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Letter to the Stockholders LSB Corporation (the Company) reported net income of $4,136,000 or $0.94
diluted earnings per share for the year ended December 31, 2003 compared to net
income of $3,100,000 or $0.69 diluted earnings per share for the year ended
December 31, 2002. During 2003, there were several financial highlights or
other items worth noting for the Company and its wholly owned subsidiary,
Lawrence Savings Bank, (the Bank), such as the Banks commitment to the local
community, net interest income, non-interest income, non-interest expense,
lawsuit recovery, capital adequacy and shareholders value. The Company conducts its business in the Merrimack Valley in Massachusetts and
southern New Hampshire. The Company helps meet the needs of the community
through various means. The Directors and Officers meet these needs through
participation in various organizations located in or around the community.
Almost all Directors and Officers have had direct or indirect participation for
many years with community organizations. During 2003, approximately 43
community organizations had 71 positions held by 32 Officers of the Company.
Some of these organizations provide direct care to individuals such as Family
Services, Inc., Lawrence General Hospital, YWCA, Salvation Army and Samaritans.
Other organizations provide a higher level of service to the community such as
the Chamber of Commerce, Exchange Club, Kiwanis and Rotary. There are industry
organizations that our Officers actively participate beside these community
organizations such as the Deposit Insurance Fund (DIF), Savings Bank Employee
Retirement Associations (SBERA) and MassBankers. All these organizations
severed by our Directors and Officers keep us in touch with the needs of our
customers and the community. Meeting these customer and community needs can be a challenging job especially
in a declining interest rate environment. The focus has been to originate
commercial real estate, construction and commercial loans while improving upon
our core deposits. The net-interest margin has declined in the past three years
to 2.90% in 2003 from 3.20% in 2002 and 3.21% in 2001. Lower interest rates
give loan customers incentive to refinance existing loans at lower rates. The
average yield on loans has dropped to 6.55% in 2003 from 7.20% in 2002 and
7.93% in 2001. The Company has purchased investment securities when profitable
to do so in order to maintain net interest income at approximately $12.4
million in 2003 down from $13.6 million in 2002 and $13.2 million in 2001.
Deposits and borrowed funds are the main sources of financing assets for the
Company. Although the cost of funds for deposits and borrowings do not always
rise or fall in tandem with loan or investment security yields, the Company
constantly monitors these cost of funds, which were 2.44% in 2003, 3.14% in
2002 and 4.36% in 2001, in order to help maintain net interest income with
declining asset yields.




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Non-interest income increased by $2,111,000 (including the lawsuit payment
noted below) for the year ended 2003 compared to $1,493,000 in 2002. Income on
loan fees increased to $20,000 in 2003 compared to a loss of $145,000 in 2002.
The income on loan fees can be attributed to $186,000 in commercial loan
prepayment penalties for the year ended 2003. Also contributing to the increase
were deposit account fees of $713,000 in 2003 compared to $665,000 in the same
period of 2002. Partially offsetting these increases was a reduction in gains
on the sale of mortgage loans to $467,000 from $529,000 in 2003 and 2002,
respectively. Non-interest expenses decreased to $9,738,000 from $10,155,000 in 2002. This
decline is primarily attributable to a reduction in professional fees to
$643,000 from $806,000 resulting from lower legal fees. Salaries and employee
benefits decreased to $5,923,000 from $6,006,000 resulting from the salary
reduction initiatives and lower headcount. Other expenses decreased $148,000
mainly attributable to reductions in marketing, professional development and
administrative expenses due to expense reduction efforts. On October 21, 2003 the Massachusetts Appeals Court rendered a favorable
opinion on a lawsuit in which the Bank was the plaintiff. The Company received
payment in the amount of $1,996,000 on October 30, 2003. This payment received
was recorded in non-interest income. The after tax impact is approximately
$1,251,000, which represents approximately $0.29 per basic earnings per share. Capital levels have been consistent in 2003 from 2002 for the Company. The
Company is considered to be well capitalized as defined by the Federal
Reserve Bank and the Federal Deposit Insurance Corporation for all periods
presented. The Corporations leverage ratio was 12.11% and 12.10% at December
31, 2003 and December 31, 2002, respectively. The Companys stock price closed at $17.31 and $12.24 at December 31, 2003 and
2002, respectively. The increase of $5.07 represents approximately a 41%
increase at December 31, 2003 compared to December 31, 2002. Shareholders
received an increase in the dividend paid during the year to $0.48 per share in
2003 compared to $0.44 per share in 2002 with a dividend payout ratio of
approximately 50% or more for both years. During 2004, our Board of Directors,
management and staff will continue to work to further improve the earnings of
the Company and shareholder value. -s- PAUL A. MILLER Paul A. Miller
President and Chief Executive Officer
LSB Corporation 2




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Financial Table of Contents 4
    
    Financial Highlights5
    
    Business8
    
    Managements Discussion and Analysis
of Financial Condition and Results
of Operations22
    
    Report of Management Responsibility23
    
    Independent Auditors Report24
    
    Consolidated Balance Sheets25
    
    Consolidated Statements of
Operations26
    
    Consolidated Statements of Changes in
Stockholders Equity27
    
    Consolidated Statements of
Cash Flows28
    
    Notes to Consolidated Financial
Statements46
    
    Stockholders InformationEX-13 2003 ANNUAL REPORT TO SHAREHOLDERSEX-14 CODE OF PROFESSIONAL CONDUCTEX-20 2004 PROXY STATEMENTEX-21 SUBSIDIARIES OF LSB CORPORATIONEX-23.1 CONSENT OF KPMG LLPEX-31.1 SECTION 302 CERTIFICATION OF C.E.O.EX-31.2 SECTION 302 CERTIFICATION OF C.F.O.EX-32.1 SECTION 906 CERTIFICATION OF C.E.O.EX-32.2 SECTION 906 CERTIFICATION OF C.F.O.
 3




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FINANCIAL HIGHLIGHTS December 31,
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999(Dollars in Thousands, Except Per Share Data)Balance Sheet Data:Total assets
    
    $
    466,108
    
    
    $
    439,134
    
    
    $
    438,267
    
    
    $
    413,090
    
    
    $
    404,172Loans, gross
    
    
    211,503
    
    
    
    243,127
    
    
    
    236,397
    
    
    
    222,045
    
    
    
    198,098Allowance for loan losses
    
    
    4,220
    
    
    
    4,167
    
    
    
    4,070
    
    
    
    3,685
    
    
    
    3,381Other real estate owned
    
    
    2
    
    
    
    12
    
    
    
    22
    
    
    
    32
    
    
    
    519Federal funds sold
    
    
    889
    
    
    
    9,633
    
    
    
    5,705
    
    
    
    15,427
    
    
    
    U.S. Treasury, Government
agency and Corporate obligations
    
    
    226,338
    
    
    
    155,132
    
    
    
    160,337
    
    
    
    125,542
    
    
    
    151,358Municipal obligations
    
    
    1,624
    
    
    
    4,021
    
    
    
    2,062
    
    
    
    60
    
    
    
    113Other securities
    
    
    4,916
    
    
    
    7,256
    
    
    
    11,369
    
    
    
    25,231
    
    
    
    26,301Deposits
    
    
    272,540
    
    
    
    279,465
    
    
    
    268,450
    
    
    
    270,548
    
    
    
    246,040Borrowed funds
    
    
    133,352
    
    
    
    101,591
    
    
    
    111,099
    
    
    
    86,161
    
    
    
    104,167Equity
    
    
    55,002
    
    
    
    54,059
    
    
    
    54,092
    
    
    
    52,313
    
    
    
    48,408
 Year Ended December 31,
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Operating Data:Interest income
    
    $
    21,334
    
    
    $
    25,138
    
    
    $
    28,792
    
    
    $
    29,037
    
    
    $
    26,097Interest expense
    
    
    8,977
    
    
    
    11,565
    
    
    
    15,611
    
    
    
    16,358
    
    
    
    13,183Net interest income
    
    
    12,357
    
    
    
    13,573
    
    
    
    13,181
    
    
    
    12,679
    
    
    
    12,914Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    175
    
    
    
    250
    
    
    
    75Non-interest income
    
    
    1,608
    
    
    
    1,493
    
    
    
    1,426
    
    
    
    1,124
    
    
    
    844Lawsuit judgment collected
    
    
    1,996
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Non-interest expense
    
    
    9,738
    
    
    
    10,155
    
    
    
    9,122
    
    
    
    8,376
    
    
    
    9,347Income before income taxes
    
    
    6,223
    
    
    
    4,911
    
    
    
    5,310
    
    
    
    5,177
    
    
    
    4,336Income tax expense
    
    
    2,087
    
    
    
    1,811
    
    
    
    1,953
    
    
    
    854
    
    
    
    1,582Net income
    
    $
    4,136
    
    
    $
    3,100
    
    
    $
    3,357
    
    
    $
    4,323
    
    
    $
    2,754Basic earnings per share
    
    $
    0.98
    
    
    $
    0.71
    
    
    $
    0.77
    
    
    $
    0.99
    
    
    $
    0.63Diluted earnings per share
    
    $
    0.94
    
    
    $
    0.69
    
    
    $
    0.74
    
    
    $
    0.97
    
    
    $
    0.61
 At or for the year ended December 31,
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Other Data:Interest rate spread
    
    
    2.57
    %
    
    
    2.78
    %
    
    
    2.64
    %
    
    
    2.66
    %
    
    
    3.05
    %Net interest margin on average earning
assets
    
    
    2.90
    
    
    
    3.20
    
    
    
    3.21
    
    
    
    3.22
    
    
    
    3.55Return on average assets (net income /
average assets)
    
    
    0.94
    
    
    
    0.71
    
    
    
    0.79
    
    
    
    1.05
    
    
    
    0.72Return on average equity (net income /
average stockholders equity)
    
    
    7.76
    
    
    
    5.72
    
    
    
    6.35
    
    
    
    8.72
    
    
    
    5.77Dividend payout ratio (dividends declared per
share divided by basic earnings per share)
    
    
    48.98
    
    
    
    61.97
    
    
    
    51.95
    
    
    
    26.26
    
    
    
    23.81Average stockholders equity to average
assets ratio
    
    
    12.16
    
    
    
    12.34
    
    
    
    12.39
    
    
    
    12.06
    
    
    
    12.47Cash dividends declared and paid per
common share
    
    $
    0.48
    
    
    $
    0.44
    
    
    $
    0.40
    
    
    $
    0.26
    
    
    $
    0.15Book value per share at year end
    
    
    12.99
    
    
    
    12.71
    
    
    
    12.35
    
    
    
    11.99
    
    
    
    11.11
 4




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BUSINESS Summary LSB Corporation (the Corporation or the Company) is a one bank-holding
company principally conducting business through Lawrence Savings Bank (the
Bank). The Corporation became the holding company for the Bank on July 1,
2001 pursuant to a plan of reorganization in which each share of Bank common
stock then outstanding (and accompanying preferred stock purchase rights) was
converted into and exchanged for one share of the Corporations common stock
(and accompanying preferred stock purchase rights). The Corporations common
stock is currently traded on the Nasdaq Stock Market under the symbol LSBX.
Prices of the common stock are reported in the Wall Street Journal as LSB
Corp. The Bank was established as a Massachusetts savings bank in 1868; the Bank
converted from mutual to stock form on May 9, 1986. The Corporation is subject to regulation and supervision by the Board of
Governors of the Federal Reserve System (FRB), and Massachusetts Division of
Banks. The Bank is subject to supervision and regulation of, and periodic
examination by, the Federal Deposit Insurance Corporation (FDIC) and the
Massachusetts Division of Banks. The Bank has four wholly-owned subsidiaries at December 31, 2003. Shawsheen
Security Corporation and Shawsheen Security Corporation II engage exclusively
in buying, selling, dealing in and holding securities for their own accounts.
Pemberton Corporation and Spruce Wood Realty Trust, respectively, hold
foreclosed real estate and real estate used in the ordinary course of the
Banks business. The Bank offers various financial products to the general public. These
products include loans for residential real estate, commercial real estate,
construction, consumer and commercial businesses. The Bank offers various
deposit accounts including savings, checking, money market, certificates of
deposit and individual retirement accounts. The Bank invests a portion of its
funds in federal funds and investment securities. The principal source of funds for the Corporation is dividends from its Bank
subsidiary. The principal sources of funds for the Banks lending and
investment activities are deposits, loan payments and prepayments, investment
securities payments and maturities, advances from the Federal Home Loan Bank,
Federal funds purchased and securities sold under agreements to repurchase. Market Area The Banks primary market area is the Merrimack Valley in Massachusetts and
southern New Hampshire. The Bank has five banking offices in the communities of
Andover, Lawrence, Methuen (2), and North Andover, Massachusetts. The Bank has
a remote ATM location in Haverhill, Massachusetts. Lending Activities The Banks loan portfolio consists of commercial real estate, commercial
business, construction, residential mortgage, home equity and consumer loans.
The Bank is aggressive in seeking loans from creditworthy customers;
competition on both pricing and underwriting terms has been strong in the
Banks market area. Gross loans at December 31, 2003 were $211.5 million down
from $243.1 million at December 31, 2002. Commercial real estate.The Bank originates loans secured by real estate other
than 1-4 family residential properties. These loans are generally secured by
various types of commercial real estate including income properties, commercial
facilities (including retail, manufacturing, office and office condominiums)
and small businesses. The interest rates on these loans are fixed or variable.
The interest rates are based on a margin over the Treasury note rate or another
index (such as the Prime Rate as published in The Wall Street Journal) for a
similar term. The margin is determined by the Bank based on the
creditworthiness of the borrower, relationship profitability and competitive
factors. Commercial business.The Bank originates loans secured by business assets
which are not real estate. The Bank has Preferred Lender status from the U.S.
Small Business Administration (SBA). The interest rates on these loans may be
fixed or variable. The rates are primarily based on a margin over the Prime
Rate as published in the The Wall Street Journal or the Base Rate determined by
the Bank. The margin is determined based on the creditworthiness of the
borrower, security offered and competitive factors. Construction.These loans are generally short-term in nature and are for land
development, construction of residential homes built on speculation,
construction of homes for homeowners with permanent financing, and for
construction of commercial facilities (including retail, manufacturing and
office space). These loans are generally priced to yield the The Wall Street
Journal Prime Rate plus a margin. Construction loans may involve additional
risk due to uncertainty of estimated cost of completion of a project, or
ultimate sale of the property to an end buyer. The Bank attempts to reduce
these risks by lending to contractors with pre-arranged buyers or having
financing commitments upon completion, or to businesses that are expanding and
will occupy the completed project. 5




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Residential mortgages.The Bank originates fixed and adjustable rate
residential mortgage loans which are underwritten to be eligible for sale in
the secondary market. These loans are secured primarily by owner occupied 1-4
family primary residential properties. Adjustable rate mortgage loans are
generally held by the Bank in the loan portfolio as a means to manage interest
rate risk. Fixed rate mortgages are generally sold into the secondary market
unless management believes they represent a good long-term asset based on
various factors such as loan-to-value ratios, interest rates and managements
expectations of a loans duration. Secondary mortgage market.The Bank is an approved seller and servicer for the
Federal Home Loan Mortgage Corporation (FHLMC) and the Massachusetts Housing
Financing Agency (MHFA). Sales of mortgage loans may be made at a premium or
discount resulting in gains or losses on the transaction. Based on the
structure of the sale, loans sold to the secondary market provide the Bank with
service fee income over the life of the loan. Home equity.The Bank makes second mortgage and home equity loans. Home
equity loans can be accessed by the borrower by a deposit account established
with the Bank. These loans carry interest rates that are either fixed or
variable based on the Prime Rate published in the The Wall Street Journal plus
or minus a margin above or below this rate depending on the particular product
selected by the borrower. Consumer.The Bank offers a variety of consumer loan products including
overdraft lines of credit, collateral loans, and secured and unsecured
personal loans. These loans are generally fixed rate in nature. The Bank
adjusts interest rates on these products from time-to-time based on competitive
factors in the marketplace. Deposit Activity and Other Sources of Funds Deposits and borrowings are the primary source of funds for funding loans and
purchasing investment securities. The mix of deposits and borrowings is
dependent on many factors, such as loan demand, competition, the economy,
interest rates, and capital resources. Deposits are obtained from the general
public through the Banks branch offices by additions to various deposit
accounts, including checking, savings, money market, certificates of deposit
and individual retirement accounts. The interest rates on these accounts
generally are competitive with other local financial institutions. The Banks
core deposit products (savings, checking and money market accounts) allow
customers more flexibility and access and generally earn lower interest rates
than other types of accounts due to the Banks operating costs to service these
accounts. Certificates of deposit provide customers with higher interest rates,
but less flexibility and access to deposits. Increasing and decreasing interest
rates offered on certificates of deposit allows the Bank to adjust its sources
of funds while providing a competitive interest rate. In addition to deposit
accounts, other sources of funds include advances from the Federal Home Loan
Bank of Boston (FHLB), Federal funds purchased and securities sold under
agreements to repurchase. The Bank is a member of the FHLB. As a member, the Bank is required to hold
FHLB stock equal to at least 1% of residential mortgage loans or 5% of
outstanding FHLB advances, whichever is higher. All FHLB advances are secured
by a blanket lien on the Banks qualifying collateral. These FHLB advances may
be used to fund loans and investment securities or meet other cash needs of the
Bank. The terms of FHLB advances can be short or long-term with interest rates
based on U.S. Treasury obligations with similar maturities. Competition The Bank competes with local, regional and national financial service providers
in its lending and deposit activities. The Bank competes in the local market
against other local and branch offices of regional financial institutions such
as banks, thrifts and credit unions. In addition, less regulated local and
national businesses such as mortgage companies, securities brokerage firms,
insurance companies and mutual funds offer services competitive with those of
the Bank. Bank mergers and recent legislation permitting interstate and
cross-industry expansion may increase competition. The Bank competes on the
basis of interest rates, deposit and loan terms, fees, office location, product
and service arrays, customer convenience and technological advantages.
Competition in the Banks deposit taking and lending activities is affected by
movements in interest rates, local and national market developments, economic
trends and the Banks ability to adjust to change. Supervision and regulation The Corporation is subject to regulation and supervision by the Federal Reserve
Bank (FRB) pursuant to the Bank Holding Company Act of 1956, as amended, and
files with the FRB an annual report and such additional reports as the FRB may
require. The Corporation is also subject to the jurisdiction of the
Massachusetts Division of Banks. As a bank holding company, the Corporations
activities are limited to the business of banking and activities closely
related or incidental to banking. The Corporation may not directly or
indirectly acquire the ownership or control of more than five percent of any
class of voting shares or substantially all of the assets of any company that
is not engaged in activities closely related to banking and also generally must
provide notice to or obtain approval of the FRB in connection with any such
acquisition. The Bank is a state-chartered savings bank subject to the
regulations and supervisory authority of, and periodic examinations by, both
the Federal Deposit Insurance Corporation (FDIC) and the Massachusetts
Division of Banks. These examinations test the Banks safety and soundness and
compliance with various statutory and regulatory requirements. The Corporation
and the Bank are subject to federal and state taxation authorities. The Bank
is subject to certain reserve and reporting requirements as a non-member bank
of the Federal Reserve System. Federal and state bank regulatory agencies have
authority to issue cease and desist orders, assess civil money penalties,
remove officers and directors, issue capital directives and impose prompt
corrective action restrictions or requirements to address safety and soundness
and compliance issues of the Bank. In addition, the Bank must obtain prior
regulatory approvals to undertake certain banking transactions and initiatives,
including establishment, relocation or termination of a banking office, and
merger or acquisition transactions with other banks or non- 6




