003 included as part of itsannual report on Form 10-K.

 

In the opinion of management, the accompanying unaudited financialstatements reflect all adjustments (consisting of normal recurring adjustments)and disclosures necessary for a fair presentation.  Management is required to make estimates and assumptions thataffect amounts reported in the financial statements.  Actual results could differ significantly from those estimates.

 

### **Summary ofSignificant Accounting Policies**

 

The Company’s significant accounting policies are described in Note 1of the Notes to Consolidated Financial Statements included in its Form 10-K asof and for the year ended December 31, 2003 filed with the Securities andExchange Commission.  For interimreporting purposes, the Company follows the same significant accountingpolicies.  Certain reclassificationshave been made to prior year balances to conform to the current yearpresentation.

 

**Earnings (Loss) Per Share**

 

Basic EPS was computed based on the weighted average number of commonshares outstanding during the periods presented.  Unallocated ESOP shares and unvested restricted stock awards arenot considered outstanding in computing basic EPS.  Diluted EPS reflects the potential dilution that could occur ifcontracts to issue common stock were exercised and has been computed aftergiving consideration to the dilutive effect of stock options, stock awards andshares held in an employee trust.

 

**Stock-Based Compensation**

 

The Company applies APB Opinion No. 25 in accounting for stock optionswhich measures compensation cost for

stock-based compensation plans as the difference between the exerciseprice of options granted and the fair market value of the Company’s stock atthe grant date.  This generally does notresult in any compensation charges to earnings.  Below, the Company discloses pro forma net income and earningsper share as if compensation was measured at the date of grant based on thefair value of the award and recognized over the service period.  This is required by SFAS No. 123, as amendedby SFAS No. 148, for all companies that elect to continue using APB Opinion No.25 for stock option grants.  There wereno stock option grants during the quarters ended March 31, 2004 and 2003.

 

Had the Company applied SFAS No. 123, as amended by SFAS No. 148, inaccounting for its stock option grants, net income (loss) and EPS (basic anddiluted) would have been reduced to the pro forma amounts indicated below:

 
|               |   | **Quarter  Ended March 31,**              |   |
|--------------------|--------|-------------------------------------------|--------|
|               |   | **2004**                                  |   | **2003** |   |
|               |   | **(In  thousands, except for per share)** |   |
| Net income (loss): |   |                                      |   |   |   |
| As reported        |   | $                                         | 6,665  |   | $ | (3,053 | ) |
| Pro forma          |   | 6,547                                     |   | (3,155 | ) |
| Basic EPS:         |   |                                      |   |   |   |
| As reported        |   | $                                         | 0.27   |   | $ | (0.14 | ) |
| Pro forma          |   | 0.26                                      |   | (0.14 | ) |
| Diluted EPS:       |   |                                      |   |   |   |
| As reported        |   | $                                         | 0.26   |   | $ | (0.14 | ) |
| Pro forma          |   | 0.26                                      |   | (0.14 | ) |

 

8

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**(2)  COMPREHENSIVE INCOME (LOSS)**

 

The components of comprehensive income (loss) for Seacoast are netincome (loss) and unrealized gains (losses) on securities available for sale,net of tax.  The following table showsthe components of comprehensive income (loss) for the three months ended March31, 2004 and 2003.

 
|                                                                                                             |   | **Three  months ended  March 31,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                                             |   | **2004**                           |   | **2003** |   |
|                                                                                                             |   | **(In  thousands)**                |   |
| Net income (loss)                                                                                                |   | $                                  | 6,665  |   | $ | (3,053 | ) |
| Other comprehensive income (loss), net of  tax:                                                                  |   |                               |   |   |   |
| Unrealized gains on available for sale  securities:                                                              |   |                               |   |   |   |
| Unrealized holding gains arising during the  period, net of taxes of $492 and $87, respectively                  |   | 873                                |   | 158 |   |
| Reclassification adjustment for gains  included in net income (loss), net of taxes of $347 and $91, respectively |   | (644                               | )      | (168 | ) |
| Other components of income, net                                                                                  |   | 229                                |   | (10 | ) |
| Comprehensive income (loss)                                                                                      |   | $                                  | 6,894  |   | $ | (3,063 | ) |

 

**(3) ****PENDINGACQUISITION OF THE COMPANY BY SOVEREIGN BANCORP, INC.**

 

On January 26, 2004, the Company announced that it had entered into adefinitive agreement with Sovereign Bancorp, Inc. (Sovereign) pursuant to whichit would be acquired by Sovereign.  OnApril 12, 2004, the Company and Sovereign amended the merger agreement.  Under the Sovereign/Seacoast mergeragreement, as amended, stockholders of Seacoast will receive for each share ofSeacoast that they own either a specified number of shares of Sovereign commonstock or a specific amount of cash, depending on the average of Sovereign’sclosing share prices as reported on the New York Stock Exchange for 15consecutive trading days (the average final price) prior to the later to occurof (1) Seacoast’s stockholder meeting to consider the Sovereign/Seacoastmerger, or (2) the date of the receipt of the last governmental approvalrequired to complete the Sovereign/Seacoast merger (the Sovereign determinationdate).  If the average final price ofSovereign common stock ending on the Sovereign determination date is:

 

•                       equal to orgreater than $23.96, then each share of Company common stock will be convertedinto the right to receive either 1.461 shares of Sovereign common stock or anamount of cash equal to 1.461 multiplied by the average final price on theSovereign determination date;

 

•                       greaterthan $21.56 but less than $23.96, then each share of Company common stock willbe converted into the right to receive either a number of shares of Sovereigncommon stock equal to the quotient obtained by dividing $35.00 by the averagefinal price on the Sovereign determination date or $35.00 in cash; or

 

•                       equal to orless than $21.56, then each share of Company common stock will be convertedinto the right to receive either a number of shares of Sovereign common stockor an amount of cash each having a value on the Sovereign determination dateequal to the sum of (1) 1.21725 times the average final price on the Sovereigndetermination date plus (2) $8.75 (the equalization formula).

 

The equalization formula will be applied only if the average finalprice of Sovereign common stock is below $21.57 on the Sovereign determinationdate.  The equalization formula isdesigned to provide that, under such circumstances, each Company stockholder,whether receiving cash or Sovereign common stock, will receive for each shareof Company common stock that he, she or it owns a blended merger considerationvalue equal to 75% of the value to be received under the original mergeragreement (which originally had a fixed floor exchange ratio of 1.623) plus 25%of $35.00.

 

Except under certain circumstances, the merger agreement containsallocation procedures designed to ensure that 75% of the shares of Company commonstock will be converted into the right to receive shares of Sovereign commonstock and 25% will be converted into the right to receive cash.  The number of shares of Company common stockthat will be converted into the right to receive stock may be increased ifnecessary for Sovereign’s and Company’s respective legal counsels to rendertheir opinions that the merger will be treated as a reorganization for UnitedStates federal income tax purposes.

 

9

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Seacoast has a right to terminate the transaction at any time prior tothe Sovereign/Seacoast merger if (1) the average final price of Sovereigncommon stock on the Sovereign determination date is less than $20.37 and (2)the decline in the average final price of Sovereign common stock since January23, 2004 is at least 15 percentage points more than the change during the sameperiod in a peer index based on the stock prices of ten other bank and thriftholding companies, unless Sovereign, after receiving notice of termination fromthe Company, elects to pay an incremental additional amount of cash for eachoutstanding share of Company common stock exchanged in the merger equal to theresult obtained when (a) the product of 1.21725 multiplied by the average finalprice on the determination date is subtracted from (b) $24.795. In all cases,cash will be paid in lieu of any fractional shares. The Sovereign/Seacoastmerger is intended to constitute a tax-free “reorganization” for federal incometax purposes. The Sovereign/Seacoast merger agreement was filed on January 28,2004 with the Securities and Exchange Commission as an exhibit to Sovereign’sCurrent Report on Form 8-K and the amendment to the merger agreement was filedon April 13, 2004 as an exhibit to Sovereign’s Current Report on Form 8-K.  Completion of the Sovereign/Seacoast merger,which is currently anticipated to occur in the third quarter of 2004, issubject to a number of conditions, including receipt of all requisitegovernmental approvals and certain other customary conditions, as well as theright of each party to terminate the Sovereign/Seacoast merger under certaincircumstances.

 

**(4) SHARE REPURCHASE PROGRAMS**

 

During the three months ended March 31, 2004,Seacoast did not repurchase any shares of its outstanding common stock.  At March 31, 2004, there were a total of 2,171,459shares remaining under existing repurchase authorizations.  Due to the previously announced merger withSovereign, the Company has no intention to make further purchases under itsshare repurchase programs.

