** **

**SECURITIES AND EXCHANGE COMMISSION**

**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 SEPTEMBER 30, 2001**

 

**or**

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

 

**COMMISSION FILE NUMBER: 000-25077**

 

# **SEACOASTFINANCIAL 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 Since  Last Report |

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 
| Yes | ý |   | No | o |
|-----|--------|--------|----|---|

 

 

AtNovember 9, 2001, the Company had 24,625,136 shares of common stockoutstanding.

 

** **

**SEACOAST FINANCIAL SERVICES CORPORATION**

**INDEX**

 
| **PART I - FINANCIAL INFORMATION** |
|------------------------------------|
|                               |   |
| Item 1.                            | Financial Statements  (Unaudited) |
|                               |   |
|                               | Consolidated Balance Sheets  at September 30, 2001 and December 31, 2000 |
|                               |   |
|                               | Consolidated  Statements of Income for the three months and nine months ended September 30,  2001 and 2000 |
|                               |   |
|                               | Consolidated  Statements of Changes in Stockholders’ Equity for the nine months ended  September 30, 2001 and 2000 |
|                               |   |
|                               | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2001 and  2000 |
|                               |   |
|                               | Notes  to Unaudited Consolidated Financial Statements |
|                               |   |
| Item  2.                           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                               |   |
|                               | Liquidity and Capital  Resources |
|                               |   |
|                               |   |
| Item  3.                           | Quantitative  and Qualitative Disclosures about Market Risk |
|                               |   |
|                               |   |
| **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**                     |
|                                    |  |  |

 

 

 

**SEACOAST FINANCIAL SERVICES CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**(Unaudited)**

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

** **
|                                                                                             |   | **September  30,** |      | **December  31,** |   |
|--------------------------------------------------------------------------------------------------|--------|--------------------|-----------|-------------------|--------|
|                                                                                             |   | **2001**           |      | **2000**          |   |
| ASSETS:                                                                                          |   |               |      |              |   |
| Cash and due from banks                                                                          |   | $                  | 104,265   |              | $      | 101,665 |   |
| Federal funds sold                                                                               |   | 107,313            |      | 5,848             |   |
| Short-term investment                                                                            |   | 10,000             |      | —            |   |
| Total cash and cash equivalents                                                                  |   | 221,578            |      | 107,513           |   |
| Investment securities—                                                                      |   |               |      |              |   |
| Available-for-sale, at fair value                                                                |   | 338,032            |      | 248,855           |   |
| Held-to-maturity, at amortized cost                                                              |   | 22,730             |      | 29,728            |   |
| Restricted equity securities                                                                     |   | 40,837             |      | 28,974            |   |
| Loans held-for-sale                                                                              |   | 32,235             |      | 13,666            |   |
| Loans, net (Note 3)                                                                              |   | 2,557,603          |      | 2,338,251         |   |
| Accrued interest receivable                                                                      |   | 14,725             |      | 14,927            |   |
| Banking premises and equipment, net                                                              |   | 51,797             |      | 50,878            |   |
| Other real estate owned, net                                                                     |   | 358                |      | 86                |   |
| Net deferred tax asset                                                                           |   | 9,984              |      | 11,247            |   |
| Intangible assets, net (Note 2)                                                                  |   | 35,457             |      | 38,800            |   |
| Other assets                                                                                     |   | 10,590             |      | 7,840             |   |
| Total assets                                                                                     |   | $                  | 3,335,926 |              | $      | 2,890,765 |   |
|                                                                                             |   |               |      |              |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY:                                                       |   |               |      |              |   |
| Deposits (Note 4)                                                                                |   | $                  | 2,182,845 |              | $      | 1,989,630 |   |
| Short-term borrowings                                                                            |   | 36,820             |      | 31,427            |   |
| Federal Home Loan Bank advances                                                                  |   | 782,682            |      | 556,958           |   |
| Other borrowings                                                                                 |   | 1,838              |      | 1,881             |   |
| Mortgagors’ escrow payments                                                                 |   | 5,543              |      | 4,428             |   |
| Accrued expenses and other liabilities                                                           |   | 22,174             |      | 18,253            |   |
| Total liabilities                                                                                |   | 3,031,902          |      | 2,602,577         |   |
| COMMITMENTS AND CONTINGENCIES                                                                    |   |               |      |              |   |
| Stockholders’ equity (Notes 7 and 8):                                                       |   |               |      |              |   |
| 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; 26,758,136 shares issued |   | 268                |      | 268               |   |
| Additional paid-in capital                                                                       |   | 153,127            |      | 152,795           |   |
| Treasury stock, at cost, 2,129,000 shares in 2001 and 1,799,775  shares in 2000                  |   | (22,961            | )         | (17,990           | )      |
| Retained earnings                                                                                |   | 182,666            |      | 166,865           |   |
| Accumulated other comprehensive income                                                           |   | 4,219              |      | 791               |   |
| Unearned compensation - ESOP and restricted stock                                                |   | (13,027            | )         | (14,384           | )      |
| Shares held in employee trust                                                                    |   | (268               | )         | (157              | )      |
| Total stockholders’ equity                                                                  |   | 304,024            |      | 288,188           |   |
| Total liabilities and stockholders’ equity                                                  |   | $                  | 3,335,926 |              | $      | 2,890,765 |   |

 

See accompanying notes to the unaudited consolidated financialstatements.

 

** **

**CONSOLIDATEDSTATEMENTS OF INCOME**

**(Unaudited)**

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

** **
|                                                      |   | **Three  Months****Ended September 30,** |   | **Nine  Months**** Ended September 30,** |   |
|-----------------------------------------------------------|--------|------------------------------------------|--------|-----------------------------------------------|--------|
|                                                      |   | **2001**                                 |   | **2000**                                      |   | **2001** |   | **2000** |   |
| INTEREST AND DIVIDEND INCOME:                             |   |                                     |   |                                          |   |   |   |   |   |
| Interest on loans                                         |   | $                                        | 49,190 |                                          | $      | 38,803 |   | $ | 144,902 |   | $ | 107,893 |   |
| Interest and dividends on investment securities           |   | 4,732                                    |   | 4,235                                         |   | 14,445 |   | 12,704 |   |
| Interest on federal funds sold and short-term investments |   | 1,427                                    |   | 266                                           |   | 2,624 |   | 300 |   |
| Total interest and dividend income                        |   | 55,349                                   |   | 43,304                                        |   | 161,971 |   | 120,897 |   |
| INTEREST EXPENSE:                                         |   |                                     |   |                                          |   |   |   |   |   |
| Interest on deposits                                      |   | 18,221                                   |   | 16,965                                        |   | 55,995 |   | 45,667 |   |
| Interest on borrowed funds                                |   | 10,839                                   |   | 5,979                                         |   | 30,545 |   | 16,082 |   |
| Total interest expense                                    |   | 29,060                                   |   | 22,944                                        |   | 86,540 |   | 61,749 |   |
| Net interest income                                       |   | 26,289                                   |   | 20,360                                        |   | 75,431 |   | 59,148 |   |
| PROVISION FOR LOAN LOSSES                                 |   | 1,550                                    |   | 1,250                                         |   | 4,425 |   | 3,500 |   |
| Net interest income after provision for loan losses       |   | 24,739                                   |   | 19,110                                        |   | 71,006 |   | 55,648 |   |
| NONINTEREST INCOME:                                       |   |                                     |   |                                          |   |   |   |   |   |
| Deposit and other banking fees                            |   | 2,471                                    |   | 1,819                                         |   | 6,488 |   | 4,704 |   |
| Loan servicing fees, net                                  |   | 246                                      |   | 158                                           |   | 775 |   | 502 |   |
| Merchant card fee income, net                             |   | 239                                      |   | 205                                           |   | 526 |   | 421 |   |
| Other loan fees                                           |   | 299                                      |   | 179                                           |   | 1,019 |   | 602 |   |
| Gain on sales of investment securities, net               |   | 57                                       |   | —                                        |   | 71 |   | 4 |   |
| Gain on sales of loans, net                               |   | 107                                      |   | 27                                            |   | 328 |   | 28 |   |
| Other income                                              |   | 267                                      |   | 540                                           |   | 1,042 |   | 1,147 |   |
| Total noninterest income                                  |   | 3,686                                    |   | 2,928                                         |   | 10,249 |   | 7,408 |   |
| NONINTEREST EXPENSE:                                      |   |                                     |   |                                          |   |   |   |   |   |
| Salaries and employee benefits                            |   | 8,230                                    |   | 6,549                                         |   | 24,281 |   | 19,705 |   |
| Occupancy and equipment expenses                          |   | 2,116                                    |   | 1,867                                         |   | 6,484 |   | 4,714 |   |
| Data processing expenses                                  |   | 1,566                                    |   | 1,309                                         |   | 4,610 |   | 3,631 |   |
| Marketing expenses                                        |   | 665                                      |   | 844                                           |   | 2,197 |   | 2,012 |   |
| Professional services expenses                            |   | 719                                      |   | 431                                           |   | 2,202 |   | 1,235 |   |
| Amortization of intangibles (Notes 2 and 9)               |   | 732                                      |   | 148                                           |   | 2,202 |   | 452 |   |
| Other operating expenses                                  |   | 1,963                                    |   | 1,612                                         |   | 5,889 |   | 4,299 |   |
| Total noninterest expense                                 |   | 15,991                                   |   | 12,760                                        |   | 47,865 |   | 36,048 |   |
| Income before provision for income taxes                  |   | 12,434                                   |   | 9,278                                         |   | 33,390 |   | 27,008 |   |
| PROVISION FOR INCOME TAXES                                |   | 4,400                                    |   | 3,183                                         |   | 11,624 |   | 9,486 |   |
| Net income                                                |   | $                                        | 8,034  |                                          | $      | 6,095 |   | $ | 21,766 |   | $ | 17,522 |   |
| EARNINGS PER SHARE (Note 5):                              |   |                                     |   |                                          |   |   |   |   |   |
| Basic                                                     |   | $                                        | 0.34   |                                          | $      | 0.26 |   | $ | 0.93 |   | $ | 0.74 |   |
| Diluted                                                   |   | $                                        | 0.34   |                                          | $      | 0.26 |   | $ | 0.92 |   | $ | 0.74 |   |