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banking entities. The supervision and regulation of the Bank are intended
primarily for the protection of depositors and non-business borrowers. The results of examinations provide regulators with a means of measuring and
assessing each institution and taking prompt corrective actions to address any
safety and soundness or compliance issues. USA Patriot Act.On October 26, 2001, President George W. Bush signed into law
the Uniting and Strengthening America by providing Appropriate Tools Required
to Intercept and Obstruct Terrorism Act of 2001 (or USA Patriot Act). Title
III of the USA Patriot Act, known as The International Money Laundering
Abatement and Anti-Terrorist Financing Act of 2001 (the Act) is intended to
make it more difficult for terrorists to launder money in the United States.
In addition, the Act also makes it easier for law enforcement and regulatory
officials to share information and identify illegal money laundering activity. Pursuant to Section 326 of the Act the Secretary of the Treasury promulgated
regulations that substantially increase the identification and verification
requirements for customers of financial institutions. The regulations require
financial institutions to develop procedures for verifying the identity of a
person opening an account, maintaining records of such information, and,
consulting lists of suspected terrorists and terrorist organizations to
determine whether a person seeking to open an account appears on any such
list. In addition, under Section 311 of the Act the Secretary of the Treasury may
require, by regulation or by order, that financial institutions take certain
special measures for all institutions, accounts or transactions that the
Secretary deems to be a
primary money laundering concern. Most significant among these are
requirements to maintain records and report information which identify the
participants in a transaction involving a money laundering concern (also known
as know your customer), and to maintain information relative to the
beneficiaries of such a transaction. Section 352 of the Act amends the Bank Secrecy Act to require all financial
institutions to establish anti-money laundering programs. These must include,
at a minimum: (A) the development of internal policies, procedures, and
controls; (B) the designation of a compliance officer; (C) an ongoing employee
training program; and (D) an independent audit function to test programs. Pursuant to Section 314 of the USA Patriot Act, the Secretary of the Treasury
promulgated regulations to encourage cooperation among financial institutions,
their regulators, and law enforcement officials. The purpose is to help
provide financial institutions with information regarding suspected terrorist
or money laundering activity. The regulations require each financial
institution to designate one or more individuals to receive such information
and may establish procedures for the protection of such information. Sarbanes-Oxley Act of 2002.On July 30, 2002, President George W. Bush signed
into law the SarbanesOxley Act of 2002 (or the Sarbanes-Oxley Act). The
Sarbanes-Oxley Act establishes a comprehensive framework for modernizing and
reforming the oversight of public company financial accounting and disclosure
practices. Principal components of the Sarbanes-Oxley Act include:  
    
    The creation of a public Company Accounting Oversight Board, with
which all accounting firms performing audits for public companies are
required to register, and which is empowered to set auditing, quality
control and independence standards, to inspect registered firms, and to
conduct investigations and to take disciplinary actions, subject to SEC
oversight.
    
    The strengthening of auditor independence from corporate management
by limiting the type and scope of non-audit services that auditors can
offer their public company audit clients, requiring periodic rotation of
public company audit partners, requiring direct auditor reports to
company audit committees, and prohibiting public companies from exerting
improper influence over their outside auditors.
    
    The imposition of new corporate governance requirements including
among other things, independence and financial expertise requirements
for audit committee membership and empowerment of public company audit
committees to appoint, compensate and oversee their companys outside
auditors.
    
    Requirements that the Chief Executive Officer and the Chief Financial
Officer certify financial statements included in public company filings
with the SEC and disgorge bonuses and stock-based compensation for
periods for which the company is forced to restate its financial
results, a prohibition of insider stock trades during black-out
periods when a companys employee benefits plans are precluded from
trading, and a prohibition of public company loans or extensions of
credit to directors and officers.
    
    Requirements that public companies disclose whether they have a code
of ethics for their senior financial officers and if not, why not, and
that management periodically assess and report on the adequacy of the
companys internal controls.
    
    The imposition of new and accelerated public company disclosure
requirements, requirements to report off balance sheet transactions and
of accelerated reporting of insider transactions in company stock The SEC has issued and continues to issue final and proposed regulations
implementing many of the Sarbanes-Oxley Act provisions. 7




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Securities and Exchange Commission Filings on Companys Web Site.Under the
Securities Exchange Act of 1934 Sections 13 and 15(d), periodic and current
reports must be filed with the Securities and Exchange Commission (SEC). The
Company electronically files the following reports with the SEC: Form 10-K
(Annual Report), Form 10-Q (Quarterly Report), Form 8-K (Report of Unscheduled
Material Events), Forms 3, 4 & 5 (Statements of Ownership), Form S-3 and 8-A
(Registration Statements, and Form DEF 14A (Proxy Statement). The Company may
file additional forms. The SEC maintains an Internet site, www.sec.gov in
which all forms filed electronically may be accessed. The Companys website:
www.lawrencesavings.com has a new section for SEC filings available free of
charge and provides a link under www.lawrencesavings.com/stockholder-info.asp. 
 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS Forward-Looking Statements and Factors Which May Affect Future Results This Annual Report contains forward-looking statements (within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities and
Exchange Act of 1934 as amended) that are subject to risks and uncertainties.
Forward-looking statements include information concerning possible or assumed
future results of operations of the Corporation, projected or anticipated
benefits, or events related to other future developments involving the
Corporation or the industry in which it operates. When verbs in the present
tense such as believes, expects, anticipates, continues, attempts or
similar expressions are used, forward-looking statements are being made.
Stockholders should note that many factors, some of which are discussed
elsewhere in this document and in other documents which we incorporate by
reference here in, could affect the future financial results of the Corporation
and could cause results to differ materially from those expressed in or
incorporated by reference in this document. Those factors include fluctuations
in interest rates, or in the relationship between long and short term rates,
inflation, changes in government regulations and economic conditions. Other
factors include competition in the geographic and business areas in which the
Corporation conducts its operations such as might, result, for example:
increased mergers and acquisitions, consolidation of size of competing
financial institutions in the Companys market area, or increased competition
in the Companys market area from other types of lending institutions such as
credit unions or lending institutions based outside of the Companys market
area. As a result of such risks and uncertainties, the Corporations actual
results may differ materially from such forward-looking statements. The
Corporation does not undertake, and specifically disclaims any obligation to
publicly release revisions to any such forward-looking statements to reflect
the occurrence of anticipated or unanticipated events or circumstances after
the date of such statements. Executive Level Overview The Companys financial results are dependent on the following areas of the
income statement: net interest income, provision for loan losses, non-interest
income, non-interest expense and provision for income taxes. Net interest
income is the primary earnings of the Company and the main focus of management.
Net interest income is the difference between interest earned on loans and
investment securities and interest paid on deposits and borrowings. Deposits
and borrowings have short durations and the cost of these funds do not rise and
fall in tandem with loans and investment securities. There are many risks
involved in managing net interest income including, but not limited to
underwriting standards, interest rate and duration risk. These risks have a
direct impact on the level of net interest income. The Company manages these
risks through credit review by an outside firm and the Asset and Liability
Management Committee (ALCO) meetings on a regular basis. The credit review
process reviews loans for underwriting and grading of loan quality while ALCO
reviews the liquidity, interest rate risk and capital resources. Loan quality
has a direct impact on the amount of provisions for loan losses the Company
reports. Non-interest income has a direct impact on earnings of the Company.
Maintenance of customers accounts for loans and deposits generate fee income
depending on the product selected. The Company generates gains on sales of
mortgage loans and receives fee income from servicing loans sold. Non-interest
income is primarily impacted by the volume of transactions from customers,
which could change based on interest rates, pricing and competition. Non-interest expenses include various expenses of the Company which are
controlled by a budget process. In 2003, management determined that
net-interest income would experience some compression due to lower interest
rates and implemented various expense reduction programs to help offset the
reduction in net interest income. Provisions for income taxes are directly related to earnings or implemented tax
strategies of the Company. Changes in the statutory tax rates and the earnings
of the Company, the Bank and its subsidiaries, would effect the amount of
income taxes reported. There are areas in the Consolidated Financial Statements were significant
estimates or assumptions are used in preparation of the Consolidated Financial
Statements. Management monitors the application of the Companys Critical
Accounting Policies due to the nature and impact of these estimates and
assumptions on earnings. The Critical Accounting Policies are discussed
below. Critical Accounting Policies Critical accounting policies are defined as those policies that have
significant judgments and uncertainties, and could potentially result in
materially different results under different assumptions and conditions.
Management believes that the Companys critical accounting policies upon which
the Consolidated Financial Statements depend and which involve the most complex
or subjective decisions or assessments are as follows: 8




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##### Table of Contents



Allowance for Loan Losses: The allowance balance reflects managements
assessment of losses and is based on a review of the risk characteristics of
the loan portfolio. The Company considers many factors in determining the
adequacy of the allowance for loan losses. Collateral value on a loan-by-loan
basis, trends of loan delinquencies on a portfolio segment level, risk
classification identified in the Companys regular review of individual loans,
and economic conditions are primary factors in establishing the allowance. The
allowance for loan losses reflects all information available at the end of the
year. The allowance is increased by provisions for loan losses, which are a
charge to the income statement, and by recoveries on loans previously
charged-off. The allowance is reduced by loans charged-off. For a further
discussion of the Companys methodology of assessing the adequacy of the
allowance for loan losses, see Managements Discussion and Analysis of
Financial Condition and Results of Operation and see Note 1 to the Consolidated
Financial Statements for more details on establishing the allowance for loan
losses. Income Taxes: Operating losses in the early 1990s resulted in available tax
loss carry-forwards. A deferred tax valuation allowance is required to reduce
the potential deferred tax asset when it is more likely than not that all or
some portion of the potential deferred tax asset will not be realized due to
the lack of sufficient taxable income in the carry-forward period. Deferred
tax assets and liabilities are recognized for estimated future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis. Deferred
assets and liabilities are measured using enacted tax rates in effect for the
year in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Deferred tax valuation allowances are established and based on managements
judgment as to whether it is more likely than not that all or some portion of
the future tax benefits of prior operating losses will be realized. It should
be noted, however, that factors beyond managements control, such as the
general state of the economy and real estate values, can affect future levels
of taxable income and that no assurance can be given that sufficient taxable
income will be generated to fully absorb gross deductible temporary
differences. For a further discussion on income taxes, see Managements
Discussion and Analysis of Financial Condition and Results of Operation and see
Notes 1 & 8 to the Consolidated Financial Statements. Mortgage Servicing Rights (MSR): When loans are sold with servicing rights
retained, the Company allocates the carrying amount of the loan between the
underlying asset sold and the rights retained, based on their relative fair
values. The fair value is estimated using market prices when available or
using a valuation model that calculates the present value of future servicing
fee income using discount rates and prepayment assumptions that management
believes represent current market conditions. The following risk
characteristics are considered for determining fair value; loan type, interest
rate, loan term and remaining maturities. The resulting MSR are amortized over
the period of estimated net servicing income using a method which approximates
the interest method. Actual prepayment experience is reviewed periodically.
When actual prepayments exceed estimated prepayments, the balance of the MSR is
adjusted accordingly through the establishment of a valuation allowance.
Periodically, the MSR are assessed for impairment based on the fair value of
such rights and recognized by a charge to the valuation allowance. For further
details on Mortgage Servicing Rights see Notes 1 & 4 to the Consolidated
Financial Statements. Financial Condition Overview Total assets amounted to $466.1 million at December 31, 2003 up from $439.1
million at December 31, 2002. The increase in asset size is due to an increase
of $66.5 million in investment securities. The cash used for the net
securities purchase came from the payoff of loans which declined by $31.6
million, a reduction of $8.7 million in Federal funds sold and an increase in
borrowed funds totaling $31.8 million from December 31, 2002. Interest Earning Assets The Company manages its earning assets by utilizing available capital resources
in a manner consistent with the Companys credit, investment and leverage
policies. Loans, U.S. Treasury and Government Agency obligations,
mortgage-backed securities, other investment securities, and short-term
investments comprise the Companys earning assets. Total earning assets
averaged $425.7 million in 2003, an increase of $919 thousand or 0.2% from
2002. One of the Companys primary objectives continues to be the origination of
loans that are soundly underwritten and collateralized. The Companys loan
portfolios decreased in 2003. The change in these portfolios caused the
average balance of the loan portfolio to decrease in 2003 by $15.9 million to
$219.2 million. The Company increases the investment portfolio through funds obtained from the
FHLB, repurchase agreements and other borrowings when it is profitable to do
so. The average balance of investment securities, including U.S. Treasury and
Government Agency securities, mortgage-backed securities, other bonds and
equity securities, and short-term investments amounted to $206.5 million in
2003 as compared to $189.7 million in 2002. These securities represent 47.1%
of the Companys average assets for the year ended December 31, 2003 versus
43.2% of average assets for the year ended December 31, 2002. 9




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##### Table of Contents



Investment Securities The investment portfolio totaled $232.9 million and $166.4 million,
respectively, at December 31, 2003 and 2002, an increase of $66.5 million or
39.9%. The largest increase of $58.2 million was in U.S. Government Agency
obligations. Also experiencing increases were mortgage-backed securities and
mutual funds increasing $30.0 million and $969 thousand, respectively.
Partially offsetting these increases were decreases of $15.3 million, $2.4
million and $1.2 million in corporate obligations, municipal obligations and
U.S. Treasury obligations, respectively, as these securities matured.
Asset-backed securities decreased $3.8 million due to higher than normal
prepayment speeds. For more information on investment securities, see
Financial Highlights and Note 2 of the Consolidated Financial Statements. Loans Total loans at December 31, 2003 and 2002 amounted to $211.5 million and $243.1
million, respectively, a decrease of $31.6 million or 13.1%. Residential loans
decreased $3.1 million or 5.2% during 2003 and commercial loans, construction
loans and commercial real estate loans decreased by $17.2 million, $7.5 million
and $242 thousand, respectively. The decrease in the portfolios was due to
prepayment or loan payoffs during 2003. Equity loans decreased $1.3 million or
10.9% as a result of the heavy refinance market. For more information on
loans, see Interest Rate Sensitivity and Note 4 to the Consolidated Financial
Statements. The components of the loan portfolio at December 31, follow: 2003
    
    2002
    
    2001
    
    2000
    
    1999Balance
    
    Percent
    
    Balance
    
    Percent
    
    Balance
    
    Percent
    
    Balance
    
    Percent
    
    Balance
    
    Percent(Dollars in Thousands)Residential real estate loans:Fixed rate
    
    $
    33,059
    
    
    
    15.7
    %
    
    $
    31,583
    
    
    
    13.0
    %
    
    $
    40,861
    
    
    
    17.3
    %
    
    $
    44,350
    
    
    
    20.0
    %
    
    $
    49,825
    
    
    
    25.1
    %Adjustable rate
    
    
    23,958
    
    
    
    11.3
    
    
    
    28,557
    
    
    
    11.7
    
    
    
    37,744
    
    
    
    16.0
    
    
    
    33,576
    
    
    
    15.1
    
    
    
    30,232
    
    
    
    15.357,017
    
    
    
    27.0
    
    
    
    60,140
    
    
    
    24.7
    
    
    
    78,605
    
    
    
    33.3
    
    
    
    77,926
    
    
    
    35.1
    
    
    
    80,057
    
    
    
    40.4Home equity loans:Fixed rate
    
    
    5,882
    
    
    
    2.7
    
    
    
    7,915
    
    
    
    3.3
    
    
    
    10,155
    
    
    
    4.3
    
    
    
    12,367
    
    
    
    5.6
    
    
    
    8,716
    
    
    
    4.4Adjustable rate
    
    
    4,354
    
    
    
    2.1
    
    
    
    3,575
    
    
    
    1.5
    
    
    
    3,238
    
    
    
    1.4
    
    
    
    3,630
    
    
    
    1.6
    
    
    
    3,890
    
    
    
    2.010,236
    
    
    
    4.8
    
    
    
    11,490
    
    
    
    4.8
    
    
    
    13,393
    
    
    
    5.7
    
    
    
    15,997
    
    
    
    7.2
    
    
    
    12,606
    
    
    
    6.4Commercial real estate loans:Fixed rate
    
    
    16,508
    
    
    
    7.8
    
    
    
    16,651
    
    
    
    6.8
    
    
    
    16,447
    
    
    
    7.0
    
    
    
    10,247
    
    
    
    4.6
    
    
    
    10,898
    
    
    
    5.5Adjustable rate
    
    
    95,995
    
    
    
    45.3
    
    
    
    96,094
    
    
    
    39.4
    
    
    
    83,663
    
    
    
    35.3
    
    
    
    76,882
    
    
    
    34.6
    
    
    
    69,995
    
    
    
    35.3112,503
    
    
    
    53.1
    
    
    
    112,745
    
    
    
    46.2
    
    
    
    100,110
    
    
    
    42.3
    
    
    
    87,129
    
    
    
    39.2
    
    
    
    80,893
    
    
    
    40.8Construction loans
    
    
    16,040
    
    
    
    7.6
    
    
    
    23,502
    
    
    
    9.7
    
    
    
    20,593
    
    
    
    8.7
    
    
    
    17,148
    
    
    
    7.7
    
    
    
    9,666
    
    
    
    4.9Loans held for sale
    
    
    338
    
    
    
    0.2
    
    
    
    2,579
    
    
    
    1.1
    
    
    
    4,156
    
    
    
    1.8
    
    
    
    
    
    
    
    0.0
    
    
    
    
    
    
    
    Commercial loans
    
    
    14,805
    
    
    
    7.0
    
    
    
    32,017
    
    
    
    13.2
    
    
    
    18,549
    
    
    
    7.8
    
    
    
    22,602
    
    
    
    10.2
    
    
    
    13,143
    
    
    
    6.6Consumer loans
    
    
    564
    
    
    
    0.3
    
    
    
    654
    
    
    
    0.3
    
    
    
    991
    
    
    
    0.4
    
    
    
    1,243
    
    
    
    0.6
    
    
    
    1,733
    
    
    
    0.9Total loans
    
    
    211,503
    
    
    
    100.0
    %
    
    
    243,127
    
    
    