 

**(5) QUARTERLY CASH DIVIDEND**

 

On April 22, 2004, the Board of Directors voted for the payment of aquarterly cash dividend of $0.14 per share. The dividend is payable on May 21, 2004 to stockholders of record on May7, 2004.

 

**(6) RECENT ACCOUNTING PRONOUNCEMENTS**

 

OnMarch 31, 2004, the Financial Accounting Standards Board issued an ExposureDraft “Share-Based Payment: an Amendment of FASB Statements No. 123 and95”.  The exposure draft proposes thatall companies recognize the fair value of stock options and other stock-basedcompensation awards to employees in an attempt to achieve as much convergencewith international accounting standards for share-based awards.  The intent of both governing agencies is torecognize compensation expense based on the fair value of the award determinedat the grant date and recognized over the service date.  The proposed requirements would be effectivefor companies for the first fiscal year after December 15, 2004, with earlyadoption permitted.  However,restatement of prior year financial statements would not be permitted.

 

#### **(7) SUBSEQUENT EVENT**

 

On April 29, 2004, the Company completed its acquisition of AbingtonBancorp, Inc. (Abington) after receiving all requisite regulatory and shareholderapprovals.  In addition, Abington’sbanking subsidiary, Abington Savings Bank was merged with and into CompassBank, the banking subsidiary of Seacoast. The total consideration paid to the Abington shareholders wasapproximately 4,395,000 shares of Seacoast stock and approximately $34.4million in cash.  At March 31, 2004,Abington had total assets of approximately $811.3 million, primarily ininvestments available for sale and residential loans, and total deposits ofapproximately $640.4 million with 17 branches located throughout thesoutheastern Boston metropolitan area.

 

On April 26, 2004, the Company borrowed $25 million fromSovereign.  The Company used theproceeds of the loan to fund a portion of the cash component paid in connectionwith its merger with Abington.  The loanis unsecured and generally bears interest at an annual rate equal to LIBOR plus3.5%, or, if LIBOR is unavailable, Seacoast is in default on the loan orotherwise at Seacoast’s choosing, at prime plus 1.0%.  Interest on the loan is payable monthly and no principal paymentsare due with respect to the loan until its maturity.  Unless it is accelerated by reason of default, the loan willmature on the earlier of (1) the business day immediately preceding theeffective time of the Sovereign/Seacoast merger or (2) 24 months following theeffective date of the termination of the merger agreement.  If for some reason the merger with Sovereignis terminated or not completed by December 31, 2004, the interest rate willincrease (120 days after termination) to equal LIBOR plus 4.5% or if LIBOR isnot available, at prime plus 2.0%.  Thedefault rate on the loan is 2.0% higher than the otherwise applicable interestrate.

 

10

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**Item 2****.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

### **Forward-Looking Statements**

 

This Form 10-Q contains certain “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934.  Whenused in this report, the words or phrases, “will likely result,” “are expectedto,” “will continue,” “is anticipated,” “estimates,” “believes,” “intends” andsimilar expressions are intended to identify such forward-lookingstatements.  Actual events could differmaterially from those anticipated in the forward-looking statements.  Important factors that might cause such adifference include, among other things, general economic conditions,particularly the real estate market, in the Company’s primary market area,credit risk management, asset/liability management, legislation and changes ingovernment regulation and supervision, including changes in accountingstandards, changes in interest rates, achieving cost savings goals and timeframes for successful acquisitions and integration, the success of theCompany’s pending acquisition by Sovereign, the availability of and costsassociated with sources of liquidity and increased competition and bankconsolidations in the Company’s market area. These and other factors that might cause differences between actual andanticipated results, performance and achievements are discussed in greaterdetail in this Item 2.

 

### **COMPARISON OF OPERATING RESULTS FOR THEQUARTERS ENDED MARCH 31, 2004 AND 2003**

# ** **

***Executive Overview***

# ** **

# **The Company derives the majority of its revenue fromlending activities.  Interest incomeearned on loans has represented approximately 90% of all income earned onearning assets over the last several years. The Company has relied on deposit growth as the primary funding sourcefor growth in earning assets.  Over thelast several years, deposits have funded approximately 70% of earning assets**.

 

Growth in earnings is therefore derived primarily through growth inloans and deposits and the spread between the interest earned on loans and theinterest paid on deposits.  In turn,growth in loans and deposits are impacted by several factors including generaleconomic conditions, the level of interest rates and competition.

 

The Company’s strategy has been to grow loans and deposits by offeringcompetitive pricing, superior customer service, a broad range of products andservices as well as expansion of the franchise by and through acquisitions ofwhole banks and branches.

 

The last several years have produced unique market opportunities togrow the franchise resulting from volatile equity and fixed income markets,increased industry consolidation, and the historical decline in interest rates.  These events have caused consumers to preferthe safety of bank deposits backed by the full faith of the U.S. and stategovernments via deposit insurance to the risk of equity investments.  The decline in market rates to levels notseen in 40 years has also produced increased interest by consumers andbusinesses alike in refinancing existing debt as well as increasing debtlevels.  Increased industryconsolidation has aided the Company’s growth both directly via acquisitions andindirectly by the servicing of disenfranchised customers impacted by theindustry consolidation.

 

As an independent stand-alone company, some of the challenges and risksthe Company is focused on managing are:

 

•                  Integration riskof acquisitions

•                  Interest-raterisk

•                  Credit risk

•                  General economicconditions in its market area.

•                  The level ofinterest rates and the slope of the yield curve (the difference between shortterm rates and long term rates).

 

To this end,management and the Seacoast Board of Directors actively monitor and manage thevarious risks via frequent committee and board meetings where issues regardingtrends and conditions are analyzed and addressed.  However, as a result of our pending acquisition by Sovereign,management’s focus will be directed in large part towards maintaining our presentbusiness and guiding the Company through the corporate and regulatory tasks andissues necessary to consummate the merger as required under theSovereign/Seacoast merger agreement.  Ona related note, the Sovereign/Seacoast merger agreement provides for a numberof restrictions on Seacoast’s ability to conduct its business,

 

11

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which may limit the Company’s ability tocompete with other financial institutions and may require the Company to foregocertain other opportunities.

 

*Summary.* Net income totaled $6.7 million, or $0.26 per diluted share, for thequarter ended March 31, 2004, compared to a net loss of $3.1 million, or $0.14per diluted share, for the quarter ended March 31, 2003.  During the first quarter of 2004, theCompany recorded a charge for expenses incurred in connection with its pendingmerger with Sovereign, which reduced net income by $1.8 million, or $0.07 perdiluted share.  Included in the first quarter2003 results is an $11.2 million charge to earnings, or $0.50 per dilutedshare, due to a retroactive change to Massachusetts tax law implemented onMarch 5, 2003.

 

*Interest Income.*  Interest income for the quarter ended March31, 2004 was $56.5 million, compared to $53.5 million for the quarter endedMarch 31, 2003, an increase of $3.0 million, or 5.6%.  The increase in interest income resulted from growth in averageinterest-earning assets of $527.1 million, or 14.8%, primarily resulting fromthe acquisition of Bay State Bancorp, Inc. (Bay State) during the secondquarter of 2003, partially offset by the 49 basis point decline in the yield oninterest-earning assets in the 2004 period to 5.55%.  The principal areas of growth in average balances were related toreal estate loans (up $480.9 million, or 22.8%) and indirect auto loans (up$72.9 million, or 9.4%).  The growth inreal estate loans reflect the acquisition of Bay State in May 2003 while theincrease in indirect auto loans resulted from the continued geographicexpansion of the network of participating dealers.

 

*Interest Expense.*  Interest expense for the quarter ended March31, 2004 was $21.8 million, compared to $22.5 million for the quarter endedMarch 31, 2003, a decrease of $767,000, or 3.4%.  This decrease resulted from a 47 basis points decrease in thecost of all funds from 2.82% in 2003 to 2.35% in 2004, partially offset by ahigher average balance of interest-bearing liabilities (up $514.0 million, or16.1%).  Average interest-bearingdeposit balances increased $432.1 million, or 19.6%, during the quarter endedMarch 31, 2004 compared to the same period in 2003.  The rate paid on interest-bearing deposits declined 36 basispoints to 1.63% for the first quarter of 2004.

 

Interest expense on total borrowings decreased $529,000 in the quarterended March 31, 2004 primarily the result of a decrease of 55 basis points inthe average rate paid on borrowed funds to 4.11% in 2004 from 4.66% in2003.  The decline in the rate paid ontotal borrowings was partially offset by an increase in the average balance ofsuch funds of $81.9 million, or 8.2%, during the first quarter of 2004.