 

See accompanying notes to the unaudited consolidated financialstatements.

 

** **

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

**FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000**

**(Unaudited)**

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

** **
|                                                                                                                                        |   | **Common  Stock** |   | **Additional  Paid-In  Capital** |   | **Treasury  Stock** |   | **Retained  Earnings** |    | **Accumulated    Other Comprehensive   Income (Loss)** |   | **Unearned  Compensation   ESOP/Restricted   Stock** |   | **Shares  Held  in Employee  Trust** |   | **Total** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|----------------------------------|--------|---------------------|--------|------------------------|---------|--------------------------------------------------------|--------|------------------------------------------------------|--------|--------------------------------------|--------|-----------|--------|
| Balance, December 31, 1999                                                                                                                  |   | $                 | 268    |                             | $      | 152,702             |   | $                      | (9,310  | )                                                      | $      | 149,256                                              |   | $                                    | (2,430 | )         | $      | (16,326 | ) | $ | (139 | ) | $ | 274,021 |   |
| Repurchase of common stock (Note 7)                                                                                                         |   | —            |   | —                           |   | (6,641              | )      | —                 |    | —                                                 |   | —                                               |   | —                               |   | (6,641    | )      |
| Net income                                                                                                                                  |   | —            |   | —                           |   | —              |   | 17,522                 |    | —                                                 |   | —                                               |   | —                               |   | 17,522    |   |
| Other comprehensive income — Change in unrealized loss on securities  available for sale, net of taxes and reclassification adjustment |   | —            |   | —                           |   | —              |   | —                 |    | 1,521                                                  |   | —                                               |   | —                               |   | 1,521     |   |
| Comprehensive income                                                                                                                        |   |              |   |                             |   |                |   |                   |    |                                                   |   |                                                 |   |                                 |   | 19,043    |   |
| Cash dividends - $.19 per share                                                                                                             |   | —            |   | —                           |   | —              |   | (4,633                 | )       | —                                                 |   | —                                               |   | —                               |   | (4,633    | )      |
| Amortization of unearned compensation                                                                                                       |   | —            |   | (15                              | )      | —              |   | —                 |    | —                                                 |   | 1,490                                                |   | —                               |   | 1,475     |   |
| Other                                                                                                                                       |   | —            |   | 102                              |   | —              |   | —                 |    | —                                                 |   | —                                               |   | (15                                  | )      | 87        |   |
| Balance, September 30, 2000                                                                                                                 |   | $                 | 268    |                             | $      | 152,789             |   | $                      | (15,951 | )                                                      | $      | 162,145                                              |   | $                                    | (909   | )         | $      | (14,836 | ) | $ | (154 | ) | $ | 283,352 |   |
| Balance, December 31, 2000                                                                                                                  |   | $                 | 268    |                             | $      | 152,795             |   | $                      | (17,990 | )                                                      | $      | 166,865                                              |   | $                                    | 791    |      | $      | (14,384 | ) | $ | (157 | ) | $ | 288,188 |   |
| Exercise of stock options                                                                                                                   |   | —            |   | 18                               |   | 221                 |   | —                 |    | —                                                 |   | —                                               |   | —                               |   | 239       |   |
| Repurchase of common stock (Note 7)                                                                                                         |   | —            |   | —                           |   | (5,192              | )      | —                 |    | —                                                 |   | —                                               |   | —                               |   | (5,192    | )      |
| Net income                                                                                                                                  |   | —            |   | —                           |   | —              |   | 21,766                 |    | —                                                 |   | —                                               |   | —                               |   | 21,766    |   |
| Other comprehensive income — Change in unrealized gain on securities  available for sale, net of taxes and reclassification adjustment |   | —            |   | —                           |   | —              |   | —                 |    | 3,428                                                  |   | —                                               |   | —                               |   | 3,428     |   |
| Comprehensive income                                                                                                                        |   |              |   |                             |   |                |   |                   |    |                                                   |   |                                                 |   |                                 |   | 25,194    |   |
| Cash dividends - $.25 per share                                                                                                             |   | —            |   | —                           |   | —              |   | (5,965                 | )       | —                                                 |   | —                                               |   | —                               |   | (5,965    | )      |
| Amortization of unearned compensation                                                                                                       |   | —            |   | 183                              |   | —              |   | —                 |    | —                                                 |   | 1,357                                                |   | —                               |   | 1,540     |   |
| Other                                                                                                                                       |   | —            |   | 131                              |   | —              |   | —                 |    | —                                                 |   | —                                               |   | (111                                 | )      | 20        |   |
| Balance, September 30, 2001                                                                                                                 |   | $                 | 268    |                             | $      | 153,127             |   | $                      | (22,961 | )                                                      | $      | 182,666                                              |   | $                                    | 4,219  |      | $      | (13,027 | ) | $ | (268 | ) | $ | 304,024 |   |

 

See accompanying notes to the unaudited consolidated financialstatements.