    100.0
    %
    
    
    236,397
    
    
    
    100.0
    %
    
    
    222,045
    
    
    
    100.0
    %
    
    
    198,098
    
    
    
    100.0
    %Allowance for loan losses
    
    
    4,220
    
    
    
    
    
    
    
    4,167
    
    
    
    
    
    
    
    4,070
    
    
    
    
    
    
    
    3,685
    
    
    
    
    
    
    
    3,381Loans, net
    
    $
    207,283
    
    
    
    
    
    
    $
    238,960
    

    
    
    
    
    
    $
    232,327
    
    
    
    
    
    
    $
    218,360
    
    
    
    
    
    
    $
    194,717
 Allowance for Loan Losses The allowance for loan losses is maintained through the provision for loan
losses which is a charge to operations. The allowance balance reflects
managements assessment of losses and is based on a review of the risk
characteristics of the loan portfolio. The Company considers many factors in
determining the adequacy of the allowance for loan losses. Collateral value on
a loan-by-loan basis, trends of loan delinquencies on a portfolio segment
level, risk classification identified in the Companys regular review of
individual loans, and economic conditions are primary factors in establishing
the allowance. The allowance for loan losses reflects all information available
at the end of each year. The Company considers the current year end 2003 level
of the allowance for loan losses to be appropriate. The allowance as a
percentage of total loans was 2.0% at December 31, 2003 and 1.7% at December
31, 2002. See Note 1 to the financial statements for further details on
establishing the allowance for loan losses. Impaired loans are commercial, commercial real estate and individually
significant residential mortgage loans for which it is probable that the
Company will not be able to collect all amounts due according to the
contractual terms of the loan agreement. Impaired loans are not the same as
non-accrual loans, although the two categories overlap. Non-accrual loans
include impaired loans and are those on which the accrual of interest is
discontinued when principal or interest has become contractually past due 90
days. The Company may choose to place a loan on non-accrual status due to
payment delinquency or the uncertainty of collectibility, while not classifying
the loan as impaired, if (i) it is probable that the Company will collect all
amounts due in accordance with the contractual terms of the loan or (ii) the
loan is not a commercial, commercial real estate or an individually significant
residential mortgage loans. Factors considered by management in determining
impairment include payment status and collateral value. The amount of
impairment is determined by the difference between the present value of the
expected cash flows related to the loan, using the original contractual
interest rate, and its recorded value, or, as a practical expedient in the case
of collateral dependent loans, the difference between the fair 10




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##### Table of Contents



value of the collateral and the recorded amount of the loans. When foreclosure
is probable, impairment is based on the fair value of the collateral. The Company maintained a low level of risk assets and delinquencies during the
year 2003. As a result, there was no charge to the provision for loan losses
in the years 2003 or 2002. The Company had net recoveries of $53 thousand in
2003 and $97 thousand in 2002. The following table summarizes changes in the allowance for loan losses for the years ended December 31: 2003
    
    2002
    
    2001
    
    2000
    
    1999(Dollars in Thousands)Balance at beginning of year
    
    $
    4,167
    
    
    $
    4,070
    
    
    $
    3,685
    
    
    $
    3,381
    
    
    $
    3,272Charge-offs by loan type:Residential mortgage
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17
    )Commercial
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    Commercial real estate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (27
    )
    
    
    Consumer
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )
    
    
    Total charge-offs
    
    
    
    
    
    
    (1
    )
    
    
    (3
    )
    
    
    (28
    )
    
    
    (17
    )Recoveries by loan type:Residential mortgage
    
    
    31
    
    
    
    
    
    
    
    2
    
    
    
    6
    
    
    
    28Commercial
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    3Commercial real estate
    
    
    16
    
    
    
    89
    
    
    
    201
    
    
    
    62
    
    
    
    13Consumer
    
    
    6
    
    
    
    9
    
    
    
    10
    
    
    
    9
    
    
    
    7Total recoveries
    
    
    53
    
    
    
    98
    
    
    
    213
    
    
    
    82
    
    
    
    51Net recoveries (charge-offs)
    
    
    53
    
    
    
    97
    
    
    
    210
    
    
    
    54
    
    
    
    34Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    175
    
    
    
    250
    
    
    
    75Ending balance
    
    $
    4,220
    
    
    $
    4,167
    
    
    $
    4,070
    
    
    $
    3,685
    
    
    $
    3,381Ratio of net recoveries (charge-offs) to average loans outstanding
during the period
    
    
    0.02
    %
    
    
    0.04
    %
    
    
    0.09
    %
    
    
    0.03
    %
    
    
    0.02
    %
 The following table sets forth the breakdown of the allowance for loan losses
by loan category for the years ended December 31. The allocation of the
allowance to each category is not necessarily indicative of future losses and
does not restrict the use of the allowance to absorb losses in any category. 2003
    
    2002
    
    2001
    
    2000
    
    1999Percent
    
    
    
    
    
    Percent
    
    
    
    
    
    Percent
    
    
    
    
    
    Percent
    
    
    
    
    
    Percentof loans
    
    
    
    
    
    of loans
    
    
    
    
    
    of loans
    
    
    
    
    
    of loans
    
    
    
    
    
    of loansin each
    
    
    
    
    
    in each
    
    
    
    
    
    in each
    
    
    
    
    
    in each
    
    
    
    
    
    in eachcategory
    
    
    

    
    
    category
    
    
    
    
    
    category
    
    
    
    
    
    category
    
    
    
    
    
    categoryto Total
    
    
    
    
    
    to Total
    
    
    
    
    
    to Total
    
    
    
    
    
    to Total
    
    
    
    
    
    to Total(Dollars in Thousands)
    
    Amount
    
    Loans
    
    Amount
    
    Loans
    
    Amount
    
    Loans
    
    Amount
    
    Loans
    
    Amount
    
    LoansConstruction, commercial and
commercial real estate
    
    $
    3,175
    
    
    
    67.7
    %
    
    $
    3,525
    
    
    
    69.1
    %
    
    $
    3,251
    
    
    
    58.8
    %
    
    $
    2,711
    
    
    
    57.1
    %
    
    $
    1,933
    
    
    
    52.3
    %Residential mortgage and home equity
    
    
    270
    
    
    
    32.0
    
    
    
    314
    
    
    
    30.6
    
    
    
    397
    
    
    
    40.8
    
    
    
    436
    
    
    
    42.3
    
    
    
    526
    
    
    
    46.8Consumer
    
    
    26
    
    
    
    0.3
    
    
    
    29
    
    
    
    0.3
    
    
    
    41
    
    
    
    0.4
    
    
    
    49
    
    
    
    0.6
    
    
    
    55
    
    
    
    0.9Unallocated
    
    
    749
    
    
    
    N/A
    
    
    
    299
    
    
    
    N/A
    
    
    
    381
    
    
    
    N/A
    
    
    
    489
    
    
    
    N/A
    
    
    
    867
    
    
    
    N/A$
    4,220
    
    
    
    100.0
    %
    
    $
    4,167
    
    
    
    100.0
    %
    
    $
    4,070
    
    
    
    100.0
    %
    
    $
    3,685
    
    
    
    100.0
    %
    
    $
    3,381
    
    
    
    100.0
    %
 In determining the adequacy of the allowance for loan losses, the Company
aggregates the estimated credit loss on individual loans, pools of loans and
other pools of risk having geographic, industry or other common exposures where
inherent losses are identified or anticipated. All loans classified as Substandard or Doubtful are evaluated for
collectibility and an allocation is made based on an assessment of the net
realizable value of any collateral. The Company categorizes each commercial loan into different pools of risk.
Each risk level allocation factor has been determined based upon the Companys
review of common practices within the industry, its estimate of expected loss
for loans with similar credit characteristics based upon historical experience
and migration analysis, the losses experienced by the Company in the most
recent 36 months, together with the Companys assessment of future economic
trends, conditions and other relevant factors that may have an impact on or may
affect repayment of loans in these pools. Residential mortgages, home equity loans, equity lines of credit, second
mortgages and all other small consumer loans are considered in the aggregate
and an allocation factor is assessed based upon the Companys most recent
24-month historical loss experience together with an assessment of future
economic trends, conditions and other relevant factors that may have an impact
on, or may affect repayment of, the loans in these pools. 11




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##### Table of Contents



On a quarterly basis, the Company evaluates all allocation factors for
appropriateness, considering (i) significant changes in the nature and volume
of the loan portfolio, (ii) the Companys assessment of local and national
economic business conditions, and (iii) any other relevant factor that it
considers may have an impact on loan portfolio risk. Based upon these evaluations, changes to the reserve provision may be made to
maintain the overall level of the reserve at a level that the Company deems
appropriate and adequate to cover the estimated credit losses inherent in the
Companys loan portfolio. Potential Problem Loans The Company has a loan review and grading system. During the loan review
process, deteriorating conditions of certain loans come to managements
attention in which erosion of the borrowers ability to comply with the
original terms of the loan agreement could potentially result in the
classification of the loan as a risk asset. This may result from deteriorating
conditions such as cash flows, collateral values or creditworthiness of the
borrower. At December 31, 2003 and 2002, there were $2.5 million and $1.5
million respectively, identified as potential problem loans. Risk Assets Risk assets consist of non-performing loans, OREO, and restructured loans. The
components of risk assets at December 31, for the years indicated are as
follows: 2003
    
    2002
    
    2001
    
    2000
    
    1999(Dollars in Thousands)Risk assets:Non-performing loans:Residential real estate
    
    $
    
    
    
    $
    1
    
    
    $
    10
    
    
    $
    10
    
    
    $
    Commercial real estate
    
    
    
    
    
    
    
    
    
    
    730
    
    
    
    
    
    
    
    Commercial business
    
    
    
    
    
    
    
    
    
    
    211
    
    
    
    
    
    
    
    Total non-performing loans
    
    
    
    
    
    
    1
    
    
    
    951
    
    
    
    10
    
    
    
    Other real estate owned:Land
    
    
    47
    
    
    
    57
    
    
    
    67
    
    
    
    77
    
    
    
    87Commercial real estate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    477OREO valuation allowance
    
    
    (45
    )
    
    
    (45
    )
    
    
    (45
    )
    
    
    (45
    )
    
    
    (45
    )Total other real estate owned
    
    
    2
    
    
    
    12
    
    
    
    22
    
    
    
    32
    
    
    
    519Total risk assets
    
    $
    2
    
    
    $
    13
    
    
    $
    973
    
    
    $
    42
    
    
    $
    519Risk assets as a percent of total loans and OREO
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.4
    %
    
    
    0.0
    %
    
    
    0.3
    %Risk assets as a percent of total assets
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.2
    %
    
    
    0.0
    %
    
    
    0.1
    %
 Non-performing loans consist of both (i) loans 90 days or more past due, and
(ii) loans placed on a non-accrual status because full collection of the
principal balance is in doubt. Non-performing loans at December 31, 2003 were
zero and at December 31, 2002 were $1 thousand, a decrease from $951 thousand
at December 31, 2001. The Company actively monitors risk assets. The Company attempts to work with
delinquent borrowers in order to bring loans current. If the borrower is not
able to bring the loan current, the Company commences collection efforts.
Valuation of property at foreclosure, and periodically thereafter, is based
upon appraisals and managements best estimates of fair value less selling
costs. The Companys policy is to sell such property as quickly as possible at
fair value. Interest Bearing Liabilities The Companys earning assets are primarily funded with deposits, securities
sold under agreements to repurchase, FHLB advances and stockholders equity.
The Company manages its interest bearing liabilities to maintain a stable
source of funds while providing competitively priced deposit accounts. Interest
bearing deposits include regular savings accounts, NOW and Super NOW accounts,
money market accounts, and certificates of deposit. In 2003 total average interest bearing liabilities were $367.9 million which
was a $453 thousand or 0.1% decrease from $368.4 million in 2002. Average total
interest bearing deposits of $265.6 million comprised 72.2% of interest bearing
liabilities in 2003 while in 2002 such deposits totaling $261.4 million
comprised 71.0% of interest bearing liabilities. 12




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##### Table of Contents



Changing interest rates can affect the mix and level of various deposit
categories. The lower average interest rate paid on money market accounts and
certificates of deposit had an impact on the overall interest rate paid on
deposits and caused a decrease of 65 basis points in 2003 and 155 basis points
in 2002. The average balance of money market investment accounts increased by
$10.5 million to $69.5 million in 2003 and by $4.7 million to $59.0 million in
2002. The average balance for NOW and Super NOW accounts increased by $2.6
million to $36.2 million in 2003 and by $2.4 million to $33.6 million in 2002.
The average balance for certificates of deposit decreased by $8.6 million to
$115.1 million in 2003 and decreased by $13.3 million to $123.7 million in
2002. Average borrowed funds in 2003, 2002 and 2001 were $102.3 million, $107.0
million and $95.1 million, respectively, including advances from the FHLB and
other borrowed funds. The increase of $11.9 million in 2002 resulted from the
utilization of available credit in a low interest rate environment with longer
maturities of three to five years. Deposits Total deposits decreased $6.9 million or 2.5% during 2003 to $272.5 million at
December 31, 2003 from $279.5 million at December 31, 2002. Certificates of
deposit had the largest decrease of $18.1 million or 19.6%. Also decreasing
were savings accounts, retirement accounts and demand deposits by $515
thousand, $316 thousand and $72 thousand, respectively, in 2003. Partially
offsetting these decreases were increases in money market investment accounts
and NOW accounts of $11.5 million and $540 thousand, respectively, during 2003.
For more information, see Note 6 to the Consolidated Financial Statements. Borrowed Funds Total borrowed funds increased $31.8 million or 31.3% during 2003 to $133.4
million at December 31, 2003 from $101.6 million at December 31, 2002. FHLB
advances totaled $78.9 million in 2003 and $94.2 million in 2002, a decrease of
$15.4 million due to repayments. Other borrowed funds are comprised of FHLB
short-term advances which totaled $52.0 million and zero, respectively, at
December 31, 2003 and 2002, agreements to repurchase which totaled $2.5 million
and $4.0 million, at December 31, 2003 and 2002, respectively and other secured
borrowings which totaled zero and $3.4 million, respectively, at year end 2003
and 2002. See Note 7 to the Consolidated Financial Statements for further
information. Results of Operations Overview The Companys net earnings amounted to $4.1 million or $0.94 diluted earnings
per share, $3.1 million or $0.69 diluted earnings per share and $3.4 million or
$0.74 diluted earnings per share for the years ended December 31, 2003, 2002
and 2001, respectively. On October 21, 2003 the Massachusetts Appeals Court
rendered a favorable decision on a lawsuit in which the Corporations
wholly-owned subsidiary, Lawrence Savings Bank, was the Plaintiff. The Bank
received payment for the judgment in the amount of $2.0 million on October 30,
2003. This payment received was recorded in non-interest income. The
after-tax impact was approximately $1.3 million, which represents approximately
$0.29 basic earnings per share. The Companys earnings decreased by 7.7% or
$257 thousand in 2002 compared to 2001, impacted by an increase in net-interest
and non-interest income offset by an increase in net-interest expenses. The Companys net interest income, which is the difference between interest
earned on assets and interest paid on liabilities, totaled $12.4 million in
2003, $13.6 million in 2002 and $13.2 million in 2001. The decrease in 2003
versus 2002 resulted from lower rates earned on average earning assets. The
Companys net interest margin was 2.90% in 2003 versus 3.20% and 3.21% in 2002
and 2001, respectively. The decrease in 2003 resulted primarily from lower
average rates earned on interest earning assets. There was no provision for loan losses in 2003 and 2002 due to the low level of
risk assets and minimal delinquent loans. The provision for loan losses was a
charge of $175 thousand in 2001. The provision for loan losses was made to
maintain an appropriate allowance for loan losses in 2001. Non-interest income amounted to $3.6 million, $1.5 million and $1.4 million in
2003, 2002 and 2001, respectively. The increase during 2003, excluding the
payment from the lawsuit, totaled $115 thousand and was attributable mainly to
income on loan fees of $20 thousand from a loss of $145 thousand in 2002.
Deposit account fees also increased $48 thousand during 2003. The increase in
2002 and 2001 was primarily due to gains on sales of mortgage loans of $529
thousand and $249 thousand, respectively. Deposit account fees increased $71
thousand during 2002, offsetting these increases was a decrease in loan fees to
a net loss of $145 thousand from income of $155 thousand in 2001. Non-interest expense totaled $9.7 million in 2003, $10.2 million in 2002 and
$9.1 million in 2001. The decline is primarily attributable to a reduction in
professional fees of $163 thousand during 2003 resulting from lower legal fees
associated with collection efforts on loan previously charged off. Salaries
and employee benefits decreased $83 thousand resulting from salary reduction
initiatives and a lower headcount in 2003. Salaries and employee benefits
increased during 2002 by $742 thousand, of which $358 thousand was attributable
to pension expense associated with the employees defined benefit pension plan,
and professional fees increased by $135 thousand in 2002 due to increased legal
expenses associated with collection efforts. Expenses attributable to the
establishment of the holding company totaled $188 thousand in 2001, of which
$107 thousand were professional fees. 13




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##### Table of Contents



Average Balances, Net Interest Income and Average Interest Rates The table below presents the Companys average balance sheet, net interest
income and average interest rates for the years ended December 31. Average
real estate, commercial business, and consumer loans include non-performing
loans. 2003
    
    2002
    
    2001Average
    
    
    
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    
    
    
    AverageAverage
    
    
    
    
    
    Interest
    
    Average
    
    
    
    
    
    Interest
    
    Average
    
    
    
    
    
    InterestBalance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    Rate(Dollars in Thousands)AssetsLoans:Residential real estate
    
    $
    68,150
    
    
    $
    4,027
    
    
    
    5.91
    %
    
    $
    87,122
    
    
    $
    5,848
    
    
    
    6.71
    %
    
    $
    97,982
    
    
    $
    7,123
    
    
    
    7.27
    %Commercial real estate
    
    
    126,950
    
    
    
    9,005
    
    
    
    7.09
    
    
    
    126,083
    
    
    
    9,759
    
    
    
    7.74
    
    
    
    112,021
    
    
    
    9,577
    
    
    
    8.55Commercial business
    
    
    23,511
    
    
    
    1,282
    
    
    
    5.45
    
    
    
    20,918
    
    
    
    1,256
    
    
    
    6.00
    
    
    
    19,379
    
    
    
    1,490
    
    
    
    7.69Consumer
    
    
    543
    
    
    
    42
    
    
    
    7.73
    
    
    
    905
    
    
    
    69
    
    
    
    7.62
    
    
    
    1,236
    
    
    
    105
    
    
    
    8.50Total loans
    
    
    219,154
    
    
    
    14,356
    
    
    
    6.55
    
    
    
    235,028
    
    
    
    16,932
    
    
    
    7.20
    
    
    
    230,618
    
    
    
    18,295
    
    
    