 

The decrease in the cost of funds and the lower yields earned oninterest-earning assets are reflective of the low interest rate environment inwhich the Company operates.

 

12

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The followingtable presents average balances, interest income and expense and yields earnedor rates paid on the major categories of assets and liabilities for thequarters indicated.

 
|                                                |   | **Quarters  ended March 31,** |      |
|-----------------------------------------------------|--------|-------------------------------|-----------|
|                                                |   | **2004**                      |      | **2003** |   |
|                                                |   | **Average  balance**          |      | **Interest** |   | **Average  yield/  rate (1)** |   | **Average  balance** |   | **Interest** |   | **Average  yield/  rate (1)** |   |
| Assets:                                             |   |                          |      |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                            |   |                          |      |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold and other short-term investments |   | $                             | 34,816    |   | $ | 64 |   | 0.74 | % | $ | 22,093 |   | $ | 54 |   | 0.98 | % |
| Debt securities (2)                                 |   | 339,407                       |      | 3,781 |   | 4.46 |   | 423,513 |   | 4,796 |   | 4.53 |   |
| Equity securities (2)                               |   | 73,488                        |      | 398 |   | 2.17 |   | 59,629 |   | 468 |   | 3.14 |   |
| Total investments                                   |   | 447,711                       |      | 4,243 |   | 3.79 |   | 505,235 |   | 5,318 |   | 4.21 |   |
| Mortgage loans (3)                                  |   | 2,585,853                     |      | 38,494 |   | 5.95 |   | 2,104,991 |   | 34,562 |   | 6.57 |   |
| Commercial loans (3)                                |   | 165,698                       |      | 2,238 |   | 5.40 |   | 126,394 |   | 1,753 |   | 5.55 |   |
| Indirect auto loans (3)                             |   | 846,302                       |      | 10,962 |   | 5.18 |   | 773,354 |   | 11,145 |   | 5.76 |   |
| Other consumer loans (3)                            |   | 35,124                        |      | 656 |   | 7.47 |   | 43,568 |   | 839 |   | 7.70 |   |
| Total loans                                         |   | 3,632,977                     |      | 52,350 |   | 5.76 |   | 3,048,307 |   | 48,299 |   | 6.34 |   |
| Total interest-earning assets                       |   | 4,080,688                     |      | 56,593 |   | 5.55 | % | 3,553,542 |   | 53,617 |   | 6.04 | % |
| Allowance for loan losses                           |   | (43,246                       | )         |   |   |   |   | (34,602 | ) |   |   |   |   |
| Non-interest earning assets                         |   | 358,584                       |      |   |   |   |   | 234,396 |   |   |   |   |   |
| Total assets                                        |   | $                             | 4,396,026 |   |   |   |   |   | $ | 3,753,336 |   |   |   |   |   |
| Liabilities and Equity:                             |   |                          |      |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                       |   |                          |      |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                           |   |                          |      |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                        |   | $                             | 303,504   |   | $ | 114 |   | 0.15 | % | $ | 287,808 |   | $ | 184 |   | 0.26 | % |
| Savings accounts                                    |   | 396,344                       |      | 663 |   | 0.67 |   | 325,883 |   | 777 |   | 0.95 |   |
| Money market savings accounts                       |   | 830,086                       |      | 2,850 |   | 1.37 |   | 579,187 |   | 2,023 |   | 1.40 |   |
| Certificates of deposit                             |   | 1,103,431                     |      | 7,096 |   | 2.57 |   | 1,008,352 |   | 7,977 |   | 3.16 |   |
| Total interest-bearing deposits                     |   | 2,633,365                     |      | 10,723 |   | 1.63 |   | 2,201,230 |   | 10,961 |   | 1.99 |   |
| Borrowed funds:                                     |   |                          |      |   |   |   |   |   |   |   |   |   |   |
| Short-term borrowings (4)                           |   | 42,388                        |      | 144 |   | 1.36 |   | 35,818 |   | 144 |   | 1.61 |   |
| FHLB advances                                       |   | 957,860                       |      | 9,406 |   | 3.93 |   | 897,834 |   | 10,175 |   | 4.53 |   |
| Junior subordinated debentures                      |   | 74,742                        |      | 1,497 |   | 8.01 |   | 59,463 |   | 1,257 |   | 8.46 |   |
| Total borrowings                                    |   | 1,074,990                     |      | 11,047 |   | 4.11 |   | 993,115 |   | 11,576 |   | 4.66 |   |
| Total interest-bearing liabilities                  |   | 3,708,355                     |      | 21,770 |   | 2.35 |   | 3,194,345 |   | 22,537 |   | 2.82 | % |
| Non-interest bearing demand deposit accounts        |   | 266,166                       |      |   |   |   |   | 210,938 |   |   |   |   |   |
| Other liabilities                                   |   | 23,425                        |      |   |   |   |   | 20,036 |   |   |   |   |   |
| Total liabilities                                   |   | 3,997,946                     |      |   |   |   |   | 3,425,319 |   |   |   |   |   |
| Stockholders’ equity                           |   | 398,080                       |      |   |   |   |   | 328,017 |   |   |   |   |   |
| Total liabilities and stockholders’ equity     |   | $                             | 4,396,026 |   |   |   |   |   | $ | 3,753,336 |   |   |   |   |   |
| Net interest-earning assets                         |   | $                             | 372,333   |   |   |   |   |   | $ | 359,197 |   |   |   |   |   |
| Net interest income (fully-taxable equivalent)      |   |                          |      | 34,823 |   |   |   |   |   | 31,080 |   |   |   |
| Less: fully-taxable equivalent adjustments          |   |                          |      | (71 | ) |   |   |   |   | (83 | ) |   |   |
| Net interest income                                 |   |                          |      | $ | 34,752 |   |   |   |   |   | $ | 30,997 |   |   |   |
| Net interest rate spread (5)                        |   |                          |      |   |   | 3.20 | % |   |   |   |   | 3.22 | % |
| Net interest margin (6)                             |   |                          |      |   |   | 3.41 | % |   |   |   |   | 3.50 | % |

 

----

(1)    Annualized

(2)    Average balances include fair values gains onsecurities available for sale.  Equitysecurities include marketable equity securities and restricted equitysecurities.

(3)    Loans on non-accrual status are included inthe average balances.

(4)    Short-term borrowings include immaterialbalances of other borrowings.

(5)    Net interestrate spread represents the difference between the yield on interest-earningassets and the rate on interest-bearing liabilities.

(6)    Net interest margin represents net interest income(fully-taxable equivalent) divided by average interest-earning assets.

 

13

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*Rate/Volume Analysis.*  The following table presents the extent towhich changes in interest rates and changes in volume of interest-earningassets and interest-bearing liabilities have affected the Company’s interestincome and interest expense during the periods indicated.  Information is provided in each categorywith respect to: (i) changes attributable to changes in volume (changes involume multiplied by prior rate); (ii) changes attributable to changes in rate(changes in rate multiplied by prior volume); and (iii) the net change (changein rate times change in volume).  Thenet change has been allocated proportionately to the changes due to volume andthe changes due to rate.

 
|                                            |   | **Quarters  ended March 31,  2004 vs. 2003  Increase (decrease) due to****** |   |
|-------------------------------------------------|--------|------------------------------------------------------------------------------|--------|
|                                            |   | **Volume**                                                                   |   | **Rate** |   | **Net** |   |
|                                            |   | **(In  thousands)**                                                          |   |
| Interest-earning assets:                        |   |                                                                         |   |   |   |   |   |
| Federal funds sold and short-term  investments  |   | $                                                                            | 26     |   | $ | (16 | ) | $ | 10 |   |
| Debt securities                                 |   | (938                                                                         | )      | (77 | ) | (1,015 | ) |
| Equity securities                               |   | 94                                                                           |   | (164 | ) | (70 | ) |
| Mortgage loans                                  |   | 7,372                                                                        |   | (3,440 | ) | 3,932 |   |
| Commercial loans                                |   | 532                                                                          |   | (47 | ) | 485 |   |
| Indirect auto loans                             |   | 1,000                                                                        |   | (1,183 | ) | (183 | ) |
| Other consumer loans                            |   | (158                                                                         | )      | (25 | ) | (183 | ) |
| Total interest-earning assets                   |   | 7,928                                                                        |   | (4,952 | ) | 2,976 |   |
|                                            |   |                                                                         |   |   |   |   |   |
| Interest-bearing liabilities:                   |   |                                                                         |   |   |   |   |   |
| Deposits:                                       |   |                                                                         |   |   |   |   |   |
| NOW accounts                                    |   | $                                                                            | 10     |   | $ | (80 | ) | $ | (70 | ) |
| Savings accounts                                |   | 147                                                                          |   | (261 | ) | (114 | ) |
| Money market savings accounts                   |   | 862                                                                          |   | (35 | ) | 827 |   |
| Certificates of deposit                         |   | 705                                                                          |   | (1,586 | ) | (881 | ) |
| Total deposits                                  |   | 1,724                                                                        |   | (1,962 | ) | (238 | ) |
|                                            |   |                                                                         |   |   |   |   |   |
| Borrowed funds:                                 |   |                                                                         |   |   |   |   |   |
| Short-term borrowings                           |   | $                                                                            | 16     |   | $ | (16 | ) | $ | — |   |
| FHLB advances                                   |   | 650                                                                          |   | (1,419 | ) | (769 | ) |
| Junior subordinated debentures                  |   | 309                                                                          |   | (69 | ) | 240 |   |
| Total borrowings                                |   | 975                                                                          |   | (1,504 | ) | (529 | ) |
| Total interest-bearing liabilities              |   | 2,699                                                                        |   | (3,466 | ) | (767 | ) |
| Net interest income (fully-taxable  equivalent) |   | $                                                                            | 5,229  |   | $ | (1,486 | ) | $ | 3,743 |   |