** **

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000**

**(Unaudited)**

**(In Thousands)**

 
|                                                                                                |   | **2001** |    | **2000** |   |
|-----------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                              |   |     |    |     |   |
| Net income                                                                                          |   | $        | 21,766  |     | $      | 17,522 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities —            |   |     |    |     |   |
| Depreciation                                                                                        |   | 2,984    |    | 1,956    |   |
| Amortization and accretion, net                                                                     |   | 43       |    | 54       |   |
| Purchase accounting amortization, net                                                               |   | 1,968    |    | 439      |   |
| Stock-based compensation                                                                            |   | 1,540    |    | 1,475    |   |
| Provision for loan losses                                                                           |   | 4,425    |    | 3,500    |   |
| Gain on sales of investment securities, net                                                         |   | (71      | )       | (4       | )      |
| Gain on sale of fixed assets                                                                        |   | (99      | )       | (252     | )      |
| Other real estate owned income                                                                      |   | (47      | )       | —   |   |
| Provision (benefit) for deferred taxes                                                              |   | (1,208   | )       | (776     | )      |
| Originations of loans held-for-sale                                                                 |   | (23,974  | )       | (366     | )      |
| Proceeds from sales of loans originated for sale                                                    |   | 29,534   |    | 1,150    |   |
| Gain on sales of loans, net                                                                         |   | (328     | )       | (28      | )      |
| Net (increase) decrease in accrued interest receivable                                              |   | 202      |    | (2,295   | )      |
| Net increase in other assets                                                                        |   | (2,460   | )       | (47      | )      |
| Net increase in accrued expenses and other liabilities                                              |   | 3,921    |    | 206      |   |
| Net cash provided by operating activities                                                           |   | 38,196   |    | 22,534   |   |
|                                                                                                |   |     |    |     |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |   |     |    |     |   |
| Change in short-term investments, net                                                               |   | —   |    | 228      |   |
| Purchase of securities classified as available-for-sale                                             |   | (147,186 | )       | (41,547  | )      |
| Purchase of securities classified as held-to-maturity                                               |   | (3,195   | )       | (1,000   | )      |
| Purchase of restricted equity securities                                                            |   | (11,959  | )       | (3,859   | )      |
| Proceeds from sales, calls, paydowns and maturities of securities  classified as available-for-sale |   | 63,334   |    | 56,536   |   |
| Proceeds from calls, paydowns and maturities of securities classified  as held-to-maturity          |   | 10,191   |    | 1,000    |   |
| Proceeds from sale of restricted equity securities                                                  |   | 96       |    | —   |   |
| Purchase of loans                                                                                   |   | (1,557   | )       | (14,106  | )      |
| Net increase in loans                                                                               |   | (245,716 | )       | (269,024 | )      |
| Recoveries of loans previously charged off                                                          |   | 458      |    | 297      |   |
| Proceeds from sales of other real estate owned                                                      |   | 540      |    | 467      |   |
| Proceeds from sales of fixed assets                                                                 |   | 267      |    | 208      |   |
| Purchase of premises and equipment                                                                  |   | (4,099   | )       | (17,590  | )      |
| Net cash used in investing activities                                                               |   | (338,826 | )       | (288,390 | )      |
|                                                                                                |   |     |    |     |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                              |   |     |    |     |   |
| Increase in NOW, money market deposit and demand deposit accounts                                   |   |     | 166,831 |     |   | 52,053 |   |
| Increase in passbook and other savings accounts                                                     |   | 30,169   |    | 5,374    |   |
| Increase (decrease) in certificates of deposit                                                      |   | (3,740   | )       | 173,913  |   |
| Advances from Federal Home Loan Bank                                                                |   | 369,946  |    | 325,000  |   |
| Repayments of Federal Home Loan Bank advances                                                       |   | (144,189 | )       | (251,917 | )      |
| Increase (decrease) in short-term and other borrowings                                              |   | 5,350    |    | (7,046   | )      |
| Increase in mortgagors’ escrow payments                                                        |   | 1,115    |    | 529      |   |
| Exercise of stock options                                                                           |   | 239      |    | —   |   |
| Tax benefit of stock awards                                                                         |   | 131      |    | —   |   |
| Repurchase of common stock                                                                          |   | (5,192   | )       | (6,641   | )      |
| Cash dividends                                                                                      |   | (5,965   | )       | (4,633   | )      |
| Net cash provided by financing activities                                                           |   | 414,695  |    | 286,632  |   |
|                                                                                                |   |     |    |     |   |
| Net Increase in Cash and Cash Equivalents                                                           |   | 114,065  |    | 20,776   |   |
| Cash and Cash Equivalents, Beginning of Year                                                        |   | 107,513  |    | 60,351   |   |
| Cash and Cash Equivalents, End of Period                                                            |   | $        | 221,578 |     | $      | 81,127 |   |
|                                                                                                |   |     |    |     |   |
| Supplemental Disclosure of Cash Flow Information:                                                   |   |     |    |     |   |
| Interest paid on deposits and borrowed funds                                                        |   | $        | 85,599  |     | $      | 61,566 |   |
| Income taxes paid                                                                                   |   | 13,858   |    | 10,480   |   |
|                                                                                                |   |     |    |     |   |
| Supplemental Disclosure of Noncash Transactions:                                                    |   |     |    |     |   |
| Transfer from loans to loans held-for-sale                                                          |   | 23,801   |    | —   |   |
| Transfers from loans to other real estate owned                                                     |   | 833      |    | 684      |   |
| Financed sales of other real estate owned                                                           |   | 68       |    | 222      |   |
|                                                                                                     |        |          |         |          |        |  |  |  |  |

 

See accompanying notes to the unaudited consolidated financialstatements.

** **

** **

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER30, 2001 AND 2000**

 

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

 

**Basis of Presentation**

 

The unaudited consolidatedfinancial statements of Seacoast Financial Services Corporation and itswholly-owned subsidiaries, Compass Bank for Savings (“Compass”), Nantucket Bankand Lighthouse Securities Corporation (collectively referred to herein as “theCompany”) presented herein should be read in conjunction with the consolidatedfinancial statements of the Company as of and for the year ended December 31,2000 included as part of its Form 10-K.

 

In the opinion of management,the accompanying unaudited financial statements reflect all adjustments(consisting of normal recurring adjustments) and disclosures necessary for afair presentation.  Management isrequired to make estimates and assumptions that affect amounts reported in thefinancial statements.  Actual resultscould differ significantly from those estimates.

 

**Summary of Significant Accounting Policies**

 

The Company’s significantaccounting policies are described in Note 1 of the Notes to ConsolidatedFinancial Statements included in its Form 10-K for the year ended December 31,2000 filed with the Securities and Exchange Commission.  For interim reporting purposes, the Companyfollows the same significant accounting policies.

 

**Reclassifications**

 

Certain reclassifications havebeen made to the prior year financial statements to conform to the 2001presentation.  Such reclassificationshave no effect on previously reported net income.

 

**(2)   ACQUISITION OF HOME PORT BANCORP, INC.**

 

On December 31, 2000, theCompany completed its acquisition of Home Port Bancorp, Inc. (Home Port) for $68.2  million in cash, exclusive of transaction costs.  Home Port was the holding company forNantucket Bank, a three branch savings bank located on Nantucket Island,Massachusetts.  This transaction hasbeen accounted for using the purchase method of accounting and, accordingly,Home Port’s results of operations are included in the Company’s consolidatedstatements of income from the date of acquisition.

 

The Company’s pro forma summarized results ofoperations for the three months and nine months ended September 30, 2000,assuming Home Port had been acquired as of January 1, 1999, are as follows (inthousands):

 
|                         |   | **Three Months**        |   | **Nine Months**         |   |
|------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                         |   | **Ended  September 30** |   | **Ended  September 30** |   |
| Interest income              |   | $                       | 49,832 |                    | $      | 139,923 |   |
| Interest expense             |   | 26,762                  |   | 73,002                  |   |
| Net interest income          |   | 23,070                  |   | 66,921                  |   |
| Provision for loan losses    |   | 1,300                   |   | 3,650                   |   |
| Noninterest income           |   | 3,371                   |   | 8,688                   |   |
| Noninterest expense          |   | 15,748                  |   | 44,031                  |   |
| Income before taxes          |   | 9,393                   |   | 27,928                  |   |
| Provision for income taxes   |   | 3,563                   |   | 10,627                  |   |
| Net income                   |   | $                       | 5,830  |                    | $      | 17,301 |   |
| Earnings per share - diluted |   | $                       | 0.24   |                    | $      | 0.73 |   |

 

Included in noninterest expensein the pro forma results of operations for the three and nine month periodsended September 30, 2000, are certain costs incurred by Home Port in connectionwith its acquisition by the Company totaling $293,000 which reduced the proforma earnings per share by $.01 in both periods.

 

The excess of the purchaseprice over the fair value of the net assets acquired was recorded as goodwilland amounted to $36.4 million.  Goodwillis being amortized on a straight-line basis over 15 years.  Amortization expense was $606,000 and $1.8million for the three months and nine months ended September 30, 2001,respectively.  See Note 9 for adiscussion of recent accounting pronouncements which will affect theamortization of goodwill beginning in 2002.