    7.93Investment securities:U.S. Treasury and Government
Agency obligations
    
    
    122,238
    
    
    
    3,964
    
    
    
    3.24
    
    
    
    105,438
    
    
    
    4,763
    
    
    
    4.52
    
    
    
    67,293
    
    
    
    4,189
    
    
    
    6.23Other bonds and equity securities
    
    
    39,698
    
    
    
    1,580
    
    
    
    3.98
    
    
    
    57,228
    
    
    
    2,275
    
    
    
    3.98
    
    
    
    76,789
    
    
    
    4,237
    
    
    
    5.52Mortgage-backed securities
    
    
    37,746
    
    
    
    1,362
    
    
    
    3.61
    
    
    
    18,715
    
    
    
    1,040
    
    
    
    5.56
    
    
    
    26,290
    
    
    
    1,618
    
    
    
    6.15Short-term investments
    
    
    6,843
    
    
    
    72
    
    
    
    1.05
    
    
    
    8,351
    
    
    
    128
    
    
    
    1.53
    
    
    
    10,236
    
    
    
    453
    
    
    
    4.43Total investment securities
    
    
    206,525
    
    
    
    6,978
    
    
    
    3.38
    
    
    
    189,732
    
    
    
    8,206
    
    
    
    4.33
    
    
    
    180,608
    
    
    
    10,497
    
    
    
    5.81Total interest earning assets
    
    
    425,679
    
    
    
    21,334
    
    
    
    5.01
    %
    
    
    424,760
    
    
    
    25,138
    
    
    
    5.92
    %
    
    
    411,226
    
    
    
    28,792
    
    
    
    7.00
    %Allowance for loan losses
    
    
    (4,247
    )
    
    
    
    
    
    
    
    
    
    
    (4,131
    )
    
    
    
    
    
    
    
    
    
    
    (3,864
    )Cash and due from banks
    
    
    7,450
    
    
    
    
    
    
    
    
    
    
    
    7,132
    
    
    
    
    
    
    
    
    
    
    
    5,950Other real estate owned
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    28Other assets
    
    
    9,604
    
    
    
    
    
    
    
    
    
    
    
    11,841
    
    
    
    
    
    
    
    
    
    
    
    13,432Total assets
    
    $
    438,494
    
    
    
    
    
    
    
    
    
    
    $
    439,620
    
    
    
    
    
    
    
    
    
    
    $
    426,772Liabilities and
Stockholders EquityDeposits:Regular savings accounts
    
    $
    44,842
    
    
    $
    196
    
    
    
    0.44
    %
    
    $
    45,102
    
    
    $
    389
    
    
    
    0.86
    %
    
    $
    40,938
    
    
    $
    720
    
    
    
    1.76
    %NOW and Super NOW accounts
    
    
    36,175
    
    
    
    44
    
    
    
    0.12
    
    
    
    33,596
    
    
    
    86
    
    
    
    0.26
    
    
    
    31,187
    
    
    
    155
    
    
    
    0.50Money market accounts
    
    
    69,498
    
    
    
    900
    
    
    
    1.30
    
    
    
    59,011
    
    
    
    1,097
    
    
    
    1.86
    
    
    
    54,266
    
    
    
    1,664
    
    
    
    3.07Certificates of deposit
    
    
    115,121
    
    
    
    3,036
    
    
    
    2.64
    
    
    
    123,673
    
    
    
    4,232
    
    
    
    3.42
    
    
    
    136,952
    
    
    
    7,390
    
    
    
    5.40Total interest bearing deposits
    
    
    265,636
    
    
    
    4,176
    
    
    
    1.57
    
    
    
    261,382
    
    
    
    5,804
    
    
    
    2.22
    
    
    
    263,343
    
    
    
    9,929
    
    
    
    3.77Borrowed funds
    
    
    102,294
    
    
    
    4,801
    
    
    
    4.69
    
    
    
    107,001
    
    
    
    5,761
    
    
    
    5.38
    
    
    
    95,089
    
    
    
    5,682
    
    
    
    5.98Total interest bearing liabilities
    
    
    367,930
    
    
    
    8,977
    
    
    
    2.44
    
    
    
    368,383
    
    
    
    11,565
    
    
    
    3.14
    
    
    
    358,432
    
    
    
    15,611
    
    
    
    4.36Non-interest bearing deposits
    
    
    13,727
    
    
    
    
    
    
    
    
    
    
    
    13,515
    
    
    
    
    
    
    
    
    
    
    
    12,015Other liabilities
    
    
    3,510
    
    
    
    
    
    
    
    
    
    
    
    3,488
    
    
    
    
    
    
    
    
    
    
    
    3,469Total liabilities
    
    
    385,167
    
    
    
    
    
    
    
    
    
    
    
    385,386
    
    
    
    
    
    
    
    
    
    
    
    373,916Stockholders equity
    
    
    53,327
    
    
    
    
    
    
    
    
    
    
    
    54,234
    
    
    
    
    
    
    
    
    
    
    
    52,856Total liabilities and
stockholders equity
    
    $
    438,494
    
    
    
    
    
    
    
    
    
    
    $
    439,620
    
    
    
    
    
    
    
    
    
    
    $
    426,772Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.57
    %
    
    
    
    
    
    
    
    
    
    
    2.78
    %
    
    
    
    
    
    
    
    
    
    
    2.64
    %Net interest income
    
    
    
    
    
    $
    12,357
    
    
    
    
    
    
    
    
    
    
    $
    13,573
    
    
    
    
    
    
    
    
    
    
    $
    13,181Net interest margin on average
earning assets
    
    
    
    
    
    
    
    
    
    
    2.90
    %
    
    
    
    
    
    
    
    
    
    
    3.20
    %
    
    
    
    
    
    
    
    
    
    
    3.21
    %
 14




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##### Table of Contents



Rate-Volume Analysis The effect on net interest income of changes in interest rates and in the
amounts of interest earning assets and interest bearing liabilities is shown in
the following table. Information is provided on changes for the years indicated
and is attributable to (i) changes in volume (change in average balance
multiplied by prior year rate), (ii) changes in interest rate (change in rate
multiplied by prior year average balance) and (iii) the combined effects of
changes in interest rates and volume (change in rate multiplied by change in
average balance). 2003 vs. 2002
    
    2002 vs. 2001Total
    
    
    
    
    
    
    
    
    
    Rate/
    
    Total
    
    
    
    
    
    
    
    
    
    Rate/Change
    
    Volume
    
    Rate
    
    Volume
    
    Change
    
    Volume
    
    Rate
    
    Volume(In Thousands)Interest income:Loans:Residential real estate
    
    $
    (1,821
    )
    
    $
    (1,273
    )
    
    $
    (700
    )
    
    $
    152
    
    
    $
    (1,275
    )
    
    $
    (789
    )
    
    $
    (546
    )
    
    $
    60Commercial real estate
    
    
    (754
    )
    
    
    67
    
    
    
    (815
    )
    
    
    (6
    )
    
    
    182
    
    
    
    1,202
    
    
    
    (906
    )
    
    
    (114
    )Commercial business
    
    
    26
    
    
    
    156
    
    
    
    (115
    )
    
    
    (15
    )
    
    
    (234
    )
    
    
    118
    
    
    
    (326
    )
    
    
    (26
    )Consumer
    
    
    (27
    )
    
    
    (28
    )
    
    
    1
    
    
    
    
    
    
    
    (36
    )
    
    
    (28
    )
    
    
    (11
    )
    
    
    3Total loans
    
    
    (2,576
    )
    
    
    (1,078
    )
    
    
    (1,629
    )
    
    
    131
    
    
    
    (1,363
    )
    
    
    503
    
    
    
    (1,789
    )
    
    
    (77
    )Investment securities:U.S. Treasury and Government Agency obligations
    
    
    (799
    )
    
    
    759
    
    
    
    (1,344
    )
    
    
    (214
    )
    
    
    574
    
    
    
    2,375
    
    
    
    (1,149
    )
    
    
    (652
    )Other bonds and equity securities
    
    
    (695
    )
    
    
    (697
    )
    
    
    3
    
    
    
    (1
    )
    
    
    (1,962
    )
    
    
    (1,079
    )
    
    
    (1,184
    )
    
    
    301Mortgage-backed securities
    
    
    322
    
    
    
    1,058
    
    
    
    (365
    )
    
    
    (371
    )
    
    
    (578
    )
    
    
    (466
    )
    
    
    (157
    )
    
    
    45Short-term investments
    
    
    (56
    )
    
    
    (23
    )
    
    
    (40
    )
    
    
    7
    
    
    
    (325
    )
    
    
    (83
    )
    
    
    (296
    )
    
    
    54Total investments
    
    
    (1,228
    )
    
    
    1,097
    
    
    
    (1,746
    )
    
    
    (579
    )
    
    
    (2,291
    )
    
    
    747
    
    
    
    (2,786
    )
    
    
    (252
    )Total interest income
    
    
    (3,804
    )
    
    
    19
    
    
    
    (3,375
    )
    
    
    (448
    )
    
    
    (3,654
    )
    
    
    1,250
    
    
    
    (4,575
    )
    
    
    (329
    )Interest expense:Deposits:Regular savings accounts
    
    
    (193
    )
    
    
    (2
    )
    
    
    (192
    )
    
    
    1
    
    
    
    (331
    )
    
    
    73
    
    
    
    (367
    )
    
    
    (37
    )NOW and Super NOW accounts
    
    
    (42
    )
    
    
    7
    
    
    
    (45
    )
    
    
    (4
    )
    
    
    (69
    )
    
    
    12
    
    
    
    (75
    )
    
    
    (6
    )Money market accounts
    
    
    (197
    )
    
    
    195
    
    
    
    (333
    )
    
    
    (59
    )
    
    
    (567
    )
    
    
    145
    
    
    
    (655
    )
    
    
    (57
    )Certificates of deposit
    
    
    (1,196
    )
    
    
    (293
    )
    
    
    (970
    )
    
    
    67
    
    
    
    (3,158
    )
    
    
    (717
    )
    
    
    (2,704
    )
    
    
    263Total interest bearing deposits
    
    
    (1,628
    )
    
    
    (93
    )
    
    
    (1,540
    )
    
    
    5
    
    
    
    (4,125
    )
    
    
    (487
    )
    
    
    (3,801
    )
    
    
    163Borrowed funds
    
    
    (960
    )
    
    
    (253
    )
    
    
    (739
    )
    
    
    32
    
    
    
    79
    
    
    
    712
    
    
    
    (562
    )
    
    
    (71
    )Total interest expense
    
    
    (2,588
    )
    
    
    (346
    )
    
    
    (2,279
    )
    
    
    37
    
    
    
    (4,046
    )
    
    
    225
    
    
    
    (4,363
    )
    
    
    92Net interest income
    
    $
    (1,216
    )
    
    $
    365
    
    
    $
    (1,096
    )
    
    $
    (485
    )
    
    $
    392
    
    
    $
    1,025
    
    
    $
    (212
    )
    
    $
    (421
    )
 Net Interest Income Net interest income is the difference between the interest income earned on
earning assets and the interest expense paid on interest bearing liabilities.
Interest income and interest expense are affected by changes in earning assets
and interest bearing liability balances in addition to changes in interest
rates. The Companys net interest income was $12.4 million in 2003, $13.6 million in
2002 and $13.2 million in 2001. Interest income from earning assets was $21.3
million, $25.1 million and $28.8 million in 2003, 2002 and 2001, respectively.
The reduction in interest income during 2003 compared to 2002 was due
primarily to decreases in interest rates earned on investment securities and
loans with a decrease in loan volume also contributing to the decrease. The
decrease in interest income during 2002 compared to 2001 was due to a decrease
in rates earned on investment securities and loans coupled with the
acceleration of the amortization of premiums associated with collateralized
mortgage obligations in the amount of $243 thousand due to the low interest
rate environment of mortgage loans which has decreased the duration of these
investment securities. 15




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##### Table of Contents



Interest expense on interest bearing deposits was $4.2 million in 2003, $5.8
million in 2002 compared to $9.9 million in 2001. Average deposit balances
increased during 2003 while decreased in 2002 and 2001. The primary increase
during 2003 was in money market investment accounts. NOW accounts increased
partially offset by decreases in certificates of deposit and regular savings
accounts in 2003. Interest expense continued to decline during 2003
attributable mainly to the reduction of all deposit rates. The primary
decrease was in certificates of deposit in 2002. Although there were increases
in all other deposit categories in 2002, interest expense decreased due to a
decrease in rates paid on all deposit categories. Average rates paid on
certificates of deposit decreased to 2.64% during 2003 from 3.42% in 2002
resulting in a net decrease of $1.2 million in interest expense in 2003.
Average rates paid on money market investment accounts declined to 1.30% in
2003 from 1.86% in 2002 reducing interest expense by $197 thousand net.
Average rates paid on certificates of deposit decreased to 3.42% during 2002
from 5.40% in 2001 resulting from a net decrease of $3.2 million in interest
expense during 2002. Average rates paid on money market accounts decreased to
1.86% in 2002 from 3.07% in 2001 which resulted in $567 thousand net decrease
in interest expense. Interest expense on borrowed funds decreased by $1.0
million to $4.8 million in 2003 and remained stable at $5.8 million in 2002 and
$5.7 million in 2001. The decrease in interest expense on borrowed funds is
attributable mainly to a reduction in rates paid coupled with a decline in the
average balances outstandings and resulted in a net decrease to interest
expense of $960 thousand. The increase in interest expense on borrowed funds
in 2002 resulted from an increase in average balances partially offset by a
decrease in rates paid. Interest expense on total interest bearing liabilities
totaled $9.0 million, $11.6 million and $15.6 million during 2003, 2002 and
2001, respectively. Over the past three years, the Company has been operating in a declining
interest rate environment. The result of this environment has been lower
yields on assets and a lower cost of funds. The average yield on earning
assets in 2003 declined 91 basis points to 5.01% and in 2002 and 2001,
respectively, was down 108 basis points and 37 basis points to 5.92% in 2002
and 7.00% in 2001. The average rate paid on interest bearing liabilities in
2003 was 2.44%, or a decrease of 70 basis points, in 2002 was 3.14% and in 2001
was 4.36%. The net interest rate spread in 2003 was 2.57%, a 21 basis point
decline, from 2002 in which the net interest rate spread was 2.78% up 14 basis
points from 2.64% in 2001. In an environment of declining asset yields,
management strives to control the cost of funds and maintain net-interest
margin. The Companys net-interest margin declined to 2.90% in 2003 from 3.20%
and 3.21% in 2002 and 2001, respectively. Provision for loan losses There was no provision for loan losses in 2003 and 2002 due to the low level of
risk assets and minimal delinquent loans. The provision for loan losses was a
charge of $175 thousand in 2001. Non-Interest Income Non-interest income increased 141.4% and totaled $3.6 million versus $1.5
million and $1.4 million for the years ended 2003, 2002 and 2001, respectively.
In 2003, the increase is primarily due to the payment of $2.0 million in
connection with a lawsuit judgment. Excluding the lawsuit, non-interest income
increased $115 thousand during 2003. Loan servicing fees increased to income
of $20 thousand from a loss of $145 thousand in 2002 mainly attributable to
$186 thousand in commercial loan prepayments and the recovery of fair values on
MSR. Deposit account fees increased to $713 thousand in 2003 from $665
thousand for the year 2002. Partially offsetting these increases were a
reduction in gains on the sale of mortgage loans totaling $62 thousand, loss on
sale of investment securities of $14 thousand and a decrease of $22 thousand in
other income. The increase in 2002 was due to gains on the sale of mortgage loans of $529
thousand compared to $249 thousand in 2001 and an increase in deposit fees and
other income. Partially offsetting these increases in 2002 was a decrease in
loan servicing fees by $300 thousand. The primary decrease in loan servicing
fees is due to the decline in fair value of MSR which was recognized by a
charge to loan servicing fees of $302 thousand. See Note 4 in the Consolidated
Financial Statements on Mortgage Servicing Rights. Non-Interest Expense Non-interest expense decreased to $9.7 million in 2003 versus $10.2 million in
2002 and $9.1 million in 2001. The decrease in 2003 was attributable to a
reduction of $163 thousand in professional fees from lower legal fees
associated with collection efforts and a reduction of $83 thousand in salaries
and employee benefits resulting from the salary reduction initiatives and a
lower headcount. The increase in 2002 was primarily due to an increase in
salaries and employee benefits of $742 thousand and an increase of $135
thousand in professional expenses which include legal expenses relating to
collection efforts. Salaries and employee benefits expense totaled $5.9 million in 2003, $6.0
million in 2002 and $5.3 million in 2001. Full-time equivalent employees were
99 at December 31, 2003, 105 at December 31, 2002 and 102 at December 31, 2001.
The decrease in 2003 relates to several salary reduction initiatives
instituted during 2003 as a result of the net-interest margin declining during
2003. Increases in normal merit raises and an increase of $358 thousand in
pension expense associated with the employees defined benefit pension plan
accounted for the increase in 2002. The Company continually evaluates staffing
levels in order to control salaries and employee benefits while managing
business volumes. 16