 

*Provision for Loan Losses.*  The Company provides for loan losses inorder to maintain the allowance for loan losses at a level that managementbelieves is adequate to absorb inherent charge-off of loans deemeduncollectible within the loan portfolio. In determining the appropriate levelof the allowance for loan losses, management considers past and anticipatedcharge-off experience, evaluations of underlying collateral, prevailingeconomic conditions, the nature and volume of the loan portfolio and the levelsof nonperforming, delinquent and other classified loans.  The amount of the allowance is estimatedbased on numerous judgments, and ultimate loan losses may vary from currentestimates and future additions may be necessary.  Management assesses the allowance for loan losses on a quarterlybasis and believes that its analysis of the allowance for loan losses isreasonable.

 

The Company recognized a provision for loan losses of $1.7 million inthe quarter ended March 31, 2004 compared to $2.1 million in the quarter endedMarch 31, 2003.  The decrease of$437,000 in 2004 was due to the lower level of annualized charge-offs to totalaverage loans and the indirect automobile loan portfolio decreasing as apercentage of total loans.  The totalallowance of $43.3 million at March 31, 2004 represented 1.18% of total loanscompared to a ratio of 1.21% at December 31, 2003.  The allowance for loan losses as a percentage of non-performingloans was 248.3% at March 31, 2004 compared to 295.1% at December 31, 2003.

 

*Noninterest Income.*  Total noninterest income was $5.2 millionfor the quarter ended March 31, 2004 as compared to $3.6 million in the sameperiod of 2003, for an increase of $1.7 million, or 46.2%.  The increase was primarily the result ofincreases in deposit and other banking fees resulting from the acquisition ofBay State and gains on the sale of investment securities.

 

14

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*Noninterest Expense. *Noninterest expensetotaled $25.6 million for the quarter ended March 31, 2004 as compared to $20.4million in the same period of 2003, for an increase of $5.3 million, or25.8%.  This increase reflectedincreases in salaries and employee benefits ($2.4 million), occupancy andequipment expense ($883,000), marketing expense ($495,000) and professionalservices expense ($908,000).  Theseincreases in noninterest expenses were primarily due to franchise expansion andthe acquisition of Bay State in May 2003.

 

Salaries and employee benefits increased $2.4 million, or 23.7%, to$12.3 million during the quarter ended March 31, 2004 compared to the sameperiod of 2003.  This increase was theresult of the retention of former Bay State employees, salary increasesaveraging 5% and other increases in staffing related to Company growth andfranchise expansion, supplemented by increases in the cost of employeebenefits.

 

Occupancy and equipment expenses increased by $883,000, or 32.5%, to$3.6 million during the quarter ended March 31, 2004 compared to the sameperiod of 2003. This increase was primarily the result of increases in rentalexpense, building and equipment depreciation and maintenance expenses relatedto the addition of the Bay State branches and computer equipment purchases.

 

Dataprocessing expenses increased $107,000, or 5.1%, to $2.2 million during thequarter ended March 31, 2004  dueprimarily to core processing activities that are volume-related and increasesin the number of retail deposit and loan accounts. Also, software maintenanceexpenses and alternative deposit delivery costs increased during the firstquarter of 2004.

 

Marketing expenses increased $495,000, or 68.5%, to $1.2 million duringthe quarter ended March 31, 2004.  Thisincrease was primarily attributable to an overall general increase in marketingefforts related to brand building and product campaigns via newspapers andbillboards over a broader geographic footprint.

 

Professional services expenses increased $908,000 to $1.5 millionduring the quarter ended March 31, 2004. This increase was primarily the result of increased corporate legalexpense, collections fees and corporate consulting fees.

 

Amortization of intangibles increased $304,000 to $468,000 during thequarter ending March 31, 2004.  Thisincrease is primarily attributable to amortization of core deposit intangiblesand a non-compete agreement resulting from the acquisition of Bay State.

 

Merger expenses relating to the acquisition of the Company by Sovereigntotaled $1.8 million for the quarter ending March 31, 2004.  Merger expenses incurred by the Company inrelation to its acquisition of Abington are included as costs of thetransaction as part of goodwill in accordance with SFAS No. 142.

 

Other noninterest expense decreased $1.6 million, or 39.5%, to $2.5million during the quarter ended March 31, 2004. This decrease primarilyreflects the recording of an interest deficiency charge of $1.6 million for thefirst quarter of 2003 as a result of the Massachusetts law change thatretroactively disallowed the REIT dividend deduction for the years endedDecember 31, 1999 through December 31, 2002. Excluding this deficiency charge,other noninterest expense was flat when comparing both quarters.

 

*Income Taxes.* Provision for income taxes for the first quarter of 2004 was $6.1million, down $9.1 million from the $15.2 million recorded for the same period in2003.  The first quarter of 2004 incometax provisions were impacted by the non-deductibility of the $1.8 million inmerger expenses relating to the pending acquisition of the Company bySovereign.              During the quarterended March 31, 2003, the Company recorded an additional state income taxprovision of $9.6 million, net of the federal income tax benefit, as a resultof the Massachusetts law change that retroactively disallowed the REIT dividenddeduction for the years ended December 31, 1999 through December 31, 2002.  The merger expenses in 2004 and theadditional state provision and related interest deficiency charge in 2003caused the effective tax rates recognized for the quarters ended March 31, 2004and 2003 to be 48% and 125%, respectively, rather than 41.6% and 40.7%,respectively, that they would have been without such items.

 

15

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**COMPARISON OF FINANCIAL CONDITION AT MARCH31, 2004 AND DECEMBER 31, 2003**

 

Total assetsincreased by $67.7 million from $4.4 billion at December 31, 2003 to $4.5billion at March 31, 2004.  During thequarter ended March 31, 2004, investment securities decreased $43.6 millionfrom $432.3 million at December 31, 2003 to $388.6 million at March 31, 2004while federal funds sold and short-term investments increased $60.1 millionover the same period to $91.3 million at March 31, 2004.  During the quarter ended March 31, 2004, theloan portfolio increased by $62.8 million, or 1.7%, to $3.7 billion as of March31, 2004.  The balance sheet growthrealized in the first quarter of 2004 was funded principally by growth inFederal Home Loan Bank advances of $59.8 million, which totaled $987.0 millionat March 31, 2004.  Total depositsincreased $7.6 million during the first quarter of 2004 and totaled $2.9billion as of March 31, 2004.

 

**InvestmentSecurities**

 

Investmentsecurities decreased $43.6 million from $432.3 million at December 31, 2003, to$388.6 million at March 31, 2004.  Thisdecrease was due to sales, calls, paydowns and maturities exceedingreinvestment. Offsetting the decline in the investment portfolio was anincrease in federal funds sold and short-term investments of $60.1 million to$91.3 million as of March 31, 2004.  Theincrease in federal funds sold at March 31, 2004 was attributable in part tothe proceeds of the sales in the investment portfolio.  The Company expects to reinvest a portion ofthe federal funds sold in new loan originations during the second quarter of2004.