 

**(3)   LOANS**

** **

**The loan portfolio consisted of the following:**

** **
|                             |   | **September 30,**

**2001** |      | **December 31,**

**2000** |   |
|----------------------------------|--------|-----------------------------|-----------|----------------------------|--------|
|                             |   | **(In thousands)**          |      |
| Real estate loans:               |   |                        |      |                       |   |
| Residential (one-to-four family) |   | $                           | 1,313,995 |                       | $      | 1,212,595 |   |
| Commercial                       |   | 339,415                     |      | 322,724                    |   |
| Home equity lines of credit      |   | 43,053                      |      | 39,932                     |   |
| Construction                     |   | 109,877                     |      | 109,360                    |   |
| Total real estate loans          |   | 1,806,340                   |      | 1,684,611                  |   |
| Commercial loans                 |   | 120,798                     |      | 100,789                    |   |
| Consumer loans:                  |   |                        |      |                       |   |
| Indirect auto loans              |   | 603,742                     |      | 528,653                    |   |
| Less-unearned discount           |   | 2,472                       |      | 6,781                      |   |
| Indirect auto loans, net         |   | 601,270                     |      | 521,872                    |   |
| Other                            |   | 57,932                      |      | 56,060                     |   |
| Total consumer loans, net        |   | 659,202                     |      | 577,932                    |   |
| Total loans                      |   | 2,586,340                   |      | 2,363,332                  |   |
| Less-allowance for loan losses   |   | 28,737                      |      | 25,081                     |   |
|                             |   | $                           | 2,557,603 |                       | $      | 2,338,251 |   |

 

Non-accrual loans amounted to $6,107,000 and $10,405,000 at December31, 2000 and September 30, 2001, respectively.

** **

**(4)  DEPOSITS**

 

A summary of deposit balances is as follows:

 
|                                   |   | **September 30,**

**2001** |       | **December 31,**

**2000** |   |
|----------------------------------------|--------|-----------------------------|------------|----------------------------|--------|
|                                   |   | **(In thousands)**          | ** ** |
| Demand  deposit accounts               |   | $                           | 197,512    |                       | $      | 159,740 |   |
| NOW and  money market deposit accounts |   | 706,837                     |       | 577,778                    |   |
| Passbook and  other savings accounts   |   | 265,639                     |       | 235,470                    |   |
| Total non-certificate accounts         |   | 1,169,988                   |       | 972,988                    |   |
|                                   |   |                        |       |                       |   |
| Certificates  of deposit -             |   |                        |       |                       |   |
| Term certificates of $100,000 and over |   | 274,153                     |       | 265,583                    |   |
| Term certificates less than $100,000   |   | 738,704                     |       | 751,059                    |   |
| Total certificates of deposit          |   | 1,012,857                   |       | 1,016,642                  |   |
|                                   |   | $                           | 2,182,845  |                       | $      | 1,989,630 |   |

 

**(5)  EARNINGSPER SHARE (EPS)**

 

Basic EPS for the three monthsand nine months ended September 30, 2000 and 2001 was computed based on theweighted average number of shares outstanding during the periods using thefollowing share balances:

 
|               |       | **2001**   |   | **2000**   |       |
|--------------------|------------|------------|--------|------------|------------|
| Three months ended | ** ** | 23,417,024 |   | 23,676,632 | ** ** |
| Nine months  ended |       | 23,436,616 |   | 23,805,809 |       |

 

Unallocated ESOP shares andunvested restricted stock awards are not considered outstanding for purposes ofthe computation of basic EPS and have been excluded from the shares presentedabove.  Diluted EPS reflects thepotential dilution that could occur if certain agreements to issue common stockwere exercised and has been computed after giving consideration to the dilutiveeffect of the Company’s stock options and unvested restricted stock awards.

 

**(6)  BUSINESSSEGMENT INFORMATION**

 

The Company has identified itsreportable operating business segment as “Community Banking.”  The community banking business segmentconsists of commercial and retail banking. Banking services are provided within the framework of two full-servicecommunity banks which have similar economic characteristics, products andservices, distribution channels and regulatory environments.  Accordingly, disaggregated segmentinformation for each bank is not presented. The community banking segment derives its revenues from a wide range ofbanking services, including investing and lending activities and acceptance ofdemand, savings and time deposits, merchant credit card services as well asservicing loans for investors.  There isno major customer, as defined, and the banks operate within a single geographicarea (southeastern Massachusetts, including the islands of Martha’s Vineyardand Nantucket).

 

Non-reportable operatingsegments of the Company’s operations which do not have similar characteristicsto the community banking operations and do not meet the quantitative thresholdsrequiring disclosure, are included in the Other category in the disclosure ofbusiness segments below.  Thesenon-reportable segments include the Parent Company.

 

Reportable segment specific informationand reconciliation to consolidated financial information as of

September 30, 2001 and 2000 and for the nine month periods then endedare as follows (in thousands):

 
| September  30, 2001       |       | **Community Banking** |    | **Other** |   | **Other Adjustments****and Eliminations** |   | **Consolidated** |       |
|---------------------------|------------|-----------------------|---------|-----------|--------|-------------------------------------------|--------|------------------|------------|
| Investment  securities    |       | $                     | 397,748 |      | $      | 3,851                                     |   | $                | —     |   | $ | 401,599 |   |
| Net  loans                | ** ** | 2,557,603             |    | 10,368    |   | (10,368                                   | )      | 2,557,603        | ** ** |
| Total assets              |       | 3,331,667             |    | 304,838   |   | (300,579                                  | )      | 3,335,926        |       |
| Total deposits            |       | 2,182,845             |    | —    |   | —                                    |   | 2,182,845        |       |
| Total borrowings          |       | 821,340               |    | —    |   | —                                    |   | 821,340          |       |
| Total liabilities         |       | 3,031,088             |    | 814       |   | —                                    |   | 3,031,902        |       |
| Net interest income       |       | 75,294                |    | 746       |   | (609                                      | )      | 75,431           |       |
| Provision for loan losses |       | 4,425                 |    | —    |   | —                                    |   | 4,425            |       |
| Noninterest income        |       | 10,249                |    | —    |   | —                                    |   | 10,249           |       |
| Noninterest expense       |       | 46,893                |    | 972       |   | —                                    |   | 47,865           |       |
| Net income                |       | 21,925                |    | 21,766    |   | (21,925                                   | )      | 21,766           |       |
|                           |            |                       |         |           |        |                                           |        |                  |            |  |  |  |  |

 

 
| September  30, 2000       |       | **Community****Banking** |       | **Other** |   | **Other  Adjustments****and Eliminations** |   | **Consolidated** |   |
|---------------------------|------------|--------------------------|------------|-----------|--------|--------------------------------------------|--------|------------------|--------|
| Investment securities     |       | $                        | 260,853    |      | $      | 3,339                                      |   | $                | — |   | $ | 264,192 |   |
| Net loans                 | ** ** | 2,009,249                | ** ** | 10,646    |   | (10,646                                    | )      | 2,009,249        |   |
| Total assets              |       | 2,426,830                |       | 283,673   |   | (279,979                                   | )      | 2,430,524        |   |
| Total deposits            |       | 1,746,962                |       | —    |   | —                                     |   | 1,746,962        |   |
| Total borrowings          |       | 380,659                  |       | —    |   | —                                     |   | 380,659          |   |
| Total liabilities         |       | 2,146,850                |       | 322       |   | —                                     |   | 2,147,172        |   |
| Net interest income       |       | 59,049                   |       | 724       |   | (625                                       | )      | 59,148           |   |
| Provision for loan losses |       | 3,500                    |       | —    |   | —                                     |   | 3,500            |   |
| Total noninterest income  |       | 7,408                    |       | —    |   | —                                     |   | 7,408            |   |
| Total noninterest expense |       | 35,233                   |       | 815       |   | —                                     |   | 36,048           |   |
| Net income                |       | 17,568                   |       | 17,522    |   | (17,568                                    | )      | 17,522           |   |
|                           |            |                          |            |           |        |                                            |        |                  |        |  |  |  |  |

 

**(7)  STOCKREPURCHASE PROGRAMS**

 

In July 1999, the Board ofDirectors authorized the Company to repurchase up to 1,000,000 shares in theopen market to meet the anticipated needs of stock awards and stock optionsissued in connection with the 1999 Stock Incentive Plan.  In October 1999 and July 2000, the Board ofDirectors, with the approval of the Commissioner of Banks, authorized theCompany to repurchase up to an additional 1,231,900 and 1,254,312 shares,respectively, in the open market.  TheBoard of Directors delegated to the discretion of senior management theauthority to determine the timing of the repurchase programs’ commencement, thetiming of subsequent repurchases and the prices at which repurchases will bemade.

 

As of November 9, 2001, theCompany had repurchased 2,717,000 shares of its common stock under theseprograms at a total cost of $29,908,409, of which 2,710,000 shares at a cost of$29,814,049 had been repurchased as of September 30, 2001.

 

**(8)  QUARTERLYCASH DIVIDEND**

 

On October 25, 2001, the Boardof Directors voted the payment of a quarterly cash dividend of $.09 pershare.  The dividend is payable onNovember 23, 2001 to stockholders of record on November 9, 2001.