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##### Table of Contents



Occupancy and equipment expenses decreased to $752 thousand in 2003, compared
to $790 thousand in 2002 and $872 thousand in 2001. Data processing expenses
decreased to $727 thousand in 2003, compared to $749 thousand in 2002 and $705
thousand in 2001. This includes the Companys service contract to provide
on-line deposit accounting, loan accounting and item processing services.
Insurance expenses totaled $151 thousand, $153 thousand and $146 thousand in
2003, 2002 and 2001, respectively, and other expenses decreased to $1.5 million
in 2003, as compared to $1.7 million in 2002 and $1.4 million in 2001. Income Taxes The Company reported income tax expense of $2.1 million in 2003, $1.8 million
in 2002 and $2.0 million in 2001. The effective income tax rate for the year
2003 was 33.5% and for 2002 was 36.9% compared to 36.8% in 2001. The decrease
in the effective income tax rate for 2003 from 2002 is due to change in
estimate for tax contingencies. The effective income tax rates for 2002 and
2001 were consistent. Subsequent event In one litigation matter, the Bank was awarded a $4.2 million judgment against
the debtor in 1997. On February 13, 2002, the debtor filed a petition in
bankruptcy under Chapter 7 of the Bankruptcy Code. Post-judgment interest
calculated from the date of judgment to the date of the bankruptcy filing is
approximately $1.9 million. In February 2004, the Bankruptcy Trustee filed a motion seeking Bankruptcy
Court approval to make an interim distribution to the creditors. After payment
to one other creditor and reserves for anticipated taxes and administrative
costs, the Trustee has proposed to make an interim distribution to the Bank of
approximately $2.6 million. The Bank has agreed to return any of the interim
distribution as would be necessary to pay additional taxes imposed on the
bankruptcy estate in the event reserves set aside for taxes are insufficient. The diluted earnings per share impact of the proposed interim distribution are
approximately $0.37 per share based on estimated average shares outstanding for
the first quarter of 2004. This distribution will be recognized in the
Companys reported financial results when the proposed interim distribution is
approved by the Bankruptcy court. It is managements opinion the collection of any remaining balance beyond the
amount of the proposed interim distribution is substantially uncertain and is
not susceptible to meaningful estimation at this time. Accordingly, no
recognition of this judgment or interim distribution has been recorded in the
Consolidated Financial Statements. Liquidity Managing liquidity involves planning to meet anticipated funding needs at a
reasonable cost, as well as contingency plans to meet unanticipated funding
needs or a loss of funding sources. The following factors are considered in
managing liquidity; marketability of assets, the sources and stability of
funding and the level of unfunded commitments. The Companys primary source of
funds is dividends from its Bank subsidiary. The Banks loans and investments
are primarily funded by deposits, Federal Home Loan Bank advances, securities
sold under agreements to repurchase and stockholders equity. The investment portfolio is one of the primary sources of liquidity for the
Bank. Maturities of securities provide a flow of funds which are available for
cash needs such as loan originations and net deposit outflows. In addition, the
investment portfolio consists of high quality, and, therefore, readily
marketable, U.S. Treasury and Government Agency obligations. At December 31,
2003, the Banks investment securities and mortgage-backed securities available
for sale totaled $48.6 million which is available to meet the Banks liquidity
needs. Loan maturities and amortization as well as deposit growth provide for a
constant flow of funds. In addition, the Bank has two overnight lines of credit
totaling $11.8 million to meet short-term liquidity needs. The Bank did not
utilize these overnight lines at December 31, 2003 and had the full $11.8
million available. The liquidity position of the Company is managed by the Asset/Liability
Management Committee (ALCO). The duties of ALCO are to periodically review
the Companys level of liquidity under prescribed policies and procedures. It
is the responsibility of ALCO to report to the Board of Directors on a regular
basis the Companys liquidity position as it relates to these policies and
procedures. At December 31, 2003, the Companys liquidity position was above
policy guidelines. Management believes that the Bank has adequate liquidity to
meet current and future liquidity demands. Contractual Obligations and Commitments The company enters into off-balance sheet contractual obligations and
commitments in the normal course of business. The Company has contractual
obligations such as payments on FHLB advances, operating lease obligations and
customer repurchase agreements. The Company has commitments in the form of
financial instruments that are for loan originations, lines of credit, letters
of credit and to sell mortgage loans. These commitments have various
expiration dates. The following table summarizes the expiration dates of these
commitments at December 31, 2003. 17




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##### Table of Contents



Payments Due  By PeriodLess than
    
    One to
    
    Four to
    
    AfterContractual Obligations
    
    Total
    
    One Year
    
    Three Years
    
    Five Years
    
    Five Years(In Thousands)FHLB Advances
    
    $
    78,866
    
    
    $
    20,000
    
    
    $
    11,000
    
    
    $
    15,000
    
    
    $
    32,866FHLB Short-term
borrowings
    
    
    52,000
    
    
    
    52,000
    
    
    
    
    
    
    
    
    
    
    
    Lease Obligations
    
    
    1,176
    
    
    
    166
    
    
    
    364
    
    
    
    367
    
    
    
    279Data processing vendor
    
    
    5,148
    
    
    
    803
    
    
    
    1,648
    
    
    
    1,762
    
    
    
    935Employee benefit
contributions (1)
    
    
    372
    
    
    
    372
    
    
    
    
    
    
    
    
    
    
    
    Customer Repurchase
Agreements
    
    
    2,486
    
    
    
    2,486
    
    
    
    
    
    
    
    
    
    
    
    Total Contractual Cash
Obligations
    
    $
    140,048
    
    
    $
    75,827
    
    
    $
    13,012
    
    
    $
    17,129
    
    
    $
    34,080
  1)
    
    Employee benefit contributions include expected contributions to
the Companys defined pension benefit plan, post retirement plan and
supplemental executive retirement plans. Expected contributions for
the defined pension benefit plan have been included only through the
plan year November 2, 2003 through October 31, 2004. Contributions
beyond the plan year can not be quantified as contributions will be
determined based upon the return on the investments retirees is
unknown, interest rates and average salary amounts have not yet been
determined in the plan. Amount of Commitment Expiring  By PeriodLess than
    
    One to
    
    Four to
    
    AfterCommitments
    
    Total
    
    One Year
    
    Three Years
    
    Five Years
    
    Five Years(In Thousands)Loan Originations
    
    $
    18,463
    
    
    $
    18,463
    
    
    $
    
    
    
    $
    
    
    
    $
    Lines of Credit
    
    
    34,852
    
    
    
    17,926
    
    
    
    9,105
    
    
    
    5,474
    
    
    
    2,347Letters of Credit
    
    
    851
    
    
    
    851
    
    
    
    
    
    
    
    
    
    
    
    Sell mortgage Loans
    
    
    340
    
    
    
    340
    
    
    
    
    
    
    
    
    
    
    
    Total commitments
    
    $
    54,506
    
    
    $
    37,580
    
    
    $
    9,105
    
    
    $
    5,474
    
    
    $
    2,347
 The Corporation has no off-balance sheet arrangements except those discussed in
the commitment table in the Liquidity section or Note 12 of the Consolidated
Financial Statements. Capital Adequacy The Company and the Bank are required to maintain a leverage capital ratio of
5% and risk-based capital ratios of at least 10% in order to be categorized as
well capitalized in accordance with definitions in regulatory guidelines
promulgated by the FDIC and FRB. At December 31, 2003 and 2002, the Companys
and the Banks leverage and risk-based capital ratios exceeded the required
levels for the category of well-capitalized as defined by applicable
regulatory agencies. The Company and the Bank may not declare or pay cash
dividends on its shares of common stock if the effect thereof would cause its
stockholders equity to be reduced below applicable capital requirements or if
such declaration and payments would otherwise violate regulatory requirements.
See note 9 to the Consolidated Financial Statements for further information
regarding capital adequacy. On July 25, 2002, the Board of Directors of the Company adopted a stock
repurchase program (the Repurchase Program) authorizing the Company to
repurchase up to five percent of its common stock outstanding as of June 30,
2002 for cash. As of December 31, 2003 the number of shares repurchased and
included as Treasury Stock was 219,300, which had an average purchase price of
$12.57. The Companys book value per share was $12.99 at December 31, 2003.
The Company was able to purchase shares of Treasury Stock at a price close to
book value, which had a minimal impact in the calculation of book value at
December 31, 2003 and 2002. The book value per share increased from $12.71 at
December 31, 2002 due to net income of $4.1 million and exercise of stock
options of $511 thousand. Offsetting these increases were the declaration of
dividends of $2.0 million, purchase of Treasury Stock $1.0 million and a
decrease in market value of investment securities available for sale (net of
taxes) $659 thousand. Asset/Liability Management Managing interest rate risk is fundamental to banking. The Company has
continued to manage its liquidity, capital, and GAP position so as to control
its exposure to interest rate risk. 18




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##### Table of Contents



As of December 31, 2003, the Company had interest rate sensitive assets which
repriced or matured within one year of $212.7 million and interest rate
sensitive liabilities which repriced or matured within one year of $215.7
million. As of December 31, 2002, the Company had interest rate sensitive
assets which matured or repriced within one year of $228.0 million and interest
rate sensitive liabilities which repriced or matured within one year of $173.5
million. Interest Rate Sensitivity The Company actively manages its interest rate sensitivity position. The
objectives of interest rate risk management are to control exposure of net
interest income to risks associated with interest rate movements and to achieve
a stable and rising flow of net interest income. The Asset/Liability Committee
(ALCO) using policies approved by the Board of Directors, is responsible for
managing the Banks rate sensitivity position. The asset/liability management policy establishes guidelines for acceptable
exposure to interest rate risk, liquidity, and capital. The objective of ALCO
is to manage earning assets and liabilities to produce results which are
consistent with the Companys policy for net interest income, liquidity and
capital and identify acceptable levels of growth, risk and profitability. ALCO
establishes and monitors origination and pricing strategies consistent with
ALCO policy. ALCO meets regularly to review the current economic
environment, income simulation model and GAP analysis and implements
appropriate changes in strategy that will manage the Companys exposure to
interest rate risk, liquidity and capital. ALCO manages the Companys interest rate risk using both income simulation and
GAP analysis. Income simulation is used to quantify interest rate risk
inherent in the Companys consolidated balance sheet by showing the effect of a
change in net interest income over a 24 month period. The income simulation
model uses parallel interest rate shocks of up 200 basis points (bp) or down
100 basis points (bp) for earning assets and liabilities in the first year of
the model. Interest rates are not shocked in the second year of the model.
The composition of the Companys consolidated balance sheet at December 31,
2003 remains relatively well matched over the 24 month horizon with a slight
bias towards liability sensitivity in the first year. The simulation takes
into account the dates for repricing, maturing, prepaying and call options
assumptions of various financial categories which may vary under different
interest rate scenarios. Prepayment speeds are estimates for the loans and are
adjusted according to the degree of rate changes. Call options and prepayment
speeds for investment securities are estimates using industry standards for
pricing and prepayment assumptions. The assumptions of financial instrument
categories are reviewed before each simulation by ALCO in light of current
economic trends. As of December 31, 2003, the income simulation model
indicated some negative exposure of net interest income to rising interest
rates to a degree that remains within tolerance levels established by the
Companys policy. The interest rate scenario used does not necessarily
reflect ALCOs view of the most likely change in interest rates over the
models period. Furthermore, the model assumes a static consolidated balance
sheet. These results do not reflect the anticipated future net interest income
of the Company for the same periods. The following table summarizes the net interest income for the 24 month period
of the Companys consolidated balance sheet for earning assets and liabilities
for the years ended December 31; Net Interest Income Simulation Model Results: Interest Rate ShockDown
    
    Up2003
    
    Flat Rates
    
    100bp
    
    200 bp(Dollars in Thousands)Year One
    
    $
    13,246
    
    
    $
    13,538
    
    
    $
    12,902Year Two
    
    
    12,122
    
    
    
    12,201
    
    
    
    11,994Total net interest income for 2 year period
    
    $
    25,368
    
    
    $
    25,739
    
    
    $
    24,896
 Interest Rate ShockDown
    
    Up2002
    
    Flat Rates
    
    100 bp
    
    200 bp(Dollars in Thousands)Year One
    
    $
    13,501
    
    
    $
    13,227
    
    
    $
    14,190Year Two
    
    
    12,953
    
    
    
    12,236
    
    
    
    14,141Total net interest income for 2 year period
    
    $
    26,454
    
    
    $
    25,463
    
    
    $
    28,331
 The income simulation model reflects negative exposure to net interest income
in a rising interest rate environment from flat rates to up 200 bp, which would
result from shorter liabilities due to short-term borrowings from FHLB.
Margins would narrow as deposits and borrowings are faster to reprice to higher
interest rates. The Companys primary measure of interest rate risk is GAP
analysis. GAP measurement attempts to analyze any mismatches in the timing of
interest rate repricing between assets and liabilities. It identifies those
balance sheet sensitivity areas which are vulnerable to unfavorable interest 19




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##### Table of Contents



rate movements. As a tool of asset/liability management, the GAP position is
compared with potential changes in interest rate levels in an attempt to
measure the favorable and unfavorable effect such changes would have on net
interest income. For example, when the GAP is positive, (i.e., assets reprice
faster than liabilities) a rise in interest rates will increase net interest
income; and, conversely, if the GAP is negative, a rise in interest rates will
decrease net interest income. The accuracy of this measure is limited by
unpredictable loan prepayments and the lags in the interest rate indices used
for repricing variable rate loans or investment securities. The Companys one-year cumulative GAP to total assets decreased from 12% at
December, 2002, to less than 1% at December, 2003. The table below shows the
interest rate sensitivity gap position as of December 31, 2003. The table
excludes non-performing loans and assumes that all deposits except savings and
NOWs will be withdrawn within the legal time period for withdrawal. This
withdrawal of deposit assumption is not likely to occur. Rate Sensitivity GAP Position Position/VolumeTime interval from December 31, 2003
    
    0-3 Mo.
    
    4-6 Mo.
    
    7-12 Mo.
    
    13-36 Mo.
    
    37-60 Mo.
    
    +60 Mo.(Dollars in Thousands)Earning Assets:Investment securities held to maturity
    
    $
    5,393
    
    
    $
    18,691
    
    
    $
    14,937
    
    
    $
    64,106
    
    
    $
    69,986
    
    
    
    11,173Investments securities available for sale
    
    
    2,100
    
    
    
    11,116
    
    
    
    14,038
    
    
    
    10,948
    
    
    
    1,045
    
    
    
    9,177Federal Home Loan Bank Stock and other earning assets
    
    
    8,119
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    168Fixed rate mortgages loans
    
    
    2,736
    
    
    
    2,452
    
    
    
    5,588
    
    
    
    12,698
    
    
    
    7,463
    
    
    
    8,342Adjustable rate mortgages loans
    
    
    7,902
    
    
    
    1,859
    
    
    
    4,244
    
    
    
    7,960
    
    
    
    6,347
    
    
    
    Consumer loans
    
    
    530
    
    
    
    1
    
    
    
    2
    
    
    
    30
    
    
    
    1
    
    
    
    Fixed rate commercial real estate loans
    
    
    1,360
    
    
    
    536
    
    
    
    1,076
    
    
    
    3,656
    
    
    
    4,062
    
    
    
    5,817Adjustable rate commercial real estate loans
    
    
    81,433
    
    
    
    1,193
    
    
    
    2,524
    
    
    
    5,830
    
    
    
    5,015
    
    
    
    Construction loans
    
    
    13,100
    
    
    
    17
    
    
    
    35
    
    
    
    153
    
    
    
    174
    
    
    
    2,562Fixed rate commercial business loans
    
    
    773
    
    
    
    523
    
    
    
    891
    
    
    
    1,643
    
    
    
    118
    
    
    
    9Adjustable rate commercial business loans
    
    
    9,460
    
    
    
    21
    
    
    
    42
    
    
    
    1,325
    
    
    
    
    
    
    
    Total earning assets
    
    
    132,906
    
    
    
    36,409
    
    
    
    43,377
    
    
    
    108,349
    
    
    
    94,211
    
    
    
    37,248Interest Bearing Liabilities:Savings and escrow accounts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,774NOW and Super Now accounts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36,108Money market accounts
    
    
    76,148
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Certificates of deposit and retirement accounts
    
    
    23,360
    
    
    
    17,115
    
    
    
    24,489
    
    
    
    27,551
    
    
    
    9,335
    
    
    
    FHLB advances and other borrowed funds
    
    
    54,510
    
    
    
    15,025
    
    
    
    5,052
    
    
    
    11,223
    
    
    
    15,254
    
    
    
    32,288Total interest bearing liabilities
    
    
    154,018
    
    
    
    32,140
    
    
    
    29,541
    
    
    
    38,774
    
    
    
    24,589
    
    
    
    113,170Interest Sensitivity Gap
    
    $
    (21,112
    )
    
    $
    4,269
    
    
    $
    13,836
    
    
    $
    69,575
    
    
    $
    69,622
    
    
    $
    (75,922
    )Cumulative GAP
    
    $
    (21,112
    )
    
    $
    (16,843
    )
    
    $
    (3,007
    )
    
    $
    66,568
    
    
    $
    136,190
    
    
    $
    60,268Cumulative GAP as a percent of total assets
    
    
    (5
    )%
    
    
    (4
    )%
    
    
    (1
    )%
    
    
    14
    %
    
    
    29
    %
    
    
    13
    %
 Recent Accounting Developments In April 2003, the Financial Accounting Standards Board (the FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 149 Amendment of
Statement 133 on Derivative Instruments and Hedging Activities,which amends
and clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, resulting in more consistent reporting of contracts as
either derivatives or hybrid instruments. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003, and should be applied
prospectively. Implementation issues that have been effective for fiscal
quarters that began prior to June 15, 2003 should continue to be applied in
accordance with their respective effective dates. This statement did not have
a material impact on the Companys financial position or results of operation. In May 2003, the FASB issued SFAS No. 150 Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity, which
establishes standards for how certain financial instruments with
characteristics of both liabilities and equity should be measured and
classified. Certain financial instruments with characteristics of both
liabilities and equity will be required to be classified as a liability. This
statement is effective for financial instruments entered into or modified after
May 31, 2003, and July 1, 2003 for all other financial instruments with the
exception of existing mandatorily redeemable financial instruments issued by
limited life subsidiaries which have been indefinitely deferred from the scope
of the statement. The Company does not believe the adoption of SFAS 150 will
have a material impact on the Companys financial position or results of
operations. 20




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##### Table of Contents



Recent Accounting Developments (Continued) In December 2003, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position 03-3 (SOP 03-3): Accounting for
Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 requires
loans acquired through a transfer, such as a business combination, where there
are differences in expected cash flows and contractual cash flows due in part
to credit quality be recognized at their fair value. The excess of contractual
cash flows over expected cash flows is not to be recognized as an adjustment of
yield, loss accrual, or valuation allowance. Valuation allowances can not be
created nor carried over in the initial accounting for loans acquired in a
transfer on loans subject to SFAS 114, Accounting by Creditors for Impairment
of a Loan. This SOP is effective for loans acquired after December 31, 2004,
with early adoption encouraged. The Company does not believe the adoption of
SOP 03-3 will have a material impact on the Companys financial position or
results of operations. Impact of Inflation and Changing Prices The Companys asset and liability structure is substantially different from
that of an industrial company in that virtually all assets and liabilities of
the Company are monetary in nature. Management believes the impact of inflation
on financial results depends upon the Companys ability to react to changes in
interest rates and by such reaction reduce the inflationary impact on
performance. Interest rates do not necessarily move in the same direction, or
at the same magnitude, as the prices of other goods and services. As discussed
previously, management seeks to manage the relationship between
interest-sensitive assets and liabilities in order to protect against wide net
interest income fluctuations, including those resulting from inflation. Various information shown elsewhere in this Annual Report will assist in the
understanding of how well the Company is positioned to react to changing
interest rates and inflationary trends. In particular, the summary of net
interest income, the maturity distributions, the compositions of the loan and
security portfolios and the data on the interest rate sensitivity of loans and
deposits should be considered. 21