 

The followingtable sets forth a summary of the Company’s investment securities at the datesindicated:

 
|                                   |   | **March 31,  2004** |    | **December  31,  2003** |   |
|----------------------------------------|--------|---------------------|---------|-------------------------|--------|
| **Securities available for sale:**     |   |                |    |                    |   |
| Debt securities:                       |   |                |    |                    |   |
| U.S. Government and agency obligations |   | $                   | 136,534 |                    | $      | 171,807 |   |
| Corporate bonds                        |   | 82,782              |    | 87,068                  |   |
| State and municipal obligations        |   | 1,666               |    | 1,667                   |   |
| Mortgage-backed investments            |   | 80,343              |    | 82,240                  |   |
| Total debt securities                  |   | 301,325             |    | 342,782                 |   |
| Marketable equity securities           |   | 13,745              |    | 15,792                  |   |
| Total securities available for sale    |   | $                   | 315,070 |                    | $      | 358,574 |   |
|                                   |   |                |    |                    |   |
| **Securities held to maturity:**       |   |                |    |                    |   |
| U.S. Government and agency obligations |   | $                   | 14,618  |                    | $      | 14,683 |   |
| State and municipal obligations        |   | 2,964               |    | 2,964                   |   |
| Mortgage-backed investments            |   | 374                 |    | 420                     |   |
| Total securities held to maturity      |   | $                   | 17,956  |                    | $      | 18,067 |   |
|                                   |   |                |    |                    |   |
| **Restricted equity securities:**      |   |                |    |                    |   |
| Federal Home Loan Bank of Boston stock |   | $                   | 55,179  |                    | $      | 55,179 |   |
| Other                                  |   | 444                 |    | 444                     |   |
| Total restricted equity securities     |   | $                   | 55,623  |                    | $      | 55,623 |   |
|                                   |   |                |    |                    |   |
| Total investment securities            |   | $                   | 388,649 |                    | $      | 432,264 |   |
| Percent of total assets                |   | 8.7                 | %       | 9.9                     | %      |

 

16

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**Loans**

 

The increase in loans occurred primarily inthe residential, commercial real estate, construction and indirect auto loanportfolios.  From December 31, 2003 toMarch 31, 2004, residential mortgage loans increased by $29.4 million, or 1.7%,commercial real estate loans increased by $7.3 million, or 1.2%, constructionloans increased by $7.6 million, or 5.2%, and indirect auto loans increased by$15.1 million, or 1.8%.  The growthduring the quarter ended March 31, 2004 was aided by the continuing lowinterest rate environment as well as the strong housing and automobilesectors.  The Company has continued toretain the majority of its residential mortgage loan originations in portfolioand emphasize the origination of indirect auto loans through its network ofautomobile dealers.

 

The followingtable shows the composition of the Company’s loan portfolio at the datesindicated:

 
|                        |   | **March 31,  2004** |      | **December 31,  2003** |   |
|-----------------------------|--------|---------------------|-----------|------------------------|--------|
|                        |   | **(In  thousands)** |      |
| Real estate loans:          |   |                |      |                   |   |
| Residential                 |   | $                   | 1,728,107 |                   | $      | 1,698,693 |   |
| Commercial                  |   | 632,944             |      | 625,670                |   |
| Construction                |   | 154,399             |      | 146,762                |   |
| Home equity lines of credit |   | 101,285             |      | 96,281                 |   |
| Total real estate loans     |   | 2,616,735           |      | 2,567,406              |   |
| Commercial loans            |   | 157,533             |      | 155,573                |   |
| Consumer loans:             |   |                |      |                   |   |
| Indirect auto loans, net    |   | 846,829             |      | 831,695                |   |
| Other                       |   | 33,083              |      | 36,731                 |   |
| Total consumer loans, net   |   | 879,912             |      | 868,426                |   |
| Total loans                 |   | $                   | 3,654,180 |                   | $      | 3,591,405 |   |

 

Loansserviced for others on a non-recourse basis at March 31, 2004 and December 31,2003 amounted to $234.3  million and$237.0 million, respectively.

 

**Asset Quality**

 

The Company devotes significant attention to maintaining asset qualitythrough its underwriting standards, loan servicing activities and nonperformingasset management.  Nonperforming assetstotaled $18.2 million and $14.9 million as of March 31, 2004 and December 31,2003, respectively.  The increase in thenonperforming assets during the first quarter of 2004 was primarilyattributable to two relationships.  Thefirst relationship represents a borrower with approximately $1.9 million onnonaccrual collateralized by property that is currently under a purchase andsales agreement and is expected to be paid in full.  The other borrower has two loans that have matured and are paidcurrent for interest but the relationship needs to be rewritten or refinanced;no loss of principal is expected.

 

17

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*Risk Elements.*Nonaccruingloans totaled $17.4 million at March 31, 2004, compared to $14.7 million atDecember 31, 2003.  The tworelationships mentioned above represent the majority of the increase innonaccruing loans during the first quarter of 2004. Interest income of approximately$311,000 would have been recorded during the first quarter of 2004 onnonaccruing loans if those loans had been on a current basis in accordance withtheir original terms.  Interest incomeactually recognized during the first quarter of 2004 on nonaccruing loans wasapproximately $217,000 with interest foregone on those loans of $94,000.

 

*Impaired Loans.*Loansare considered impaired when it is probable that the Company will not be ableto collect principal, interest and fees according to the contractual terms ofthe loan agreement.  Total impairedloans at March 31, 2004 and December 31, 2003, were $12.4 million and $9.7million, respectively.  Interest incomeof approximately $216,000 would have been recorded during the first quarter of2004 on impaired loans if those loans had been on a current basis in accordancewith their original terms.  Interestincome actually recognized during the first quarter of 2004 on impaired loanswas approximately $176,000 with interest foregone on those loans of $40,000.  

The following table sets forth information regarding non-performingassets at the dates indicated:

 
|                                                                 |   | **March 31,  2004** |   | **December  31,  2003** |   |
|----------------------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
| Nonaccrual  loans (1):                                               |   |                |   |                    |   |
| Real estate loans:                                                   |   |                |   |                    |   |
| Residential                                                          |   | $                   | 4,364  |                    | $      | 4,700 |   |
| Commercial                                                           |   | 5,034               |   | 1,990                   |   |
| Construction                                                         |   | 1,765               |   | 2,201                   |   |
| Home equity                                                          |   | 48                  |   | 11                      |   |
| Commercial loans                                                     |   | 4,844               |   | 3,462                   |   |
| Indirect auto loans                                                  |   | 1,324               |   | 2,249                   |   |
| Other consumer loans                                                 |   | 40                  |   | 67                      |   |
| Total nonaccrual loans                                               |   | 17,419              |   | 14,680                  |   |
| Restructured loans (2)                                               |   | —              |   | —                  |   |
| Total non-performing loans                                           |   | 17,419              |   | 14,680                  |   |
| Other real estate owned and repossessed autos                        |   | 732                 |   | 266                     |   |
| Total non-performing assets                                          |   | $                   | 18,151 |                    | $      | 14,946 |   |
|                                                                 |   |                |   |                    |   |
| Loans 90 days overdue and still accruing                             |   | $                   | — |                    | $      | — |   |
|                                                                 |   |                |   |                    |   |
| Allowance for loan losses as a percent of total loans                |   | 1.18                | %      | 1.21                    | %      |
| Allowance for loan losses as a percent of total non-performing loans |   | 248.33              |   | 295.10                  |   |
| Non-performing loans as a percent of total loans                     |   | 0.48                |   | 0.41                    |   |
| Non-performing assets as a percent of total assets                   |   | 0.41                |   | 0.34                    |   |

 

----

(1)          Nonaccrual loans include all loans 90 days ormore past due and any other loans which have been identified as presentinguncertainty with respect to the collectibility of interest or principal.

(2)          Restructured loans represent performing loansfor which concessions have been granted as a result of a borrower’s adversefinancial condition.

 

18

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**Allowance forLoan Losses**

 

The allowancefor loan losses is maintained at an amount management considers adequate tocover estimated losses in the loan portfolio which are deemed probable andestimable based on information currently known to management.