 

**(9)   RECENTACCOUNTING PRONOUNCEMENTS**

 

In June  2001, the Financial Accounting StandardsBoard (FASB) issued SFAS No. 141, “Business Combinations” which is effectivefor transactions initiated after June 30, 2001.  Under SFAS No. 141, all business combinations must be accountedfor using the purchase method of accounting; use of the pooling-of-interestsmethod is no longer permitted.  Inaddition, this Statement requires that certain intangible assets acquired in abusiness combination be recognized apart from goodwill.

 

Under the transition provisionsof SFAS No. 141, no change in the amount of the purchase price assigned to theassets acquired and liabilities assumed in a business combination completedbefore July 1, 2001 and accounted for by the purchase method shall occur exceptfor certain identified intangible assets which were separately recognized atthe time of the transaction.  Based oninformation currently available, management does not believe that anyreclassification of intangible assets recognized in connection with theCompany’s acquisition of Home Port in December 2000 will be required as aresult of the application of SFAS No. 141.

 

In June 2001, the FASB alsoissued SFAS No. 142, “Goodwill and Other Intangible Assets,” which is effectivefor fiscal years beginning after December 15, 2001.  Under current accounting standards, goodwill resulting from abusiness combination is amortized against income over its estimated usefullife.  Under SFAS No. 142, goodwill isgenerally no longer amortized as an expense after 2001 but instead is reviewed andtested for impairment using a fair value methodology prescribed in thisStatement.  Goodwill will be tested forimpairment at least annually or more frequently as a result of an event orchange in circumstances (e.g. recurring operating losses by the acquiredentity) that would indicate an impairment adjustment may be necessary.  Based on its assessment of the currenteconomic environment, management does not anticipate any realization issuesrelated to the goodwill reflected in the accompanying consolidated balancesheet that would require an impairment adjustment upon adoption of SFAS No.142.

 

**(10)     PENDINGBRANCH ACQUISITION**

 

On September 6, 2001, Compassentered into a Purchase and Assumption Agreement to assume all of the depositliabilities of Charter Bank’s Hyannis, Massachusetts office for cash and aninsignificant balance of deposit-related loans.  Compass will pay a premium of 5% of the stated balance ofdeposits, which are expected to be approximately $25 million at the time ofclosing.  Following completion of thetransaction, which is expected to occur in December 2001, Charter Bank willclose its Hyannis branch at which time customer accounts will be transferred toan existing Compass branch in Hyannis.

 

**(11)     SUBSEQUENTEVENT - SETTLEMENT OF PENSION PLAN**

 

On October 15, 2001, Compasssettled its obligations under its defined benefit pension plan bydistributing lump-sum payments and purchasing nonparticipating annuitycontracts for all participants.  Inconnection with this settlement, Compass recognized a non-recurring gain ofapproximately $1.5 million in October 2001.

 

**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 the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934.  When used in this report, thewords or phrases, “will likely result,” “are expected to,” “will continue,” “isanticipated,” “estimate,” “believe,” or similar expressions are intended toidentify such forward-looking statements. Actual events could differ materially from those anticipated in theforward-looking statements.  Importantfactors that might cause such a difference include, among other things, generaleconomic conditions, particularly the real estate market, in the Company’sprimary market area, potential increases in the Company’s nonperforming assets(as well as increases in the allowance for loan losses that might benecessary), concentrations of loans in a particular geographic area or withcertain large borrowers, changes in government regulation and supervision,including increased deposit insurance premiums or capital or reserverequirements, changes in interest rates, 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.

 

**Acquisition of Home Port**

 

On December 31, 2000, theCompany completed its acquisition of Home Port and its bank subsidiary,Nantucket Bank, in a transaction accounted for under the purchase method ofaccounting.  Accordingly, while theconsolidated assets and liabilities of Home Port are reflected in the Company’sconsolidated balance sheets at September 30, 2001 and December 31, 2000, theresults of operations of Home Port for the three and nine month periods endedSeptember 30, 2000 are not included in the Company’s consolidated statements ofincome for those periods.  The impact ofthis acquisition on the consolidated statements of income for the three andnine month periods ended September 30, 2001 has been segregated in theaccompanying discussion of the comparison of operating results for 2001 and2000.

 

**Comparison of Financial Condition at September 30,2001 and December 31, 2000**

 

Total assets increased by$445.1 million from $2,890.8 million at December 31, 2000 to $3,335.9 millionat September 30, 2001.  During the ninemonths ended September 30, 2001, the loan portfolio, excluding loansheld-for-sale, increased by $223.0 million, or 9.4%, which was fundedprincipally by additional Federal Home Loan Bank advances.  During the first half of 2001, the Company’sborrowings from the Federal Home Loan Bank (FHLB) exceeded its actual fundingneeds.  This was done for tworeasons.  First, management consideredthe interest rates offered by the FHLB to be favorable.  In addition, these borrowings provided liquidityin the event of possible deposit outflows in 2001 due to the likely repricingof maturing certificates of deposit to substantially lower rates.  As a result of this strategy, at June 30,2001, the Company held federal funds sold and other cash equivalents of $75million in excess of its historical levels.

 

During the third quarter of2001, the Company experienced core deposit growth of $126 million, or12.1%.  This increase was partiallyattributable to seasonal factors but is believed by management to be primarilycaused by the decline in the stock market in the wake of an economic slowdownand the acts of terrorism against the United States occurring in September2001.  With this significant influx ofdeposits, the Company increased its investment portfolio by $94.0 million, or30.7%, with most new investments maturing in 6-12 months.  With some moderation in loan growth duringthe third quarter of 2001, federal funds sold and other cash equivalentsincreased to approximately $110 million in excess of historical levels atSeptember 30, 2001.

 

The increase in loans occurredprimarily in the residential mortgage, indirect auto and commercial loanportfolios.  From December 31, 2000 toSeptember 30, 2001, residential mortgage loans increased by $101.4 million, or8.4%, indirect auto loans (net of unearned discounts) increased by $79.4million, or 15.2% and commercial loans increased by $20.0 million, or19.9%.  During the third quarter of2001, management of Compass decided to begin to sell fixed rate residentialmortgage loans having terms of 15 years or less, at which time $23.8 million ofsuch loans were reclassified to held-for-sale status.  This decision will likely result in a reduction in the futurerate of growth in residential mortgage loans compared to recent years as themajority of current originations of such loans have fixed rates due to thefavorable interest rates currently available. Compass has continued  toemphasize the origination of indirect auto loans through its network of automobiledealers which has been expanded to include dealers in communities contiguous tothe metropolitan Boston area.  Thegrowth in commercial loans was primarily with existing customers to fundbusiness expansion and seasonal borrowing needs.

 

Total deposits at September 30,2001 were $2,182.8 million, an increase of $193.2 million, or 9.7%, compared to$1,989.6 million at December 31, 2000. Core deposit account balances increased by $197.0 million, or 20.2%,during the first nine months of 2001. Certificates of deposit declined by $3.8 million reflecting the impactof the lower interest rates currently being offered.

 

The increase in stockholders’equity of $15.8 million to $304.0 million at September 30, 2001 resulted fromthe net income of $21.8 million for the nine months ended September 30, 2001and an increase of $3.4 million in the market value of investment securitiesavailable for sale, net of taxes, which were partially offset by cash dividendsand stock repurchases totaling $11.2 million. During 1999 and 2000, the Company announced three stock repurchaseprograms aggregating 3,486,212 shares. As of November 9, 2001, 2,717,000 shares had been repurchased leaving upto 769,212 shares for repurchase. Management expects to repurchase the remaining shares under theseprograms over the next six to nine months.