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##### Table of Contents



Report of Management Responsibility The management of LSB Corporation (the Corporation or the Company) is
responsible for the preparation and integrity of the Consolidated Financial
Statements and other financial information contained in this annual report. The
Consolidated Financial Statements have been prepared in conformity with
accounting principles generally accepted in the United States of America and
prevailing practices of the banking industry and, accordingly, include amounts
based on managements best estimates and judgments. Management has established and is responsible for maintaining internal
accounting controls designed to provide reasonable assurance as to the
integrity and reliability of the Consolidated Financial Statements, the
protection of assets, and the prevention and detection of irregularities. The
concept of reasonable assurance recognizes that the cost of a system of
internal accounting controls should not exceed the benefits derived. The
internal accounting control system is augmented by written policies and
guidelines, careful selection and training of qualified personnel, a written
program of internal audits, appropriate review by management, and a written
code of professional conduct for directors, officers and all employees. The Corporations Board of Directors has an Audit Committee composed solely of
independent directors. The Committee meets periodically with management, the
internal auditors and KPMG LLP (KPMG) to review the work of each and to
inquire of each as to their assessment of the performance of the others in
their work relating to the Companys Consolidated Financial Statements. Both
the independent and internal auditors have, at all times, the right of full
access to the Audit Committee, without management present, to discuss any
matter they believe should be brought to the attention of the Audit Committee. Management recognizes that there are inherent limitations in the effectiveness
of any internal control system. However, management believes that as of
December 31, 2003 the Companys internal accounting controls provide reasonable
assurance as to the integrity and reliability of the Consolidated Financial
Statements and related financial information. The independent auditors, KPMG, are appointed by the Audit Committee. KPMGs
audits include reviews and tests of the Companys internal controls to the
extent they believe necessary to determine and conduct the audit procedures
that support their report. Members of that firm also have the right of full
access to each member of management in conducting their audits. The report of
KPMG appears on the next page. -s- PAUL A. MILLER
    
    -s- JOHN E. SHARLANDPaul A. Miller
    
    John E. SharlandPresident and
    
    Senior Vice President andChief Executive Officer
    
    Chief Financial Officer
 December 31, 2003 22




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##### Table of Contents



Independent Auditors Report The Board of Directors and Stockholders
LSB Corporation: We have audited the accompanying consolidated balance sheets of LSB Corporation
and its subsidiary as of December 31, 2003 and 2002, and the related
consolidated statements of operations, changes in stockholders equity and cash
flows for each of the years in the three-year period ended December 31, 2003.
These Consolidated Financial Statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these Consolidated
Financial Statements based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
Consolidated Financial Statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the Consolidated Financial Statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall Consolidated Financial Statement
presentation. We believe that our audits provide a reasonable basis for our
opinion. In our opinion, the Consolidated Financial Statements referred to above present
fairly, in all material respects, the financial position of LSB Corporation and
its subsidiary as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America. (KPMG LLP) Boston, Massachusetts
March 11, 2004 23




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##### Table of Contents



Consolidated Balance Sheets December 31,
    
    2003
    
    2002(In Thousands)Assets:Cash and due from banks
    
    $
    7,872
    
    
    $
    7,136Fed funds sold
    
    
    889
    
    
    
    9,633Total cash and cash equivalents
    
    
    8,761
    
    
    
    16,769Investment securities held to maturity
market value of $184,592 in 2003 and $116,321 in 2002 (notes 2 and 7)
    
    
    184,286
    
    
    
    113,325Investment securities available for sale
amortized cost of $48,571 in 2003 and $52,055 in 2002 (notes 2 and 7)
    
    
    48,592
    
    
    
    53,084Federal Home Loan Bank stock, at cost (note 3)
    
    
    6,593
    
    
    
    5,950Loans, net of allowance for loan losses of $4,220 in 2003
and $4,167 in 2002 (notes 4 and 7)
    
    
    207,283
    
    
    
    238,960Bank premises and equipment (note 5)
    
    
    2,875
    
    
    
    3,050Accrued interest receivable
    
    
    2,552
    
    
    
    2,459Deferred income tax asset (note 8)
    
    
    3,519
    
    
    
    3,686Other assets
    
    
    1,647
    
    
    
    1,851Total assets
    
    $
    466,108
    
    
    $
    439,134Liabilities and Stockholders Equity:Liabilities:Interest bearing deposits (note 6)
    
    $
    258,430
    
    
    $
    265,283Non-interest bearing deposits (note 6)
    
    
    14,110
    
    
    
    14,182Federal Home Loan Bank advances (note 7)
    
    
    78,866
    
    
    
    94,237Other borrowed funds (note 7)
    
    
    54,486
    
    
    
    7,354Advance payments by borrowers for taxes and insurance
    
    
    450
    
    
    
    518Other liabilities
    
    
    4,764
    
    
    
    3,501Total liabilities
    
    
    411,106
    
    
    
    385,075Commitments and contingencies (notes 5, 11 and 12):Stockholders equity (notes 9 and 10):Preferred stock, $.10 par value; 5,000,000
shares authorized, none issued
    
    
    
    
    
    
    Common stock, $.10 par value; 20,000,000
shares authorized; 4,454,262 and 4,389,705 shares issued
in 2003 and 2002, respectively,
4,234,962 and 4,253,205 shares outstanding in 2003 and 2002, respectively
    
    
    445
    
    
    
    439Additional paid-in capital
    
    
    58,350
    
    
    
    57,845Accumulated deficit
    
    
    (1,055
    )
    
    
    (3,168
    )Treasury stock, at cost (219,300 and 136,500 shares in 2003 and 2002, respectively)
    
    
    (2,758
    )
    
    
    (1,736
    )Accumulated other comprehensive income
    
    
    20
    
    
    
    679Total stockholders equity
    
    
    55,002
    
    
    
    54,059Total liabilities and stockholders equity
    
    $
    466,108
    
    
    $
    439,134
 The accompanying notes are an integral part of these consolidated financial
statements.  24




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##### Table of Contents



Consolidated Statements of Operations Year Ended December 31,
    
    2003
    
    2002
    
    2001(In Thousands, Except Share Data)Interest and dividend income:Loans
    
    $
    14,356
    
    
    $
    16,932
    
    
    $
    18,295Investment securities held to maturity
    
    
    4,938
    
    
    
    6,056
    
    
    
    8,166Investment securities available for sale
    
    
    1,785
    
    
    
    1,817
    
    
    
    1,514Federal Home Loan Bank stock
    
    
    183
    
    
    
    205
    
    
    
    364Other interest income
    
    
    72
    
    
    
    128
    
    
    
    453Total interest and dividend income
    
    
    21,334
    
    
    
    25,138
    
    
    
    28,792Interest expense:Deposits (note 6)
    
    
    4,176
    
    
    
    5,804
    
    
    
    9,929Borrowed funds
    
    
    4,583
    
    
    
    5,458
    
    
    
    4,984Securities sold under agreements to repurchase
    
    
    17
    
    
    
    20
    
    
    
    58Other borrowed funds
    
    
    201
    
    
    
    283
    
    
    
    640Total interest expense
    
    
    8,977
    
    
    
    11,565
    
    
    
    15,611Net interest income
    
    
    12,357
    
    
    
    13,573
    
    
    
    13,181Provision for loan losses (note 4)
    
    
    
    
    
    
    
    
    
    
    175Net interest income after provision for loan losses
    
    
    12,357
    
    
    
    13,573
    
    
    
    13,006Non-interest income:Deposit account fees
    
    
    713
    
    
    
    665
    
    
    
    594Loan servicing fees, net
    
    
    20
    
    
    
    (145
    )
    
    
    155Gains on sales of mortgage loans, net
    
    
    467
    
    
    
    529

    
    
    
    249Gains (losses) on sale of investment securities
    
    
    (14
    )
    
    
    
    
    
    
    38Lawsuit judgment collected
    
    
    1,996
    
    
    
    
    
    
    
    Other income
    
    
    422
    
    
    
    444
    
    
    
    390Total non-interest income
    
    
    3,604
    
    
    
    1,493
    
    
    
    1,426Non-interest expense:Salaries and employee benefits
    
    
    5,923
    
    
    
    6,006
    
    
    
    5,264Occupancy and equipment expense
    
    
    752
    
    
    
    790
    
    
    
    872Data processing expense
    
    
    727
    
    
    
    749
    
    
    
    705Professional expense
    
    
    643
    
    
    
    806
    
    
    
    671Insurance expense
    
    
    151
    
    
    
    153
    
    
    
    146Other expense
    
    
    1,542
    
    
    
    1,651
    
    
    
    1,464Total non-interest expense
    
    
    9,738
    
    
    
    10,155
    
    
    
    9,122Income before income tax expense
    
    
    6,223
    
    
    
    4,911
    
    
    
    5,310Income tax expense (note 8)
    
    
    2,087
    
    
    
    1,811
    
    
    
    1,953Net income
    
    $
    4,136
    
    
    $
    3,100
    
    
    $
    3,357Average shares outstanding
    
    
    4,215,944
    
    
    
    4,348,085
    
    
    
    4,374,195Average diluted shares outstanding
    
    
    4,391,812
    
    
    
    4,518,649
    
    
    
    4,535,305Basic earnings per share
    
    $
    0.98
    
    
    $
    0.71
    
    
    $
    0.77Diluted earnings per share
    
    $
    0.94
    
    
    $
    0.69
    
    
    $
    0.74
 The accompanying notes are an integral part of these consolidated financial
statements. 25




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##### Table of Contents



Consolidated Statements of Changes in Stockholders Equity
 AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    Other
    
    TotalCommon
    
    Paid-in
    
    Accumulated
    
    Treasury
    
    Comprehensive
    
    StockholdersStock
    
    Capital
    
    Deficit
    
    Stock
    
    Income (Loss)
    
    Equity(In Thousands)Balance at December 31, 2000
    
    $
    436
    
    
    $
    57,711
    
    
    $
    (5,956
    )
    
    $
    
    
    
    $
    122
    
    
    $
    52,313Net income
    
    
    
    
    
    
    
    
    
    
    3,357
    
    
    
    
    
    
    
    
    
    
    
    3,357Other comprehensive income
unrealized gain (loss) on securities
available for sale (tax effect $34)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    67
    
    
    
    67Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    

    
    
    
    
    3,424Exercise of stock options
    
    
    2
    
    
    
    102
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    104Dividends declared and paid ($0.40 per share)
    
    
    
    
    
    
    
    
    
    
    (1,749
    )
    
    
    
    
    
    
    
    
    
    
    (1,749
    )Balance at December 31, 2001
    
    
    438
    
    
    
    57,813
    
    
    
    (4,348
    )
    
    
    
    
    
    
    189
    
    
    
    54,092Net income
    
    
    
    
    
    
    
    
    
    
    3,100
    
    
    
    
    
    
    
    
    
    
    
    3,100Other comprehensive income
unrealized gain (loss) on securities
available for sale (tax effect $253)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    490
    
    
    
    490Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,590Exercise of stock options
    
    
    1
    
    
    
    32
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,736
    )
    
    
    
    
    
    
    (1,736
    )Dividends declared and paid ($0. 44 per share)
    
    
    
    
    
    
    
    
    
    
    (1,920
    )
    
    
    
    
    
    
    
    
    
    
    (1,920
    )Balance at December 31, 2002
    
    
    439
    
    
    
    57,845
    
    
    
    (3,168
    )
    
    
    (1,736
    )
    
    
    679
    
    
    
    54,059Net income
    
    
    
    
    
    
    
    
    
    
    4,136
    
    
    
    
    
    

    
    
    
    
    
    4,136Other comprehensive income
unrealized gain (loss) on securities
available for sale (tax effect $338)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (659
    )
    
    
    (659
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,447Exercise of stock options
    
    
    6
    
    
    
    505
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    511Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,022
    )
    
    
    
    
    
    
    (1,022
    )Dividends declared and paid ($0.48 per share)
    
    
    
    
    
    
    
    
    
    
    (2,023
    )
    
    
    
    
    
    
    
    
    
    
    (2,023
    )Balance at December 31, 2003
    
    $
    445
    
    
    $
    58,350
    
    
    $
    (1,055
    )
    
    $
    (2,758
    )
    
    $
    20
    
    
    $
    55,002
 Disclosure of reclassification amount:
    
    2003
    
    2002
    
    2001(In Thousands)Gross unrealized (depreciation) appreciation arising during the period
    
    $
    (1,011
    )
    
    $
    743
    
    
    $
    124Tax effect
    
    
    343
    
    
    
    (253
    )
    
    
    (42
    )Unrealized holding (depreciation) appreciation net of tax
    
    
    (668
    )
    
    
    490
    
    
    
    82Less: reclassification adjustment for gains (losses)
included in net income
    
    
    (14
    )
    
    
    
    
    
    
    22Tax effect
    
    
    5
    
    
    
    
    
    
    
    (7
    )Unrealized (depreciation) appreciation on securities,
net of reclassification
    
    $
    (659
    )
    
    $
    490
    
    
    $
    67
 The accompanying notes are an integral part of these consolidated financial statements. 26




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##### Table of Contents



Consolidated Statements
of Cash Flows Year Ended December 31,
    
    2003
    
    2002
    
    2001(In Thousands)Cash flows from operating activities:Net income
    
    $
    4,136
    
    
    $
    3,100
    
    
    $
    3,357Adjustments to reconcile net income to net cash provided by operating activities:Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    175Gains on sales of mortgage loans and mortgage-backed securities
    
    
    (467
    )
    
    
    (529
    )
    
    
    (249
    )(Gains) losses on investment securities available for sale
    
    
    14
    
    
    
    
    
    
    
    (22
    )Gains on calls of investment securities held to maturity
    
    
    
    
    
    
    
    
    
    
    (29
    )Net amortization (accretion) of investment securities
    
    
    2,117
    
    
    
    1,426
    
    
    
    (37
    )Depreciation of premises and equipment and other assets
    
    
    398
    
    
    
    454
    
    
    
    484Loans originated for sale
    
    
    (21,139
    )
    
    
    (35,415
    )
    
    
    (25,301
    )Proceeds from sales of mortgage loans and mortgage-backed securities
    
    
    23,847
    
    
    
    37,521
    
    
    
    21,394(Increase) decrease in accrued interest receivable
    
    
    (93
    )
    
    
    145
    
    
    
    365Decrease in deferred income tax asset
    
    
    516
    
    
    
    1,798
    
    
    
    1,742Decrease (increase) in other assets
    
    
    194
    
    
    
    (309
    )
    
    
    55(Decrease) increase in advance payments by borrowers
    
    
    (68
    )
    
    
    (55
    )
    
    
    60Increase (decrease) in other liabilities
    
    
    1,263
    
    
    
    (552
    )
    
    
    498Net cash provided by operating activities
    
    
    10,718
    
    
    
    7,584
    
    
    
    2,492Cash flows from investing activities:Proceeds from maturities of investment securities held to maturity
    
    
    171,500
    
    
    
    337,318
    
    
    
    642,579Proceeds from maturities of investment securities available for sale
    
    
    12,000
    
    
    
    5,493
    
    
    
    6,532Purchases of investment securities held to maturity
    
    
    (248,915
    )
    
    
    (351,927
    )
    
    
    (678,882
    )Purchases of investment securities available for sale
    
    
    (16,712
    )
    
    
    (31,194
    )
    
    
    (26,037
    )Purchase of mutual funds available for sale
    
    
    (1,000
    )
    
    
    
    
    
    
    Purchases of mortgage-backed securities held to maturity
    
    
    (38,118
    )
    
    
    (2,967
    )
    
    
    (4,335
    )Purchases of mortgage-backed securities available for sale
    
    
    (14,775
    )
    
    
    
    
    
    
    Proceeds from sales of investment securities available for sale
    
    
    
    
    
    
    
    
    
    
    6,119Proceeds from sales of mortgage-backed securities available for sale
    
    
    5,684
    
    
    
    
    
    
    
    Principal payments of securities held to maturity
    
    
    43,209
    
    
    
    38,283
    
    
    
    23,557Principal payments of securities available for sale
    
    
    17,519
    
    
    
    11,670
    
    
    
    7,765Purchase of other equity securities
    
    
    
    
    
    
    
    
    
    
    (46
    )Purchases of Federal Home Loan Bank stock
    
    
    (643
    )
    
    
    
    
    
    
    (Increase) decrease in loans, net
    
    
    29,436
    
    
    
    (8,210
    )
    
    
    (9,986
    )Proceeds from payments on OREO
    
    
    10
    
    
    
    10
    
    
    
    10Purchases of Bank premises and equipment
    
    
    (223
    )
    
    
    (337
    )
    
    
    (314
    )Net cash used in investing activities
    
    
    (41,028
    )
    
    
    (1,861
    )
    
    
    (33,038
    )Cash flows from financing activities:Net (decrease) increase in deposits
    
    
    (6,925
    )
    
    
    11,015
    
    
    
    (2,098
    )Additions to Federal Home Loan Bank advances
    
    
    
    
    
    
    11,000
    
    
    
    48,120Payments on Federal Home Loan Bank advances
    
    
    (15,371
    )
    
    
    (19,755
    )
    
    
    (27,411
    )Net increase (decrease) in agreements to repurchase securities
    
    
    (1,464
    )
    
    
    (270
    )
    
    
    4,220Increase (decrease) in other borrowed funds
    
    
    48,596
    
    
    
    (483
    )
    
    
    9Dividends paid
    
    
    (2,023
    )
    
    
    (1,920
    )
    
    
    (1,749
    )Treasury stock purchased
    
    
    (1,022
    )
    
    
    (1,736
    )
    
    
    Proceeds from exercise of stock options
    
    
    511
    
    
    
    33
    
    
    
    104Net cash provided by (used in) financing activities
    
    
    22,302
    
    
    
    (2,116
    )
    
    
    21,195Net (decrease) increase in cash and cash equivalents
    
    
    (8,008
    )
    
    
    3,607
    
    
    
    (9,351
    )Cash and cash equivalents, beginning of year
    
    
    16,769
    
    
    
    13,162
    
    
    
    22,513Cash and cash equivalents, end of year
    
    $
    8,761
    
    
    $
    16,769
    
    
    $
    13,162Cash paid during the year for:Interest on deposits and borrowed funds
    
    $
    9,039
    
    
    $
    11,632
    
    
    $
    15,603Income taxes
    
    
    538
    
    
    
    271
    
    
    
    188Cash received during the year for:Income taxes
    
    
    
    
    
    
    133
    
    
    
    Supplemental Schedule of non-cash activities:Change in valuation of investment securities available for sale
    
    
    (1,008
    )
    
    
    743
    
    
    