 

The following table sets forthactivity in the allowance for loan losses for the periods indicated:

** **
|                                                 |   | **Three  months ended  March 31,** |   |
|------------------------------------------------------|--------|------------------------------------|--------|
|                                                 |   | **2004**                           |   | **2003** |   |
|                                                 |   | **(In  thousands)**                |   |
| Balance at beginning of period                       |   | $                                  | 43,321 |   | $ | 34,354 |   |
| Provision for loan losses                            |   | 1,650                              |   | 2,087 |   |
| Charge-offs:                                         |   |                               |   |   |   |
| Mortgage loans:                                      |   |                               |   |   |   |
| Residential                                          |   | —                             |   | — |   |
| Commercial                                           |   | —                             |   | (6 | ) |
| Home equity                                          |   | —                             |   | — |   |
| Construction                                         |   | —                             |   | — |   |
| Commercial loans                                     |   | (148                               | )      | (120 | ) |
| Indirect auto loans                                  |   | (1,848                             | )      | (1,688 | ) |
| Other consumer loans                                 |   | (33                                | )      | (2 | ) |
| Total charge-offs                                    |   | (2,029                             | )      | (1,816 | ) |
|                                                 |   |                               |   |   |   |
| Recoveries:                                          |   |                               |   |   |   |
| Mortgage loans:                                      |   |                               |   |   |   |
| Residential                                          |   | —                             |   | — |   |
| Commercial                                           |   | —                             |   | — |   |
| Home equity                                          |   | —                             |   | — |   |
| Construction                                         |   | —                             |   | — |   |
| Commercial loans                                     |   | 34                                 |   | 2 |   |
| Indirect auto loans                                  |   | 279                                |   | 79 |   |
| Other consumer loans                                 |   | 2                                  |   | 3 |   |
| Total recoveries                                     |   | 315                                |   | 84 |   |
|                                                 |   |                               |   |   |   |
| Net charge-offs                                      |   | (1,714                             | )      | (1,732 | ) |
|                                                 |   |                               |   |   |   |
| Balance at end of period                             |   | $                                  | 43,257 |   | $ | 34,709 |   |
|                                                 |   |                               |   |   |   |
| Ratio of annualized net charge-offs to average loans |   | 0.19                               | %      | 0.23 | % |

 

19

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**Goodwill And Intangible Assets**

 

The Companyadopted Statements of Financial Accounting Standards No. 142, “Goodwill andOther Intangible Assets” (SFAS 142) as of January 1, 2002.  SFAS 142 addresses the method of identifyingand measuring goodwill and other intangible assets having indefinite lives acquiredin a business combination, eliminates further amortization of goodwill, andrequires periodic impairment evaluations of goodwill using a fair valuemethodology prescribed in the statement.

 

As a result ofadopting SFAS 142, the Company no longer amortizes goodwill but has performedimpairment testing as required.  Theevaluations were made using discounted future cash flows, and in each analysis,it was determined that an impairment charge was not required.  Impairment testing is required at leastannually or more frequently as a result of an event or change in circumstances(e.g. recurring operating losses by the acquired entity) that would indicate animpairment adjustment may be necessary.

 

The changes inthe carrying of goodwill and other intangibles assets for the three monthsended March 31, 2004  and the year endedDecember 31, 2003, are as follows:

 
|                                        |   |               |    | **Other  Intangible Assets**  |   |
|---------------------------------------------|--------|--------------------|---------|-------------------------------|--------|
|                                        |   | **Goodwill**       |    | **Core Deposit  Intangibles** |   | **Other  Intangibles** |   | **Total Other  IntangibleAssets** |   |
|                                        |   | **(In thousands)** |    |
| Balance, December 31, 2002                  |   | $                  | 33,903  |                          | $      | 1,539 |   | $ | 25 |   | $ | 1,564 |   |
| Recorded during the period                  |   | 82,582             |    | 4,075                         |   | 2,840 |   | 6,915 |   |
| Adjustment of purchase accounting estimates |   | (3,347             | )       | —                        |   | — |   | — |   |
| Amortization expense                        |   | —             |    | (873                          | )      | (569 | ) | (1,442 | ) |
| Impairment recognized                       |   | —             |    | —                        |   | — |   | — |   |
| Balance, December 31, 2003                  |   | 113,138            |    | 4,741                         |   | 2,296 |   | 7,037 |   |
| Amortization expense                        |   | —             |    | (229                          | )      | (239 | ) | (468 | ) |
| Adjustment of purchase accounting estimates |   | (87                | )       | —                        |   | — |   | — |   |
| Impairment recognized                       |   | —             |    | —                        |   | — |   | — |   |
| Balance, March 31, 2004                     |   | $                  | 113,051 |                          | $      | 4,512 |   | $ | 2,057 |   | $ | 6,569 |   |
|                                        |   |               |    |                          |   |   |   |   |   |
| Estimated amortization expense:             |   |               |    |                          |   |   |   |   |   |
| Remaining   2004                       |   | —             |    | 575                           |   | 716 |   | 1,291 |   |
| 2005                                        |   | —             |    | 661                           |   | 947 |   | 1,608 |   |
| 2006                                        |   | —             |    | 619                           |   | 394 |   | 1,013 |   |
| 2007                                        |   | —             |    | 568                           |   | — |   | 568 |   |
| 2008                                        |   | —             |    | 538                           |   | — |   | 538 |   |

 

The componentsof other intangible assets follow:

 
|                     |   | **March 31,  2004**        |   |
|--------------------------|--------|----------------------------|--------|
|                     |   | **Gross Carrying  Amount** |   | **Accumulated  Amortization** |   | **Net Carrying  Amount** |   |
|                     |   | **(In thousands)**         |   |
| Core deposit intangibles |   | $                          | 8,499  |   | $ | (3,987 | ) | $ | 4,512 |   |
| Other intangibles        |   | 2,988                      |   | (931 | ) | 2,057 |   |
| Total                    |   | $                          | 11,487 |   | $ | (4,918 | ) | $ | 6,569 |   |

 
|                     |   | **December  31, 2003**     |   |
|--------------------------|--------|----------------------------|--------|
|                     |   | **Gross Carrying  Amount** |   | **Accumulated  Amortization** |   | **Net Carrying  Amount** |   |
|                     |   | **(In thousands)**         |   |
| Core deposit intangibles |   | $                          | 8,499  |   | $ | (3,758 | ) | $ | 4,741 |   |
| Other intangibles        |   | 3,010                      |   | (714 | ) | 2,296 |   |
| Total                    |   | $                          | 11,509 |   | $ | (4,472 | ) | $ | 7,037 |   |

 

20

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**Sources of Funds**

 

*Deposits.* Depositshave historically represented the Banks’ primary source of funds and representover 65% of total assets.  The Banksoffer a variety of deposit accounts with a range of interest rates and otherterms.

 

Total deposits at March 31, 2004 were $2.9billion, an increase of $7.6 million, compared to $2.9 billion at December 31,2003.  Core deposit account balances(non-certificate) decreased by $16.1 million to $1.8 billion as of March 31,2004.  The decrease in core depositsduring the quarter was generally attributable to the low rates paid on theseaccounts, seasonal deposit fluctuations as well a reduction in municipalbalances.             Certificates ofdeposits increased $23.8 million to $1.1 billion as of March 31, 2004.  The increase was primarily due to a 10-monthpromotional certificate.

 

The following table shows the composition ofthe Company’s deposit balances at the dates indicated:

 
|                                   |   | **March 31,  2004** |      | **December  31,  2003** |   |
|----------------------------------------|--------|---------------------|-----------|-------------------------|--------|
|                                   |   | **(In  thousands)** |      |
| Demand deposit accounts                |   | $                   | 263,381   |                    | $      | 275,295 |   |
| NOW accounts                           |   | 314,134             |      | 302,567                 |   |
| Money market deposit accounts          |   | 848,369             |      | 850,126                 |   |
| Passbook and  other savings accounts   |   | 394,849             |      | 408,885                 |   |
| Total non-certificate accounts         |   | 1,820,733           |      | 1,836,873               |   |
| Certificates of deposit -              |   |                |      |                    |   |
| Term certificates of $100,000 and over |   | 332,685             |      | 308,546                 |   |
| Term certificates less than $100,000   |   | 771,584             |      | 771,942                 |   |
| Total certificates of deposit          |   | 1,104,269           |      | 1,080,488               |   |
| Total deposits                         |   | $                   | 2,925,002 |                    | $      | 2,917,361 |   |

 

*Borrowings.*  The Banks borrow funds from the FHLB topartially finance their loan and other funding needs.  These borrowings are subject to collateral requirements andborrowing limitations by the FHLB.  TheBanks also have available other sources of funds, including secured borrowings,securities sold under agreements to repurchase and junior subordinateddebentures.  In addition, Nantucket Bankhas a seasonal borrowing arrangement with the Federal Reserve Bank of Bostonthat extends from December through July of any year and is based on seasonalchanges in loans and deposits in the Bank’s service area.  This borrowing arrangement is collateralizedby securities and the amounts available vary by month and reach a maximum of$43.7 million in May to a low of $9.5 million in December.  As of March 31, 2004,  no balances were outstanding under theseasonal borrowing arrangement.