 

**Comparison of Operating Results for the Quarters EndedSeptember 30, 2001 and 2000**

 

As previously noted, theacquisition of Home Port on December 31, 2000 had a significant impact onchanges in the components of the Company’s consolidated statements of incomebetween the quarters ended September 30, 2001 and 2000.  The following table segregates NantucketBank’s impact on such changes (in thousands):

 
|                       |   | **Quarter Ended September 30, 2001** |   | **Quarter****Ended  September 30,****2000** |   | ** ** |   |
|----------------------------|--------|--------------------------------------|--------|---------------------------------------------|--------|------------|--------|
|                       |   |                                 |   | **Nantucket**                               |   |       |   |   | **Net** |   |
|                       |   | **Consolidated**                     |   | **Bank**                                    |   | **Net**    |   |   | **Changes** |   |
| Interest income            |   | $                                    | 55,349 |                                        | $      | 6,705      |   | $ | 48,644 |   | $ | 43,304 |   | $ | 5,340 |   |
| Interest expense           |   | 29,060                               |   | 3,793                                       |   | 25,267     |   | 22,944 |   | 2,323 |   |
| Provision for loan losses  |   | 1,550                                |   | 50                                          |   | 1,500      |   | 1,250 |   | 250 |   |
| Noninterest income         |   | 3,686                                |   | 675                                         |   | 3,011      |   | 2,928 |   | 83 |   |
| Noninterest expense        |   | 15,991                               |   | 2,467                                       |   | 13,524     |   | 12,760 |   | 764 |   |
| Income before taxes        |   | 12,434                               |   | 1,070                                       |   | 11,364     |   | 9,278 |   | 2,086 |   |
| Provision for income taxes |   | 4,400                                |   | 588                                         |   | 3,812      |   | 3,183 |   | 629 |   |
| Net income                 |   | $                                    | 8,034  |                                        | $      | 482        |   | $ | 7,552 |   | $ | 6,095 |   | $ | 1,457 |   |
|                            |        |                                      |        |                                             |        |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The remaining discussion,unless otherwise indicated, addresses the net changes presented above, whichexcludes the impact due to the acquisition of Nantucket Bank.

 

*Interest Income.*  Interest income for the quarter ended September 30, 2001 was$48.6 million compared to $43.3 million for the quarter ended  September 30, 2000, an increase of $5.3million, or 12.3%.  The increase ininterest income resulted from growth in average interest-earning assets of$449.8 million, or 19.9%, partially offset by a decrease in the overall yieldon interest-earning assets of 48 basis points in the 2001 period.  The principal areas of growth in averagebalances were related to real estate loans (up $168.9 million, or 12.4%) andindirect auto loans (up $90.7 million, or 18.3%).  Most of the real estate loan growth resulted from increasedoriginations of one-to-four family residential mortgage loans caused byfavorable interest rates.  The increasein indirect auto loans resulted from the continued geographic expansion of thenetwork of participating dealers.

 

*Interest Expense.*  Interest expense for the quarter ended September 30, 2001 was$25.3 million compared to $22.9 million for the quarter ended September 30,2000, an increase of $2.3 million, or 10.1%. This increase resulted from a higher average balance of interest-bearingliabilities (up $407.8 million, or 21.0%), partially offset by a 42 basispoints decrease in the cost of funds from 4.72% in 2000 to 4.30% in 2001.  Average interest-bearing deposit balancesincreased $150.5 million, or 9.6%, during the quarter ended September 30, 2001compared to the same period in 2000.

 

Interest expense on borrowed funds increased $2.7 million in thequarter ended September 30, 2001 due to a $257.3 million  increase in the average balance of suchfunds, partially offset by an 89 basis points decrease in the average rate paidon borrowed funds to 5.44% in the 2001 period.

 

*Provision for Loan Losses.*  The Company provides for loan losses inorder to maintain the allowance for loan losses at a level that managementestimates is adequate to absorb future charge-offs of loans deemeduncollectible.  In determining theappropriate level of the allowance for loan losses, management considers pastand anticipated loss experience, evaluations of underlying collateral,prevailing economic conditions, the nature and volume of the loan portfolio andthe levels of nonperforming and other classified loans.  The amount of the allowance is based onestimates and  ultimate losses may varyfrom such estimates.  Managementassesses the allowance for loan losses on a quarterly basis and provides forloan losses monthly in order to maintain the adequacy of the allowance.

 

Compass provided $1.55 millionfor loan losses in the quarter ended September 30, 2001 compared to $1.25million in the quarter ended September 30, 2000.  The increase of $300,000 in 2001 was primarily attributable to  growth in the loan portfolio.  The total allowance (including NantucketBank) of $28.7 million at September 30, 2001 represented 1.11% of total loanscompared to 1.06% at December 31, 2000. At September 30, 2001, the allowance for loan losses as a percentage ofnon-performing loans was 276.2% compared to 410.7% at December 31, 2000.  The increase in non-performing loans in 2001was  largely attributable to onecommercial loan customer with an aggregate loan balance of $2.5 million.

 

*Noninterest Income.*  Total noninterest income was $3.0 million for the quarter endedSeptember 30, 2001 compared to $2.9 million in the same period of 2000.  Exclusive of a non-recurring gain of$250,000 on the disposition of banking premises and equipment in 2000,noninterest income increased $333,000, or 11.4%, in 2001.  This increase was principally caused bychecking account related income, ATM/Debit card usage and loan fee income.

 

*Noninterest Expense.*   Noninterest expense increased by $764,000, or 6.0%, from $12.8million for the quarter ended September 30, 2000 to $13.5 million for thequarter ended September 30, 2001 resulting from increases in salaries andemployee benefits ($635,000), professional services expenses ($204,000) andother noninterest expense ($151,000). Such increases were partially offset by an aggregate decrease of$226,000 in all other categories of noninterest expenses, principallymarketing.

 

Salaries and employee benefitsincreased $635,000, or 9.7%, during the quarter ended September 30, 2001, dueto overall salary increases averaging 4.5% and increases in staffingnecessitated by franchise expansion (two new branches) and the start-up ofCompass’s private banking initiative.

 

Professional services expensesincreased $204,000, or 43.7%, during the quarter ended September 30, 2001.  This increase reflected consulting and legalfees associated with the start-up of Compass’s private banking initiative andother legal and consulting services.

 

Marketing expenses decreased$218,000, or 34.8%, during the quarter ended September 30, 2001.  This decrease was attributable to a plannedreduction in the airing of recently produced television commercials during thesummer months (which commercials began airing again in October) and higher thannormal costs incurred in the third quarter of 2000 due to the grand opening ofthe Company’s new corporate offices and a program targeting potential customersimpacted by the branch divestitures required by the Fleet/Bank Boston merger.

 

Other noninterest expenseincreased $151,000 during the quarter ended September 30, 2001.  Exclusive of a non-recurring item related tothe acquisition of Sandwich Bancorp, Inc. recognized in the quarter endedSeptember 30, 2000, noninterest expense increased by $26,000, or 1.6%, duringthe quarter ended September 30, 2001.

 

*Income Taxes.* The effective tax rate (including NantucketBank) for the quarter ended September 30, 2001 was 35.4% compared to 34.3% inthe same period in 2000.  This increasereflected the impact of nondeductible goodwill amortization resulting from theHome Port acquisition.

 

**Comparison of Operating Results for the Nine MonthsEnded September 30, 2001 and 2000**

 

The following table segregatesNantucket Bank’s impact on changes in the components of the Company’sconsolidated statements of income between the nine month periods endedSeptember 30, 2001 and 2000 (in thousands):

 
|                       |   | **Nine Months Ended September 30, 2001** |    | **Nine Months****Ended****September 30,****2000** |   | **Net****Changes** |   |
|----------------------------|--------|------------------------------------------|---------|---------------------------------------------------|--------|--------------------|--------|
|                       |   |                                     |    | **Nantucket**                                     |   |               |   |   |   |
|                       |   | **Consolidated**                         |    | **Bank**                                          |   | **Net**            |   |   |   |
| Interest income            |   | $                                        | 161,971 |                                              | $      | 19,861             |   | $ | 142,110 |   | $ | 120,897 |   | $ | 21,213 |   |
| Interest expense           |   | 86,540                                   |    | 11,626                                            |   | 74,914             |   | 61,749 |   | 13,165 |   |
| Provision for loan losses  |   | 4,425                                    |    | 150                                               |   | 4,275              |   | 3,500 |   | 775 |   |
| Noninterest income         |   | 10,249                                   |    | 1,765                                             |   | 8,484              |   | 7,408 |   | 1,076 |   |
| Noninterest expense        |   | 47,865                                   |    | 7,125                                             |   | 40,740             |   | 36,048 |   | 4,692 |   |
| Income before taxes        |   | 33,390                                   |    | 2,725                                             |   | 30,665             |   | 27,008 |   | 3,657 |   |
| Provision for income taxes |   | 11,624                                   |    | 1,604                                             |   | 10,020             |   | 9,486 |   | 534 |   |
| Net income                 |   | $                                        | 21,766  |                                              | $      | 1,121              |   | $ | 20,645 |   | $ | 17,522 |   | $ | 3,123 |   |

 

The remaining discussion, unlessotherwise indicated, addresses the net changes presented above, which excludesthe impact due to the acquisition of Nantucket Bank.