    99
 The accompanying notes are an integral part of these consolidated financial
statements. 27




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##### Table of Contents



Notes to Consolidated
Financial Statements (1) Summary of Significant Accounting Policies: Basis of Presentation LSB Corporation (the Corporation or the Company) is
a Massachusetts corporation and the holding company of its wholly-owned
subsidiary Lawrence Savings Bank (the Bank) a state-chartered Massachusetts
savings bank. The Corporation was organized by the Bank on July 1, 2001 to be
a bank holding company and to acquire all of the capital stock of the Bank.
The Consolidated Financial Statements presented herein reflect the accounts of
the Corporation and its predecessor, Lawrence Savings Bank. The Corporation is
supervised by the Board of Governors of the Federal Reserve Bank (FRB), and
it is also subject to the jurisdiction of the Massachusetts Division of Banks,
while the Bank is subject to the regulations of, and periodic examination by,
the Federal Deposit Insurance Corporation (FDIC) and the Massachusetts
Division of Banks. The Banks deposits are insured by the Bank Insurance Fund
of the FDIC up to $100,000 per account, as defined by the FDIC, and the
Depositors Insurance Fund, Inc. (DIF) for customer deposit amounts in excess
of $100,000.
The Consolidated Financial Statements include the accounts of LSB Corporation
and its wholly-owned consolidated subsidiary, Lawrence Savings Bank, and its
wholly-owned subsidiaries, Shawsheen Security Corporation, Shawsheen Security
Corporation II, Pemberton Corporation, and Spruce Wood Realty Trust. All
inter-company balances and transactions have been eliminated in consolidation.
The Company has one reportable operating segment. Certain amounts in prior
periods have been re-classified to conform to the current presentation. The LSB Corporations Consolidated Financial Statements have been prepared in
conformity with accounting principles generally accepted in the United States
of America. Accordingly, management is required to make estimates and
assumptions that affect amounts reported in the balance sheets and statements
of operations. Actual results could differ significantly from those estimates
and judgments. Material estimates that are particularly susceptible to change
relate to the allowance for loan losses, income taxes and MSR. Cash and Cash Equivalents For the purpose of reporting cash flows, cash and
cash equivalents include cash on hand, amounts due from banks and Federal Funds
sold. Generally, Federal Funds are sold with overnight maturities. Investment and Mortgage-Backed Securities Debt securities that the Company
has the intent and ability to hold to maturity are classified as held to
maturity and reported at amortized cost; debt, mortgage-backed and equity
securities that are bought and held principally for the purpose of selling in
the near term are classified as trading and reported at fair value, with
unrealized gains and losses included in earnings; and debt, mortgage-backed and
equity securities not classified as either held to maturity or trading are
classified as available for sale and reported at fair value, with unrealized
gains and losses excluded from earnings and reported as other comprehensive
income, net of estimated income taxes. Premiums and discounts on debt and mortgage-backed securities are amortized or
accreted into income by use of a method that approximates the interest method.
If a decline in fair value below the amortized cost basis of a debt or
mortgage-backed security is judged to be other than temporary, the cost basis
of the investment is written down to fair value and the amount of the
write-down is included as a charge to earnings. Gains and losses on the sale of
debt and mortgage-backed securities are recognized at the time of sale on a
specific identification basis. Equity Securities Includes Northeast Retirement Services (NRS) stock. NRS
stock is closely held and not publicly traded and is carried at cost. Dividend
income is recorded when dividends are declared. Interest on Loans Interest on loans is accrued as earned. Loans on which the
accrual of interest has been discontinued are designated as non-accrual loans.
It is managements policy to discontinue the accrual of interest on a loan when
there is a reasonable doubt as to its collectibility. Interest on loans 90 days
or more contractually delinquent is generally excluded from interest income.
When a loan is placed on non-accrual status, all interest previously accrued
but not collected is reversed against current period interest income. Interest
accruals are resumed on loans that have been 90 days or more past due only when
they are brought fully current with respect to interest and principal and when,
in the judgment of management, the loans are expected to be fully collectible
as to both principal and interest. Loan Fees Loan origination fees, net of direct loan acquisitions costs, are
deferred and recognized over the contractual life of the loan as an adjustment
of the loans yield using a basis, which approximates the interest method.
Amortization of loan fees is discontinued once a loan is designated as
non-accrual status. When loans are sold or paid-off, the unamortized portion of
net fees and costs is credited to income. Mortgage Banking Activities Loans held for sale are valued at the lower of
their amortized cost or market value. The Bank, from time-to-time, enters into
forward commitments to sell loans or mortgage-backed securities for the purpose
of reducing interest rate risk associated with the origination of loans for
sale. Gains or losses on sales of loans are recognized to the extent that the
sale proceeds exceed or are less than the carrying amount of the loans. Gains
and losses are determined using the specific identification method. 28




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##### Table of Contents



When loans are sold with servicing rights retained, the Bank allocates the
carrying amount of the loans between the underlying asset sold and the rights
retained, based on their relative fair values. The resulting MSR are amortized
over the period of estimated net servicing income using a method which
approximates the interest method. Actual prepayment experience is reviewed
periodically. When actual prepayments exceed estimated prepayments, the balance
of the MSR is adjusted accordingly. Periodically, the MSR are assessed for
impairment based on the fair value of such rights using market prices. Transfers and Servicing of Assets and Extinguishments of Liabilities The
Company accounts and reports for transfers and servicing of financial assets
and extinguishments of liabilities based on consistent application of a
financial components approach that focuses on control. This approach
distinguishes transfers of financial assets that are sales from transfers that
are secured borrowings. After a transfer of financial assets, the Company
recognizes all financial and servicing assets it controls and liabilities it
has incurred and derecognizes financial assets it no longer controls and
liabilities that have been extinguished. This financial components approach
focuses on the assets and liabilities that exist after the transfer. Many of
these assets and liabilities are components of financial assets that existed
prior to the transfer. If a transfer does not meet the criteria for the sale,
the Company accounts for the transfer as a secured borrowing with a pledge of
collateral. Allowance for Loan Losses Losses on loans are provided for under the
allowance method of accounting. The allowance is increased by provisions
charged to operations on the basis of many factors including the risk
characteristics of the portfolio, current economic conditions and trends in
loan delinquencies and charge-offs. When management believes that the
collection of a loans principal balance is unlikely, the principal amount is
charged against the allowance. Recoveries on loans which have been previously
charged off are credited to the allowance as received. Managements methodology for assessing the appropriateness of the allowance
consists of several key elements, which include a formula allowance, specific
allowances for identified problem loans and an unallocated allowance. The formula allowance is calculated by applying loss factors to outstanding
loans, in each case based on the internal risk grade of such loans. Changes in
risk grades affect the amount of the formula allowance. Loss factors are based
on the Banks historical loss experience as well as regulatory guidelines. Specific allowances are established in cases where management has identified
significant conditions related to a credit such that management believes it is
probable that a loss has been incurred in excess of the amount determined by
the application of the formula allowance. The unallocated allowance recognizes the model and estimation risk associated
with the formula allowance and specific allowances as well as managements
evaluation of various conditions, the effects of which are not directly
measured in the determination of the formula and specific allowances. The
evaluation of the inherent loss with respect to these conditions is subject to
a higher degree of uncertainty because they are not identified with specific
problem credits. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Banks allowance for loan losses.
Such agencies may require the Bank to recognize additions to the allowance for
loan losses based on judgments different from those of management. Impaired loans are commercial, commercial real estate, and individually
significant residential mortgage loans for which it is probable that the Bank
will not be able to collect all amounts due according to the contractual terms
of the loan agreement. Impaired loans, except those loans that are accounted
for at fair value or at lower of cost or fair value, are accounted for at the
present value of the expected future cash flows discounted at the loans
effective interest rate. Premises and Equipment Premises and equipment are stated at cost less
allowances for depreciation and amortization. Depreciation and amortization are
computed principally on the straight-line method over the estimated useful
lives of the assets or the terms of the leases, if shorter. Other Real Estate Owned Other real estate owned (OREO) is comprised of
foreclosed properties where the Bank has formally received title or has
possession of the collateral. Properties are carried at the lower of the
investment in the related loan or the estimated fair value of the property or
collateral less selling costs. 29




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##### Table of Contents



Stock Options The Corporation measures compensation cost for stock-based
plans using the intrinsic value method. The intrinsic value method measures
compensation cost, if any, as the fair market value of the Companys stock at
the grant date over the exercise price. All options granted have an exercise
price equivalent to the fair market value at the date of grant and,
accordingly, no compensation cost has been recorded. If the fair value based
method of accounting for stock options had been used, the Companys net income
and earnings per share would have been reduced to the proforma amounts for the
years ended December 31, and are presented in the table which follows: 2003
    
    2002
    
    2001(In Thousands except per share data)Net Income:As Reported
    
    $
    4,136
    
    
    $
    3,100
    
    
    $
    3,357Less: Pro forma stock based compensation cost (net of taxes)
    
    
    182
    
    
    
    233
    
    
    
    271Pro forma
    
    
    3,954
    
    
    
    2,867
    
    
    
    3,086Basic earnings per share:As Reported
    
    $
    0.98
    
    
    $
    0.71
    
    
    $
    0.77Pro forma
    
    
    0.94
    
    
    
    0.66
    
    
    
    0.71Diluted earnings per share:As Reported
    
    $
    0.94
    
    
    $
    0.69
    
    
    $
    0.74Pro forma
    
    
    0.90
    
    
    
    0.63
    
    
    
    0.68
 The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions: 2003
    
    2002
    
    2001Expected volatility
    
    
    
    
    
    
    
    
    
    
    35.00
    %Risk-free interest rate
    
    
    
    
    
    
    
    
    
    
    5.12
    %Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    3.37
    %Expected life in years
    
    
    
    
    
    
    
    
    
    10 years
 Pension Expense The Bank is a participant in a multiple employer defined
benefit pension plan. Pension expense is recognized on a net periodic pension
cost method over the employees approximate service period. Pension costs are
funded in the year of accrual using the aggregate cost method. Income Taxes Deferred tax assets and liabilities are recognized for estimated
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred assets and liabilities are measured using
enacted tax rates in effect for the year in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date. Deferred tax valuation allowances are established
and based on managements judgment as to whether it is more likely than not
that all or some portion of the future tax benefits will be realized. Earnings per Share Basic EPS is calculated based on the weighted average
number of common shares outstanding during each period. Stock options
outstanding, accounted for under the treasury stock method, have a dilutive
effect to the computation of diluted EPS. Recent Accounting Developments In April 2003, the Financial Accounting Standards Board (the FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 149 Amendment of
Statement 133 on Derivative Instruments and Hedging Activities,which amends
and clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, resulting in more consistent reporting of contracts as
either derivatives or hybrid instruments. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003, and should be applied
prospectively. Implementation issues that have been effective for fiscal
quarters that began prior to June 15, 2003 should continue to be applied in
accordance with their respective effective dates. This statement did not have
a material impact on the Companys financial position or results of operation. In May 2003, the FASB issued SFAS No. 150 Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity, which
establishes standards for how certain financial instruments with
characteristics of both liabilities and equity should be measured and
classified. Certain financial instruments with characteristics of both
liabilities and equity will be required to be classified as a liability. This
statement is effective for financial instruments entered into or modified after
May 31, 2003, and July 1, 2003 for all other financial instruments with the
exception of existing mandatorily redeemable financial instruments issued by
limited life subsidiaries which have been indefinitely deferred from the scope
of the statement. The Company does not believe the adoption of SFAS 150 will
have a material impact on the Companys financial position or results of
operations. 30




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##### Table of Contents



In December 2003, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position 03-3 (SOP 03-3): Accounting for
Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 requires
loans acquired through a transfer, such as a business combination, where there
are differences in expected cash flows and contractual cash flows due in part
to credit quality be recognized at their fair value. The excess of contractual
cash flows over expected cash flows is not to be recognized as an adjustment of
yield, loss accrual, or valuation allowance. Valuation allowances can not be
created nor carried over in the initial accounting for loans acquired in a
transfer on loans subject to SFAS 114, Accounting by Creditors for Impairment
of a Loan. This SOP is effective for loans acquired after December 31, 2004,
with early adoption encouraged. The Company does not believe the adoption of
SOP 03-3 will have a material impact on the Companys financial position or
results of operations. (2) Investment Securities The amortized cost and market value of investment securities at December 31,
follows: 2003
    
    2002Amortized
    
    Unrealized
    
    Market
    
    Amortized
    
    Unrealized
    
    MarketCost
    
    Gain
    
    Loss
    
    Value
    
    Cost
    
    Gain
    
    Loss
    
    Value(In Thousands)Investment securities held to maturity:US Treasury obligations
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    6,002
    
    
    $
    58
    
    
    $
    
    
    
    $
    6,060US Government
Agency obligations
    
    
    94,798
    
    
    
    1,058
    
    
    
    (367
    )
    
    
    95,489
    
    
    
    26,243
    
    
    
    1,471
    
    
    
    
    
    
    
    27,714Mortgage-backed securities
    
    
    39,467
    
    
    
    188
    
    
    
    (686
    )
    
    
    38,969
    
    
    
    13,440
    
    
    
    407
    
    
    
    (7
    )
    
    
    13,840Asset-backed securities
    
    
    32,735
    
    
    
    204
    
    
    
    (284
    )
    
    
    32,655
    
    
    
    32,551
    
    
    
    610
    
    
    
    (14
    )
    
    
    33,147Corporate obligations
    
    
    15,662
    
    
    
    323
    
    
    
    (133
    )
    
    
    15,852
    
    
    
    33,068
    
    
    
    456
    
    
    
    (16
    )
    
    
    33,508Municipal obligations
    
    
    1,624
    
    
    
    3
    
    
    
    
    
    
    
    1,627
    
    
    
    2,021
    
    
    
    31
    
    
    
    
    
    
    
    2,052$
    184,286
    
    
    $
    1,776
    
    
    $
    (1,470
    )
    
    $
    184,592
    
    
    $
    113,325
    
    
    $
    3,033
    
    
    $
    (37
    )
    
    $
    116,321Investment securities available for sale:US Treasury obligations
    
    $
    5,146
    
    
    $
    
    
    
    $
    (351
    )
    
    $
    4,795
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    US Government
Agency obligations
    
    
    21,015
    
    
    
    464
    
    
    
    
    
    
    
    21,479
    
    
    
    31,078
    
    
    
    742
    
    
    
    
    
    
    
    31,820Mortgage-backed securities
    
    
    6,858
    
    
    
    34
    
    
    
    (30
    )
    
    
    6,862
    
    
    
    2,770
    
    
    
    80
    
    
    
    
    
    
    
    2,850Asset-backed securities
    
    
    8,139
    
    
    
    13
    
    
    
    (61
    )
    
    
    8,091
    
    
    
    12,074
    
    
    
    14
    
    
    
    (9
    )
    
    
    12,079Corporate obligations
    
    
    6,245
    
    
    
    81
    
    
    
    (98
    )
    
    
    6,228
    
    
    
    3,965
    
    
    
    212
    
    
    
    (10
    )
    
    
    4,167Municipal obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,000
    
    
    
    
    
    
    
    
    
    
    
    2,000Mutual funds
    
    
    1,000
    
    
    
    
    
    
    
    (31
    )
    
    
    969
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Equity securities
    
    
    168
    
    
    
    
    
    
    
    
    
    
    
    168
    
    
    
    168
    
    
    
    
    
    
    
    
    
    
    
    168$
    48,571
    
    
    $
    592
    
    
    $
    (571
    )
    
    $
    48,592
    
    
    $
    52,055
    
    
    $
    1,048
    
    
    $
    (19
    )
    
    $
    53,084
 Proceeds from sales, realized gains and losses on investments available for sale for the years ended December 31, follow: 2003
    
    2002
    
    2001(In Thousands)Proceeds from sales
    
    $
    5,684
    
    
    $
    
    
    
    $
    6,119Realized gains on sales
    
    
    
    
    
    
    
    
    
    
    38Realized losses on sales
    
    
    14
    
    
    
    
    
    
    
    
 Other Than Temporarily Impaired Securities The table below details the Companys investment securities which were at an
unrealized loss position as of December 31, 2003. At December 31, 2003 the
Company had $122.8 million at fair value of investment securities with $2.0
million in unrealized losses on these investments. The majority of the
investment securities, $119.9 million at fair value with losses of $2.0
million, have been at a loss position for less than 12 months and $2.9 million
at fair value of these investment securities, with losses of $10 thousand, have
been at a loss position for longer than 12 months. The Company believes that
these securities are only temporarily impaired and that the full principal will
be collected as anticipated. Of the total, $4.8 million were US Treasury
obligations and $41.5 million were direct obligations of U.S. Government
Agencies and are at a loss position because they were acquired when the general
level of interest rates were lower than that on December 31, 2003. As of
December 31, 2003, $37.8 million and $28.8 million were mortgage-backed
securities and asset-backed securities, respectively, in the less than 12 month
category 100% of which are guaranteed by the U.S. Government or its agencies.
The majority of the mortgage-backed and asset-backed securities are also at a
loss because they were purchased during a lower interest rate environment
coupled with losses due to accelerated prepayments driven by the low rate
environment. As of December 31, 2003, $8.9 million and $1.0 million of
corporate obligations and mutual funds, respectively, were at a loss because of
the interest rate environment at the time of purchase. 31




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##### Table of Contents



(2) Investment
Securities  (continued) Less Than 12 Months
    
    12 Months or Longer
    
    TotalUnrealized
    
    
    
    
    
    Unrealized
    
    
    
    
    
    UnrealizedFair Value
    
    Losses
    
    Fair Value
    
    Losses
    
    Fair Value
    
    Losses(In Thousands)US Treasury obligations
    
    $
    4,795
    
    
    $
    (351
    )
    
    $
    
    
    
    $
    
    
    
    $
    4,795
    
    
    $
    (351
    )US Government Agency
obligations
    
    
    41,517
    
    
    
    (367
    )
    
    
    
    
    
    
    
    
    
    
    41,517
    
    
    
    (367
    )Mortgage-backed securities
    
    
    37,819
    
    
    
    (716
    )
    
    
    
    
    
    
    
    
    
    
    37,819
    
    
    
    (716
    )Asset-backed securities
    
    
    26,844
    
    
    
    (343
    )
    
    
    1,921
    
    
    
    (2
    )
    
    
    28,765
    
    
    
    (345
    )Corporate obligations
    
    
    7,921
    
    
    
    (223
    )
    
    
    992
    
    
    
    (8
    )
    
    
    8,913
    
    
    
    (231
    )Mutual funds
    
    
    969
    
    
    
    (31
    )
    
    
    
    
    
    
    
    
    
    
    969
    
    
    
    (31
    )Total temporarily impaired
securities
    
    $
    119,865
    
    
    $
    (2,031
    )
    
    $
    2,913
    
    
    $
    (10
    )
    
    $
    122,778
    
    
    $
    (2,041
    )
 The following table is a summary of the contractual maturities of investment
securities held to maturity and available for sale at December 31, 2003. These
amounts exclude mutual funds and equity securities, which have no contractual
maturities. Mortgage-backed securities consist of FHLMC, FNMA, and GNMA
certificates. Mortgage-backed and asset-backed securities are shown at their
final contractual maturity date but are expected to have shorter average
lives. Held to maturity
    
    Available for SaleWeighted
    
    
    
    
    
    
    
    
    
    WeightedAmortized
    
    Market
    
    Average
    
    Amortized
    
    Market
    
    AverageDecember 31, 2003
    
    Cost
    
    Value
    
    Yield
    
    Cost
    
    Value
    
    Yield(Dollars in Thousands)US Treasury & Agencies obligations:Within 1 year
    
    $
    2,011
    
    
    