 

The following table sets forth certaininformation regarding the composition of borrowed funds at the dates indicated:

 
|                                            |   | **March 31,  2004** |      | **December  31,  2003** |   |
|-------------------------------------------------|--------|---------------------|-----------|-------------------------|--------|
|                                            |   | **(In  thousands)** |      |
| FHLB advances                                   |   | $                   | 986,970   |                    | $      | 927,162 |   |
| Junior subordinated debentures                  |   | 74,742              |      | 74,742                  |   |
| Securities sold under agreements to  repurchase |   | 37,212              |      | 43,886                  |   |
| TT&L agreements                             |   | 961                 |      | 1,841                   |   |
| Other borrowings                                |   | 1,678               |      | 1,697                   |   |
| Total borrowed funds                            |   | $                   | 1,101,563 |                    | $      | 1,049,328 |   |

 

21

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**Liquidity And Capital Resources**

 

The increase in stockholders’ equity of $5.8million to $396.7 million at March 31, 2004 resulted primarily from theexercise of stock options of $1.7 million and net income of $6.7 millionpartially offset by cash dividends paid in the amount of $3.5 million.

 

Liquidity, represented by cash and cash equivalents and debt securitiesis a productof theCompany’s operating, investing, and financing activities.  The Company’s primary sources of funds aredeposits, borrowings, principal and interest payments on outstanding loans andmortgage-backed securities, maturities of investment securities and fundsprovided from operations.  Whilescheduled payments from the amortization of loans and mortgage relatedsecurities and maturing investment securities are relatively predictablesources of funds, deposit flows and loan prepayments are greatly influenced bygeneral interest rates and, in the case of deposits, other instrumentsavailable to the public such as mutual funds and annuities.

 

As voluntary members of the Federal Home Loan Bank of Boston (FHLB),Compass and Nantucket Bank are entitled to borrow an amount up to the value ofits qualified collateral that has not been pledged to others.  Qualified collateral generally consists of residential first mortgage loans, U.S. Government andagency securities and funds on deposit specifically pledged to the FHLB.  At March 31, 2004, Compass and NantucketBank had approximately $365.5 million and $27.8 million, respectively, inunused borrowing capacity that is contingent upon the purchase of additional FHLBstock.  Use of this borrowing capacitymay also be impacted by regulatory capital requirements.  See note 7 to the unaudited consolidatedfinancial statements for information regarding a $25 million unsecured notepayable to Sovereign signed on April 26, 2004.

 

Liquidity management is both a daily and long-term function of businessmanagement.  The measure of a bank’sliquidity is its abilityto meet its cash commitments at all times with available cash or by conversionof other assets to cash at a reasonable price. At March 31, 2004, the Company maintained cash and due from banks,federal funds sold, short-term investments and debt securities maturing withinone year of $278.7 million, or 6.3% of total assets.  The Company invests excess funds, if any, in federal funds soldwhich provide liquidity to meet lending requirements.

 

At March 31, 2004, the Company hadcommitments to originate loans, unused outstanding lines of credit, standbyletters of credit and undisbursed proceeds of loans totaling $409.6million.  The Company anticipates thatit will have sufficient funds available to meet its current commitments.  Certificates of deposit maturing within oneyear from March 31, 2004 amounted to $780.7 million.  The Company expects that a significant portion of maturingcertificate accounts will be retained at maturity.  The following table summarizes the Company’s contractual cashobligations and other commitments and their respective expiration dates.

 

**Contractual Obligations andCommitments by Maturity (In thousands)**

 
|                                            |   | **Payments  Due – By Period** |      |
|-------------------------------------------------|--------|------------------------------------|-----------|
|                                            |   | **Total**                          |      | **Less than  One Year** |   | **One to  Three Years** |   | **Four to  Five Years** |   | **After  Five Years** |   |
| *Contractual obligations:*                      |   |                               |      |   |   |   |   |   |   |   |   |
| FHLB advances                                   |   | $                                  | 986,970   |   | $ | 206,291 |   | $ | 269,392 |   | $ | 179,653 |   | $ | 331,634 |   |
| Junior subordinated debentures                  |   | 74,742                             |      | — |   | — |   | — |   | 74,742 |   |
| Lease obligations                               |   | 15,312                             |      | 2,072 |   | 3,554 |   | 2,240 |   | 7,446 |   |
| Other:                                          |   |                               |      |   |   |   |   |   |   |   |   |
| TT&L                                        |   | 961                                |      | 961 |   | — |   | — |   | — |   |
| Securities sold under agreements to  repurchase |   | 37,212                             |      | 37,212 |   | — |   | — |   | — |   |
| Total contractual cash obligations              |   | $                                  | 1,115,197 |   | $ | 246,536 |   | $ | 272,946 |   | $ | 181,893 |   | $ | 413,822 |   |

 
|                     |   | **Amount of Commitment Expiring – By Period** |    |
|--------------------------|--------|----------------------------------------------------|---------|
|                     |   | **Total**                                          |    | **Less than  One Year** |   | **One to  Three Years** |   | **Four to  Five Years** |   | **After  Five Years** |   |
| *Other Commitments:*     |   |                                               |    |   |   |   |   |   |   |   |   |
| Lines of credit          |   | $                                                  | 180,699 |   | $ | 84,195 |   | $ | 1,879 |   | $ | 6,468 |   | $ | 88,157 |   |
| Other commitments        |   | 227,035                                            |    | 227,035 |   | — |   | — |   | — |   |
| Standby letter of credit |   | 1,901                                              |    | 1,264 |   | 637 |   | — |   | — |   |
| Total commitments        |   | $                                                  | 409,635 |   | $ | 312,494 |   | $ | 2,516 |   | $ | 6,468 |   | $ | 88,157 |   |

 

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The Company’s and the Banks’ capital ratios at March31, 2004 were as follows:

 
|                                         |   | **Seacoast** |   | **Compass** |   | **Nantucket  Bank** |   |
|----------------------------------------------|--------|--------------|--------|-------------|--------|---------------------|--------|
| Total capital (to risk weighted assets)      |   | 12.45        | %      | 11.12       | %      | 12.62               | %      |
| Tier 1 capital (to risk weighed assets)      |   | 11.13        |   | 9.85        |   | 11.35               |   |
| Tier 1 leverage capital ((to average assets) |   | 7.98         |   | 7.06        |   | 8.34                |   |

 

These ratios placed theCompany in excess of regulatory standards and the Banks in the “wellcapitalized” category as set forth by the FDIC.

 

**Item 3****.  Quantitativeand Qualitative Disclosures about Market Risk**

 

The chief marketrisk factor affecting the financial condition and operating results of theCompany is interest rate risk.  Thisrisk is managed by periodic evaluation of the interest risk inherent in certainbalance sheet accounts, determination of the level of risk consideredappropriate given capital and liquidity requirements, business strategy,performance objectives and operating environment and maintenance of such riskswithin guidelines approved by the Board of Directors.  Through such management, the Company seeks to reduce thevulnerability of its net earnings to changes in interest rates.  Each Bank’s Asset/Liability Committee, comprisedof senior management, is responsible for managing interest rate risk andreviewing with its Board of Directors on a quarterly basis its activities andstrategies, the effect of those strategies on operating results, the Bank’sinterest rate risk position and the effect changes in interest rates would haveon net interest income. The extent of movement of interest rates is anuncertainty that could have a negative impact on earnings.

 

The principalstrategies that the Company uses to manage interest rate risk include (i)emphasizing the origination and retention of adjustable rate loans, originationof indirect auto loans (Compass only) which have relatively short maturitiesand origination of loans with maturities at least partly matched with those ofthe deposits and borrowings funding the loans, (ii) investing in debt securitieswith relatively short maturities and (iii) classifying a significant portion ofits investment portfolio as available for sale so as to provide sufficientflexibility in liquidity management.

 

TheCompany and the Banks quantify their interest rate risk exposure using asophisticated simulation model. Simulation analysis is used to measure the exposure of net interestincome to changes in interest rates over a specified time horizon.  Simulation analysis involves projectingfuture interest income and expense under various rate scenarios.  Internal guidelines on interest rate riskspecify that for every 100 basis points immediate shift in interest rates, theestimated net interest income over the next 12 months should decline by lessthan 5%.

 

Inutilizing a 300 basis point increase in rates in its simulation model, the fullimpact of annual rate caps of 200 basis points common to most adjustable ratemortgage loan products is considered. The rate shocks used assume an instantaneous and parallel change in interestrates and that no strategies are implemented in response to the change ininterest rates.  Prepayment speeds forloans are based on published median dealer forecasts for each interest ratescenario.