 

*Interest Income.*  Interest income for the nine months ended September 30, 2001 was$142.1 million compared to $120.9 million for the nine months ended September30, 2000, an increase of $21.2 million, or 17.5%.  The increase in interest income resulted from growth in averageinterest-earning assets of $413.9 million, or 19.2%, partially offset by adecrease in the overall yield on interest-earning assets of 11 basis points inthe 2001 period.  The principal areas ofgrowth in average balances were related to real estate loans (up $190.1million, or 14.6%) and indirect auto loans (up $95.1 million, or 20.4%).  Most of the real estate loan growth resultedfrom increased originations and retention in portfolio, until September 2001,of one-to-four family residential mortgage loans.  The increase in indirect auto loans resulted from the continuedgeographic expansion of the network of participating dealers.

 

*Interest Expense.*  Interest expense for the nine months ended September 30, 2001 was$74.9 million compared to $61.7 million for the nine months ended September 30,2000, an increase of $13.2 million or 21.3%. This increase resulted from a higher average balance of interest-bearingliabilities (up $379.1 million, or 20.5%) and a 3 basis points increase in thecost of all funds from 4.46% in 2000 to 4.49% in 2001.  Average interest-bearing deposit balancesincreased $172.5 million, or 11.6%, during the nine months ended September 30,2001 compared to the same period in 2000.

 

Interest expense on borrowedfunds increased $7.6 million in the nine months ended September 30, 2001 to$23.7 million due to a $206.6 million increase in the average balance of suchfunds, partially offset by a 43 basis points decrease in the average rate paidon borrowed funds to 5.63% in the 2001 period.

 

The small increase in the costof funds in 2001 reflected the lingering effect of the series of rate increasesinitiated by the Federal Reserve Board beginning in September 1999 andcontinuing into 2000 as well as the greater utilization of certificates ofdeposit and FHLB advances as funding sources during that period.  With the series of rate reductions initiatedby the Federal Reserve Board in 2001 and the scheduled maturity of $450 millionof certificates of deposit in the fourth quarter of 2001, management expectsCompass’s interest margin to improve in the fourth quarter.

 

*Provision for Loan Losses.*  Compass provided $4.3 million for loanlosses in the nine months ended September 30, 2001 compared to $3.5 million inthe comparable prior year period.  Theincrease of $775,000 in 2001 was primarily attributable to the growth in theloan portfolio.

 

*Noninterest Income.*  Total noninterest income was $8.5 million for the nine monthsended September 30, 2001 compared to $7.4 million in the same period of 2000,an increase of $1.1 million, or 14.5%. This increase was principally caused by increases in checking accountrelated income, ATM/Debit card usage and, to a lesser extent, increases in loanfee income.

 

*Noninterest Expense.* Noninterest expense increased by $4.7 million, or 13.0%, from $36.0million for the nine months ended September 30, 2000 to $40.7 million for thenine months ended September 30, 2001. This increase reflected increases in all areas of expense includingsalaries and employee benefits ($1.5 million), occupancy and equipment ($1.0million), data processing ($392,000), marketing ($34,000), professionalservices ($782,000) and other noninterest expense ($1.0 million).

 

Salaries and employee benefitsincreased $1.5 million, or 7.9%, during the nine months ended September 30,2001, due to overall salary increases averaging 4.5% ($637,000), increases instaffing necessitated by three new branches and the start-up of Compass’sprivate banking initiative ($875,000) as well as increases in employee healthinsurance costs and the ESOP.

 

Occupancy and equipmentexpenses increased $1.0 million, or 20.9%, during the nine months endedSeptember 30, 2001.  This increase wasprimarily due to higher costs associated with the new corporate offices whichopened during the third quarter of 2000 and new branches in Dennis, Seekonk andMattapoisett, as well as higher utility costs caused by increases in ratescharged by service providers.

 

Data processing expensesincreased $392,000, or 10.8%, during the nine months ended September 30, 2001due primarily to volume-related services such as item processing, expandedbranch and ATM networks and ATM/Debit card usage.  These increases were partially offset by a rate decrease receivedon certain services from the Company’s core processing service provider.

 

Marketing expenses increased$34,000, or 1.7%, during the nine months ended September 30, 2001.  This increase was attributable to productionand media costs for television commercials, partially offset by costs incurredin 2000 related to the grand opening of the Company’s new corporate offices anda program targeting potential customers impacted by the branch divestituresrequired by the Fleet/Bank Boston merger.

 

Professional services expensesincreased $782,000, or 63.3%, during the nine months  ended September 30, 2001. This increase primarily reflected consulting and legal fees associatedwith the start-up of Compass’s private banking initiative, certainnon-recurring costs for tax services, costs associated with an assessment ofthe risk management function and other legal and consulting services.

 

Other noninterest expenseincreased $1.0 million, or 23.6%, during the nine months ended September 30,2001.  Exclusive of a non-recurring itemrelated to the acquisition of Sandwich Bancorp, Inc. recognized in 2000,noninterest expense increased by 13.0% during 2001.  This increase reflects primarily volume-related items such asprinting, postage, and telephone costs.

 

*Income Taxes.* The effective tax rate(including Nantucket Bank) for the nine months ended September 30, 2001 was34.8% compared to 35.1% in the same period in 2000.  In 2001, the Company completed an analysis addressing the impactof a recent Tax Court decision on the deductibility of certain merger-relatedcosts incurred in connection with the acquisition of Sandwich Bancorp, Inc. in1998.  Based on this analysis, theprovision for income taxes was reduced by $479,000 for the nine months endedSeptember 30, 2001.  Exclusive of thisnon-recurring item, the effective tax rate in 2001 was 36.2%.  This increase from 2000 reflected the impactof nondeductible goodwill amortization resulting from the Home Portacquisition.

 

**Liquidityand Capital Resources**

 

Liquidity, represented by cashand cash equivalents and debt securities is a product of the Company’soperating, investing, and financing activities.  The Company’s primary sources of funds are deposits, borrowings,principal and interest payments on outstanding loans and mortgage-backedsecurities, maturities of investment securities and funds provided fromoperations.  While scheduled paymentsfrom the amortization of loans and mortgage related securities and maturinginvestment securities are relatively predictable sources of funds, depositflows and loan prepayments are greatly influenced by general interest ratesand, in the case of deposits, other instruments available to the public such asmutual funds and annuities.

 

As voluntary members of theFederal Home Loan Bank of Boston (FHLB), Compass and Nantucket Bank areentitled to borrow up to the value of their qualified collateral that has notbeen pledged to others.  Qualifiedcollateral generally consists of residential first mortgage loans, U.S.Government and agency securities and funds on deposit at the FHLB.  At September 30, 2001, Compass and NantucketBank had approximately $371.0 million and $86.9 million, respectively, inunused borrowing capacity that is contingent upon the purchase of additionalFHLB stock.  Use of this borrowingcapacity may also be impacted by regulatory capital requirements.

 

Liquidity management is both adaily and long-term function of business management.  The measure of a bank’s liquidity is its ability to meet its cashcommitments at all times with available cash or by conversion of other assetsto cash at a reasonable price.  AtSeptember 30, 2001, the Company maintained cash and due from banks, federalfunds sold and debt securities maturing within one year of $313.3 million, or9.39% of total assets.  The Companyinvests excess funds, if any, in federal funds sold which provides liquidity tomeet lending requirements.  During 2001,the Company borrowed from the FHLB approximately $110 million more than wasrequired to meet its immediate needs in order to take advantage of interestrates which management considered to be favorable. In addition, theseborrowings provide liquidity in the event the Company experiences depositoutflows during the remainder of 2001. This outflow will occur due to, among other things, certificate ofdeposit customers who, based on current rates, will experience a substantialreduction in their reinvestment rate. At September 30, 2001, these additionalfunds were invested in federal funds sold and short-term investments.

 

At September 30, 2001, theCompany had commitments to originate loans, unused outstanding lines of credit,standby letters of credit and undisbursed proceeds of loans totaling $276.9million.  The Company anticipates thatit will have sufficient funds available to meet its current loancommitments.  Certificates of depositmaturing within one year from September 30, 2001 amounted to $846 million.  The Company expects that a significantportion of maturing certificate accounts will be retained as deposits atmaturity.

 

The Company’s andthe Banks’ capital ratios at September 30, 2001 were as follows:    

 

|                                      |   | **Seacoast  Financial** |   | **Compass** |   | **Nantucket  Bank** |   |
|-------------------------------------------|--------|-------------------------|--------|-------------|--------|---------------------|--------|
| Total Capital (to risk  weighted assets)  |   | 13.18                   | %      | 12.02       | %      | 16.72               | %      |
| Tier 1 Capital (to risk  weighted assets) |   | 11.91                   |   | 10.80       |   | 15.14               |   |
| Tier 1 Capital (to average  assets)       |   | 8.22                    |   | 7.48        |   | 9.35                |   |

 

These ratiosplaced the Company in excess of regulatory standards and the Banks in the “wellcapitalized” category as set forth by the FDIC.

 

###### **Item 3.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

The chief market risk factoraffecting the financial condition and operating results of the Company isinterest rate risk.  This risk ismanaged by periodic evaluation of the interest risk inherent in certain balancesheet accounts, determination of the level of risk considered appropriate givencapital and liquidity requirements, business strategy, performance objectivesand operating environment and maintenance of such risks within guidelinesapproved by the Board of Directors. Through such management, the Company seeks to reduce the vulnerabilityof its net earnings to changes in interest rates.  Each Bank’s Asset/Liability Committee, comprised of seniormanagement, is responsible for managing interest rate risk and reviewing withits Board of Directors on a quarterly basis its activities and strategies, theeffect of those strategies on operating results, the Bank’s interest rate riskposition and the effect changes in interest rates would have on net interestincome. The extent of movement of interest rates is an uncertainty that couldhave a negative impact on earnings.

 

The principal strategies thatthe Company generally uses to manage interest rate risk include (i) emphasizingthe origination and retention of adjustable-rate loans, origination of indirectauto loans (Compass only) which have relatively short maturities  and origination of loans with maturities atleast partly matched with those of the deposits and borrowings funding theloans, (ii) investing in debt securities with relatively short maturities and(iii) classifying a significant portion of its investment portfolio as availablefor sale so as to provide sufficient flexibility in liquidity management.

 

The Company and the Banksquantify their interest rate risk exposure using a sophisticated simulationmodel.  Simulation analysis is used tomeasure the exposure of net interest income to changes in interest rates over aspecified time horizon.  Simulationanalysis involves projecting future interest income and expense under variousrate scenarios.  Internal guidelines oninterest rate risk specify that for every 100 basis points immediate shift ininterest rates, the estimated net interest income over the next 12 monthsshould decline by less than 5%.

 

In utilizing a 300 basis pointincrease in rates in its simulation model, the full impact of annual rate capsof 200 basis points common to most adjustable rate mortgage loan products isconsidered.  The rate shocks used assumean instantaneous and parallel change in interest rates and that no strategiesare implemented in response to the change in interest rates.  Prepayment speeds for loans are based onpublished median dealer forecasts for each interest rate scenario.

 

As of September 30, 2001, theCompany s estimated exposure as a percentage of estimated net interest incomefor the next twelve and twenty-four month periods is as follows:

** **

|                              |       | **Percentage  Change in Estimated** |       |
|-----------------------------------|------------|-------------------------------------|------------|
|                              | ** ** | **Net  Interest Income Over:**      | ** ** |
|                              |       | **12 Months**                       |       | **24 Months** | ** ** |
| 300 basis point increase in rates |       | (7.59                               | )%         | (4.97 | )% |
| 200 basis point decrease in rates |       | (0.10                               | )%         | (2.64 | )% |

 

Based on the scenario above,net income would be adversely affected (within internal guidelines) in both thetwelve and twenty-four month periods. For each one percent change in net interest income, the effect on netincome would be $760,000 assuming a 36% tax rate.

 

**PART II -OTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

The Company is not involved inany pending legal proceedings other than those occurring in the ordinary courseof business.  Management believes thatthe resolution of these matters will not materially affect the Company’s financialposition, results of operations or liquidity.

 

**Item2.  Changes in Securities and Use ofProceeds**

 

Not applicable.

 

**Item3.  Defaults Upon Senior Securities**

 

Notapplicable.

 

**Item4.  Submission of Matters to A Vote ofSecurity Holders**

 

 

        Not applicable.

 

**Item5.  Other Information**

 

 

Notapplicable.

 

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

 

a.             Exhibits:

 

2.1           Agreement and Planof Merger by and between Seacoast Financial Services Corporation and Home PortBancorp, Inc. date as of July 20, 2000++++++

 

2.2           Stock OptionAgreement between Home Port Bancorp, Inc. and Seacoast Financial ServicesCorporation dated as of July 20, 2000++++++

 

3.1           Articles ofOrganization of Seacoast Financial Services Corporation+++

 

3.2           By-Laws of SeacoastFinancial Services Corporation+++

 

4              Specimencertificate for the common stock of Seacoast Financial Services Corporation++

 

10.1*       Formof Employment Agreement by and among Seacoast Financial Services Corporation,Compass Bank for Savings and Kevin G. Champagne+

 

10.2*       Form of EmploymentAgreement by and among Compass Bank for Savings, Seacoast Financial ServicesCorporation and certain Officers of Compass Bank for Savings+

 

10.3*       Form of Change inControl Agreements by and among Seacoast Financial Services Corporation, CompassBank for Savings, Kevin G. Champagne and certain other Officers of Compass Bankfor Savings+

10.4*       Form of Change inControl Agreement by and among Seacoast Financial Services Corporation, CompassBank for Savings and certain Officers of Compass Bank for Savings+

 

10.5*       Form of ExecutiveSalary Continuation Agreements made and entered into by and between CompassBank for Savings and Kevin G. Champagne, Arthur W. Short, John D. Kelleher andFrancis S. Mascianica and forms of amendments thereto+

 

10.6*       Trust Agreement, madeas of December 18, 1992, by and between Compass Bank for Savings and ShawmutBank, N.A.+

 

10.7*       Compass Bank forSavings January 2000 Incentive Compensation Plan +++++

 

10.12*     Compass Bank forSavings Executive Deferred Compensation Plan+

 

10.13*     Rabbi Trust for CompassBank for Savings Executive Deferred Compensation Plan+

 

10.17*     Sandwich Co-operativeBank 1992 Directors Deferred Compensation Plan++

 

10.20*     Seacoast FinancialServices Corporation 1999 Stock Incentive Plan++++

 

11            A statementregarding earnings per share is included in Item 1, Note 5, of this report.

 

b.             Reports on Form8-K: No reports on Form 8-K were filed during the quarter ended September 30,2001.

 

----

*             Management compensatory plan orarrangement.

 

+              Incorporatedby reference to the Company’s Registration Statement on Form S-1 (333-52889),filed with the Securities and Exchange Commission under the Company’s priorname, “The 1855 Bancorp”, on May 15, 1998.

 

++           Incorporatedby reference to Amendment No. 1 to the Company’s Registration Statement on FormS-1 (333-52889), filed with the Securities and Exchange Commission under theCompany’s prior name, “The 1855 Bancorp”, on August 14, 1998.

 

+++         Incorporatedby reference to the Company’s Registration Statement on Form 8-A filed with theSecurities and Exchange Commission on November 18, 1998.

 

++++       Incorporatedby reference to the Company’s Proxy Statement on Schedule 14A filed with theSecurities and Exchange Commission on April 16, 1999.

 

 

+++++    Incorporatedby reference to the Company’s Annual Report on Form 10-K filed with theSecurities and Exchange Commission on March 28, 2000.

 

++++++  Incorporatedby reference to the Company’s Current Report on Form 8-K filed with the SEC onAugust 3, 2000.

 

 

**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: November 13, 2001 | By     | /s/ Kevin G. Champagne                  |
|                    |   | Kevin G. Champagne                      |
|                    |   | President and Chief Executive Officer   |
|                    |   |                                    |
|                    |   |                                    |
| Date: November 13, 2001 | By     | /s/ Francis S. Mascianica, Jr.          |
|                    |   | Francis S. Mascianica, Jr.              |
|                    |   | Treasurer, as Principal Financial and   |
|                    |   | Accounting Officer                      |