 

As of March 31,2004, the Company’s estimated exposure as a percentage of estimated netinterest income for the next twelve and twenty-four month periods is asfollows:

 
|                                          |   | **Percentage  Change in Estimated  Net Interest Income Over:** |   |
|-----------------------------------------------|--------|----------------------------------------------------------------|--------|
|                                          |   | **12 months**                                                  |   | **24 months** |   |
| 300 basis point increase in rates             |   | (13.7                                                          | )%     | (10.7 | )% |
|   75  basis point decrease in rates |   | (0.2                                                           | )%     | (2.1 | )% |

 

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(1)           Due to the low interest rateenvironment in effect at March 31, 2004 (the average Federal Fund overnightrates were trading below 1.00%) the simulation model could only be rate shockeddown 75 basis points.

### ** **

### **The results above are dependent on material assumptions such as (i)changes in the composition and prepayment speeds of mortgage assets and loans,(ii) the shape of the U.S. government securities and interest rate swap yieldcurve, (iii) the level of U.S. prime interest rates and (iv) the level of ratespaid on deposit accounts.  Asymmetricalrate movements could also have a material impact on simulation results.**

### ** **

23

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### **Item 4**.  Controls and Procedures

 

(a) Evaluation of Disclosure Controls and Procedures.  Our Chief Executive Officer, our Treasurerand Chief Financial Officer (as principal financial officer)  and other members of our senior managementteam have evaluated the effectiveness of our disclosure controls and procedures(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)).  Based on such evaluation, our ChiefExecutive Officer and Treasurer and Chief Financial Officer have concluded thatour disclosure controls and procedures, as of the end of the period covered bythis report, were adequate and effective to provide reasonable assurance thatinformation required to be disclosed by the Company, including our consolidatedsubsidiaries, in reports that it files or submits under the Exchange Act, isrecorded, processed, summarized and reported, within the time periods specifiedin the Commission’s rules and forms.

 

Theeffectiveness of a system of disclosure controls and procedures is subject tovarious inherent limitations, including cost limitations, judgments used indecision making, assumptions about the likelihood of future events, thesoundness of internal controls, and fraud. Due to such inherent limitations, there can be no assurance that anysystem of disclosure controls and procedures will be successful in preventingall errors or fraud, or in making all material information known in a timelymanner to the appropriate levels of management.

 

(b)           Changes inInternal Controls.  There were nochanges in our internal control over financial reporting identified during thefirst quarter of 2004 that have materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

 

24

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**PART II - OTHER INFORMATION**

 

### **Item 1.  Legal Proceedings**

 

The Company is involved inroutine legal proceedings occurring in the ordinary course of business which inthe aggregate are believed by management to be immaterial to our financialcondition and results of operations.

 

**Item2.  Changes in Securities****, Use of Proceeds and IssuerPurchases of Equity Securities**

 

Notapplicable.

 

**Item 3.  Defaults UponSenior****Securities**

 

Notapplicable.

 

#### **Item 4.  Submission of Matters**to A Vote of Security Holders

 

Notapplicable.

 

###### **Item 5.  Other Information**

 

Notapplicable.

 

**Item 6.  Exhibits and****Reports on Form 8-****K**

 
| a.     |   | Exhibits:                                                                                                                                                                                               |   |   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|   |   |                                                                                                                                                                                                    |   |   |
| 2.1    |   | Agreement and Plan of Merger, dated as of December 19, 2002 by and  between Seacoast Financial Services Corporation, Seacoast Merger Sub, Inc.  and Bay State Bancorp, Inc.                             |   | (d)    |
| 2.2    |   | Agreement and Plan of Merger, dated as of October 20, 2003, by and  between Seacoast Financial Services Corporation, Coast Merger Sub Corporation  and Abington Bancorp Inc.                            |   | (e)    |
| 2.3    |   | Agreement and Plan of Merger, dated as of January  26, 2004, by and between Sovereign Bancorp, Inc. and Seacoast Financial  Services Corporation                                                        |   | (g)    |
| 2.4    |   | Amendment to Agreement and Plan of Merger between  Sovereign Bancorp, Inc. and Seacoast Financial Services Corporation dated as  of April 12, 2004                                                      |   | (h)    |
| 3.1    |   | Restated Articles of Organization of Seacoast  Financial Services Corporation                                                                                                                           |   | (b)    |
| 3.2    |   | By-Laws of Seacoast Financial Services Corporation                                                                                                                                                      |   | (f)    |
| 4      |   | Specimen certificate for the common stock of  Seacoast Financial Services Corporation                                                                                                                   |   | (a)    |
| 4.2    |   | Form of 8.50% Junior Subordinated Debenture of Seacoast Financial  Services Corporation                                                                                                                 |   | (c)    |
| 4.3    |   | Form of Preferred Security of Seacoast Capital Trust I (included as  Exhibit D to Amended and Restated Trust Agreement of Seacoast Capital Trust I  dated May 31, 2002)                                 |   | (c)    |
| 11     |   | A statement regarding earnings per share is  included in Item 1, Note 1, of this report                                                                                                                 |   |   |
| 31.1   |   | Certification by Kevin G. Champagne, Chief  Executive Officer, pursuant to section 302 of the Sarbanes-Oxley Act of 2002                                                                                |   | **     |
| 31.2   |   | Certification by Francis S. Mascianica, Treasurer  and Chief Financial Officer, pursuant to section 302 of the Sarbanes-Oxley  Act of 2002                                                              |   | **     |
| 32     |   | Certification required by section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                |   | **     |
|   |   |                                                                                                                                                                                                    |   |   |
| b.     |   | Reports  on Form 8-K:                                                                                                                                                                                   |   |   |
|   |   | •      Form 8-K dated January 28,  2004 furnished under Items 12 and 7 whereby Seacoast announced its fourth  quarter and annual results for 2003.                        |
|   |   | •     Form 8-K dated January 29, 2004 filed under  Items 5 and 7 whereby Seacoast announced that it entered into an agreement  and plan of merger with Sovereign Bancorp, Inc. |

 

25

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| **     |   | Filed  herewith                                                                                                                                                                                                                |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                           |
| (a)    |   | Incorporated by reference to Amendment No. 1 to the Company’s  Registration Statement on Form S-1 (333-52889), filed with the SEC under the  Company’s prior name, “The 1855 Bancorp”, on August 14, 1998. |
|   |   |                                                                                                                                                                                                                           |
| (b)    |   | Incorporated by reference to the Company’s Registration Statement on  Form 8-A filed with the SEC on November 18, 1998.                                                                                                   |
|   |   |                                                                                                                                                                                                                           |
| (c)    |   | Incorporated by reference to the Company’s current report on Form  10-Q for the second quarter of 2002, filed with the SEC on August 14, 2002.                                                                            |
|   |   |                                                                                                                                                                                                                           |
| (d)    |   | Incorporated by reference to the Company’s current report on Form 8-K  filed with the SEC on December 23, 2002.                                                                                                           |
|   |   |                                                                                                                                                                                                                           |
| (e)    |   | Incorporated by reference to the Company’s current report on Form 8-K  filed with the SEC on October 27, 2003.                                                                                                            |
|   |   |                                                                                                                                                                                                                           |
| (f)    |   | Incorporated by reference to the Company’s Annual Report on Form 10-K  filed with the SEC on March 12, 2004.                                                                                                              |
|   |   |                                                                                                                                                                                                                           |
| (g)    |   | Incorporated by reference to Sovereign Bancorp, Inc.’s current report  on Form 8-K filed with the SEC on January 28, 2004.                                                                                                |
|   |   |                                                                                                                                                                                                                           |
| (h)    |   | Incorporated by reference to Sovereign Bancorp, Inc.’s current report  on Form 8-K filed with the SEC on April 13, 2004.                                                                                                  |

 

26

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|               | Seacoast Financial Services Corporation |                                                                                  |
|--------------------|-----------------------------------------|---------------------------------------------------------------------------------------|
|               | (Registrant)                            |                                                                                  |
|               |                                    |
|               |                                    |
| Date: May 7, 2004  | By                                      | /s/ Kevin G. Champagne                                                                |
|               |                                    | Kevin G. Champagne                                                                    |
|               |                                    | President and Chief Executive Officer                                                 |
|               |                                    |
|               |                                    |
| Date:  May 7, 2004 | By                                      | /s/ Francis S. Mascianica, Jr.                                                        |
|               |                                    | Francis S. Mascianica, Jr.                                                            |
|               |                                    | Treasurer and Chief Financial Officer, as Principal Financial and  Accounting Officer |
|                    |                                         |                                                                                       |  |

 

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