    2,034
    
    
    
    3.36
    %
    
    
    16,016
    
    
    
    16,337
    
    
    
    3.77
    %1 to 2 years
    
    
    14,977
    
    
    
    15,799
    
    
    
    6.20
    
    
    
    4,999
    
    
    
    5,142
    
    
    
    3.892 to 3 years
    
    
    20,513
    
    
    
    20,470
    
    
    
    3.23
    
    
    
    
    
    
    
    
    
    
    
    3 to 5 years
    
    
    57,297
    
    
    
    57,186
    
    
    
    3.13
    
    
    
    
    
    
    
    
    
    
    
    5 to 10 years
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,146
    
    
    
    4,795
    
    
    
    3.2594,798
    
    
    
    95,489
    
    
    
    3.64
    
    
    
    26,161
    
    
    
    26,274
    
    
    
    3.69Mortgage-backed securities:Within 1 year
    
    
    627
    
    
    
    638
    
    
    
    8.56
    
    
    
    
    
    
    
    
    
    
    
    1 to 2 years
    
    
    1,076
    
    
    
    1,078
    
    
    
    6.27
    
    
    
    61
    
    
    
    63
    
    
    
    5.243 to 5 years
    
    
    366
    
    
    
    388
    
    
    
    7.13
    
    
    
    
    
    
    
    
    
    
    
    5 to 10 years
    
    
    36,445
    
    
    
    35,901
    
    
    
    3.62
    
    
    
    5,142
    
    
    
    5,112
    
    
    
    2.73After 10 years
    
    
    953
    
    
    
    964
    
    
    
    3.99
    
    
    
    1,655
    
    
    
    1,687
    
    
    
    3.9939,467
    
    
    
    38,969
    
    
    
    3.81
    
    
    
    6,858
    
    
    
    6,862
    
    
    
    3.06Asset-backed securities:3 to 5 years
    
    
    2,850
    
    
    
    2,959
    
    
    
    6.49
    
    
    
    
    
    
    
    
    
    
    
    5 to 10 years
    
    
    4,415
    
    
    
    4,424
    
    
    
    3.49
    
    
    
    1,826
    
    
    
    1,825
    
    
    
    1.81After 10 years
    
    
    25,470
    
    
    
    25,272
    
    
    
    3.29
    
    
    
    6,313
    
    
    
    6,266
    
    
    
    3.0032,735
    
    
    
    32,655
    
    
    
    3.60
    
    
    
    8,139
    
    
    
    8,091
    
    
    
    2.73Corporate obligations:Within 1 year
    
    
    5,540
    
    
    
    5,693
    
    
    
    5.60
    
    
    
    2,989
    
    
    
    3,070
    
    
    
    7.281 to 2 years
    
    
    1,038
    
    
    
    1,084
    
    
    
    4.84
    
    
    
    
    
    
    
    
    
    
    
    2 to 3 years
    
    
    1,085
    
    
    
    1,189
    
    
    
    7.92
    
    
    
    
    
    
    
    
    
    
    
    3 to 5 years
    
    
    7,999
    
    
    
    7,886
    
    
    
    3.19
    
    
    
    1,000
    
    
    
    992
    
    
    
    1.955 to 10 years
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,256
    
    
    
    2,166
    
    
    
    2.9815,662
    
    
    
    15,852
    
    
    
    4.48
    
    
    
    6,245
    
    
    
    6,228
    
    
    
    4.87Municipal obligations:Within 1 year
    
    
    1,624
    
    
    
    1,627
    
    
    
    2.92
    
    
    
    
    
    
    
    
    
    
    
    $
    184,286
    
    
    $
    184,592
    
    
    
    3.74
    %
    
    $
    47,403
    
    
    $
    47,455
    
    
    
    3.59
    %
 Issuers may have the right to call or prepay obligations with or without call
or prepayment penalties. This right may cause actual maturities and yields to
differ from the contractual maturities summarized above. As of December 31,
2003, the Company had callable investment securities with an amortized cost of
$10.0 million and a market value of $10.1 million in the held to maturity
portfolio which are callable during 2004. There were no callable investment
securities in the available for sale portfolio. 32




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##### Table of Contents

\

(3) Federal Home Loan Bank Stock The Bank is required to own stock of the Federal Home Loan Bank of Boston
(FHLB). The minimum investment is 5% of outstanding FHLB advances, or 1% of
outstanding residential mortgages, whichever is largest. The Bank receives an
amount equal to the par value of the stock when excess stock is redeemed. (4) Loans The components of the loan portfolio at December 31, follow: 2003
    
    2002(In Thousands)Residential real estate
    
    $
    57,017
    
    
    $
    60,140Loans held for sale
    
    
    338
    
    
    
    2,579Home equity
    
    
    10,236
    
    
    
    11,490Construction
    
    
    16,040
    
    
    
    23,502Commercial real estate
    
    
    112,503
    
    
    
    112,745Commercial business
    
    
    14,805
    
    
    
    32,017Consumer
    
    
    564
    
    
    
    654Total loans
    
    
    211,503
    
    
    
    243,127Allowance for loan losses
    
    
    (4,220
    )
    
    
    (4,167
    )$
    207,283
    
    
    $
    238,960
 The amounts above include net deferred loan origination fees and costs totaling
$81 thousand at December 31, 2003 and $153 thousand at December 31, 2002. Mortgage loans serviced by the Company for others amounted to $57.9 million and
$77.1 million at December 31, 2003 and 2002, respectively. There were no non-performing loans at December 31, 2003. Non-performing loans
at December 31, 2002 amounted to $1 thousand. There were no impaired loans at
December 31, 2003 and December 31, 2002. In the ordinary course of business, the Bank makes loans to its Directors and
Officers and their associates and affiliated companies (related parties) at
substantially the same terms and conditions as those prevailing at the time of
origination for comparable transactions with other borrowers. An analysis of total related party loans for the year ended December 31, 2003
follows: Balance at
    
    
    
    
    
    
    
    
    
    Balance atJanuary 1, 2003
    
    Additions
    
    Repayments
    
    December 31, 2003(In Thousands)$1,933
    
    $
    545
    
    
    $
    810
    
    
    $
    1,668
 The activity in the allowance for loan losses for the years ended December 31, follows: 2003
    
    2002
    
    2001(In Thousands)Balance at beginning of year
    
    $
    4,167
    
    
    $
    4,070
    
    
    $
    3,685Total charge-offs
    
    
    
    
    
    
    (1
    )
    
    
    (3
    )Total recoveries
    
    
    53
    
    
    
    98
    
    
    
    213Net recoveries
    
    
    53
    
    
    
    97
    
    
    
    210Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    175Balance at end of year
    
    $
    4,220
    
    
    $
    4,167
    
    
    $
    4,070
 33




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##### Table of Contents



(4) Loans  (continued) The following table summarizes the balances of mortgage service rights at
December 31: 2003
    
    2002(In Thousands)Balance at beginning of year
    
    $
    1,015
    
    
    $
    948Additions
    
    
    201
    
    
    
    336Amortization
    
    
    (728
    )
    
    
    (269
    )Mortgage servicing rights
    
    
    488
    
    
    
    1,015Valuation allowance
    
    
    (96
    )
    
    
    (377
    )Balance at end of year
    
    $
    392
    
    
    $
    638
 The following table summarizes activity in the mortgage service rights valuation allowance for the years ended December 31: 2003
    
    2002
    
    2001(In Thousands)Balance at beginning of year
    
    $
    377
    
    
    $
    75
    
    
    $
    (Recoveries) provision charged to operations
    
    
    (281
    )
    
    
    302
    
    
    
    75Balance at end of year
    
    $
    96
    
    
    $
    377
    
    
    $
    75
 The following table summarizes activity in the loan servicing rights net for the years ended December 31: 2003
    
    2002
    
    2001(In Thousands)Service fee income
    
    $
    216
    
    
    $
    269
    
    
    $
    281Amortization of mortgage servicing rights
    
    
    (728
    )
    
    
    (269
    )
    
    
    (158
    )Recoveries (provision) for valuation allowance
    
    
    281
    
    
    
    (302
    )
    
    
    (75
    )Mortgage servicing (expense) income
    
    
    (231
    )
    
    
    (302
    )
    
    
    48Late charges and other loan fees
    
    
    251
    
    
    
    157
    
    
    
    107Loan servicing fees, net
    
    $
    20
    
    
    $
    (145
    )
    
    $
    155
 (5) Bank Premises and Equipment The components of premises and equipment at December 31, follow: 2003
    
    2002(In Thousands)Premises
    
    $
    3,657
    
    
    $
    3,609Equipment
    
    
    2,648
    
    
    
    2,503Leasehold improvements
    
    
    408
    
    
    
    3786,713
    
    
    
    6,490Less accumulated depreciation and amortization
    
    
    (3,838
    )
    
    
    (3,440
    )$
    2,875
    
    
    $
    3,050
 Depreciation and amortization expense for the years ended December 31, 2003,
2002, and 2001 amounted to $398,000, $454,000, and $484,000, respectively. Rent expense for leased premises for the years ended December 31, 2003, 2002
and 2001 amounted to $152,000, $152,000 and $144,000, respectively. The
Company is obligated, under non-cancelable leases for premises and equipment,
for minimum payments in future periods of $166,000 in the year 2004, and
$182,000 for each of the years 2005 and 2006, $184,000 in the year 2007 and
$143,000 in the year 2008. 34




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##### Table of Contents



6) Deposits The following table shows the components of deposits at December 31, 2003 and
2002 and the range of interest rates paid as of December 31, 2003. Rates as ofDecember 31,2003
    
    2003
    
    2002(Dollars in Thousands)Interest bearing accounts:NOW and Super NOW accounts
    
    
    0.10-0.25
    %
    
    $
    36,108
    
    
    $
    35,568Savings accounts
    
    
    0.35
    %
    
    
    44,324
    
    
    
    44,839Money market investment accounts
    
    
    0.25-1.45
    %
    
    
    76,148
    
    
    
    64,653Certificates of deposit
    
    
    0.75-6.25
    %
    
    
    74,184
    
    
    
    92,241Retirement accounts
    
    
    0.75-6.25
    %
    
    
    27,666
    
    
    
    27,982Total interest bearing deposits
    
    
    
    
    
    
    258,430
    
    
    
    265,283Non-interest bearing demand deposit accounts
    
    
    
    
    
    
    14,110
    
    
    
    14,182$
    272,540
    
    
    $
    279,465
 The components of interest expense on deposits for the years ended December 31, follow: 2003
    
    2002
    
    2001(In Thousands)Now and Super NOW accounts
    
    $
    40
    
    
    $
    81
    
    
    $
    150Savings accounts
    
    
    200
    
    
    
    394
    
    
    
    725Money market investment accounts
    
    
    900
    
    
    
    1,097
    
    
    
    1,664Certificates of deposit
    
    
    2,088
    
    
    
    3,109
    
    
    
    5,908Retirement accounts
    
    
    948
    
    
    
    1,123
    
    
    
    1,482$
    4,176
    
    
    $
    5,804
    
    
    $
    9,929
 The amount and weighted average interest rate on certificates of deposit,
including retirement accounts, by periods to maturity at December 31, 2003 are
summarized as follows: Equal to
    
    
    
    
    
    WeightedLess
    
    and greater
    
    
    
    
    
    Averagethan
    
    than
    
    
    
    
    
    Interest$100,000
    
    $100,000
    
    Total
    
    Rate(Dollars in Thousands)3 months or less
    
    $
    18,027
    
    
    $
    5,312
    
    
    $
    23,339
    
    
    
    1.55
    %From three to six months
    
    
    13,656
    
    
    
    3,332
    
    
    
    16,988
    
    
    
    1.45From six to twelve months
    
    
    20,156
    
    
    
    4,403
    
    
    
    24,559
    
    
    
    2.05From one to two years
    
    
    19,605
    
    
    
    3,004
    
    
    
    22,609
    
    
    
    2.53From two to three years
    
    
    4,032
    
    
    
    985
    
    
    
    5,017
    
    
    
    4.14Three years and thereafter
    
    
    6,387
    
    
    
    2,951
    
    
    
    9,338
    
    
    
    3.64$
    81,863
    
    
    $
    19,987
    
    
    $
    101,850
    
    
    
    2.19
    %
 There were no brokered deposits at December 31, 2003. Brokered deposits at
December 31, 2002 totaled $2.0 million. 35




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##### Table of Contents



(7) Federal Home Loan Bank Advances and Other Borrowed Funds The FHLB permits member institutions to borrow funds for various purposes.
Outstanding advances at December 31, 2003 are collateralized by a blanket lien
against residential mortgages and other qualifying collateral. Advances outstanding at December 31, follow: 2003
    
    2002Weighted Average
    
    Weighted AverageMaturity
    
    Amount
    
    Interest Rate
    
    Amount
    
    Interest Rate(Dollars in Thousands)2003
    
    $
    
    
    
    
    
    %
    
    $
    15,275
    
    
    
    4.84
    %2004
    
    
    20,000
    
    
    
    4.73
    
    
    
    20,000
    
    
    
    4.732005
    
    
    6,000
    
    
    
    5.91
    
    
    
    6,000
    
    
    
    5.912006
    
    
    5,000
    
    
    
    4.69
    
    
    
    5,000
    
    
    
    4.692007
    
    
    15,000
    
    
    
    4.53
    
    
    
    15,000
    
    
    
    4.532009
    
    
    240
    
    
    
    6.42
    
    
    
    255
    
    
    
    6.422010
    
    
    20,000
    
    
    
    6.03
    
    
    
    20,000
    
    
    
    6.032011
    
    
    10,000
    
    
    
    4.93
    
    
    
    10,000
    
    
    
    4.932021
    
    
    2,626
    
    
    
    6.23
    
    
    
    2,707
    
    
    
    6.23$
    78,866
    
    
    
    5.19
    %
    
    $
    94,237
    
    
    
    5.13
    %
 Issuers may have the right to call or prepay obligations with or without call
or prepayment penalties. This right may cause actual maturities to differ from
the contractual maturities summarized above. As of December 31, 2003 the
Company had callable advances totaling $50.0 million and amortizing advances
totaling $2.9 million. The Company may enter into agreements to repurchase securities sold. These
agreements are treated as secured borrowings and the obligations to repurchase
securities sold are reflected as liabilities and the securities collateralized
by the agreements remain as assets. Generally, the outstanding collateral
consists of U.S. Treasury and Government Agency obligations and is held by
third party custodians. The components of other borrowed funds at December 31, follows: 2003
    
    2002(Dollars In Thousands)FHLB Short-term borrowings
    
    $
    52,000
    
    
    $
    Customer repurchase agreements
    
    
    2,486
    
    
    
    3,950Secured borrowings
    
    
    
    
    
    
    3,404$
    54,486
    
    
    $
    7,354
 Information relating to other borrowed funds for the years ended, follows: 2003
    
    2002
    
    2001Repurchase
    
    FHLB/FRB
    
    Repurchase
    
    FHLB/FRB
    
    Repurchase
    
    FHLB/FRBAgreements
    
    Advances
    
    Agreements
    
    Advances
    
    Agreements
    
    Advances(Dollars In Thousands)Outstanding at December 31
    
    $
    2,486
    
    
    $
    52,000
    
    
    $

    3,950
    
    
    $
    
    
    
    $
    4,220
    
    
    $
    Average balance outstanding during the year
    
    
    2,719
    
    
    
    12,152
    
    
    
    3,254
    
    
    
    41
    
    
    
    2,468
    
    
    
    21Maximum outstanding at any month end
    
    
    3,610
    
    
    
    52,000
    
    
    
    5,463
    
    
    
    
    
    
    
    5,836
    
    
    
    Weighted average rate at December 31
    
    
    0.50
    %
    
    
    1.10
    %
    
    
    0.75
    %
    
    
    
    %
    
    
    0.31
    %
    
    
    
    %Weighted average rate during the year
    
    
    0.62
    
    
    
    0.91
    
    
    
    0.58
    
    
    
    2.11
    
    
    
    2.35
    
    
    
    4.42
 36




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##### Table of Contents



(8) Income Taxes An analysis of income tax expense for the years ended December 31, follows: 2003
    
    2002
    
    2001(In Thousands)Current expense (benefit):Federal
    
    $
    1,095
    
    
    $
    (214
    )
    
    $
    65State
    
    
    476
    
    
    
    227
    
    
    
    146Total current expense
    
    
    1,571
    
    
    
    13
    
    
    
    211Deferred expense (benefit):Federal
    
    
    541
    
    
    
    1,791
    
    
    
    1,730State
    
    
    (24
    )
    
    
    (11
    )
    
    
    (11
    )Change in valuation reserve
    
    
    (1
    )
    
    
    18
    
    
    
    23Total deferred expense
    
    
    516
    
    
    
    1,798
    
    
    
    1,742Total income tax expense
    
    $
    2,087
    
    
    $
    1,811
    
    
    $
    1,953
 A reconciliation of the difference between the expected federal income tax
expense computed by applying the federal statutory rate of 34% to the amount of
actual income tax expense for the years ended December 31, follows: 2003
    
    2002
    
    2001(In Thousands)Expected federal income tax expense
    
    $
    2,116
    
    
    $
    1,670
    
    
    $
    1,805Items affecting expected tax:State income tax, net of federal benefit
    
    
    298
    
    
    
    143
    
    
    
    89Other
    
    
    (26
    )
    
    
    (20
    )
    
    
    36Change in valuation reserve
    
    
    (1
    )
    
    
    18
    
    
    
    23Change in estimate for tax contingencies
    
    
    (300
    )
    
    
    
    
    
    
    Total income tax expense
    
    $
    2,087
    
    
    $
    1,811
    
    
    $
    1,953
 The tax effects of temporary differences (the difference between financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis that give rise to deferred tax assets and liabilities for
the years ended December 31, follow: 2003
    
    2002(In Thousands)Deferred tax assets:Allowance for loan losses
    
    $
    2,464
    
    
    $
    2,464Net operating loss carryforward
    
    
    
    
    
    
    438Alternative minimum tax carryforward
    
    
    
    
    
    
    244Pension costs
    
    
    386
    
    
    
    379Deferred compensation
    
    
    486
    
    
    
    426Loan origination fees
    
    
    10
    
    
    
    37Depreciation
    
    
    318
    
    
    
    314Other
    
    
    248
    
    
    
    292Gross deferred tax asset
    
    
    3,912
    
    
    
    4,594Valuation reserve
    
    
    (55
    )
    
    
    (56
    )Deferred tax asset
    
    
    3,857
    
    
    
    4,538Deferred tax liabilities:Unrealized gains on investment securities available for sale
    
    
    (1
    )
    
    
    (350
    )Other
    
    
    (337
    )
    
    
    (502
    )Gross deferred tax liability
    
    
    (338
    )
    
    
    (852
    )Net deferred income tax asset
    
    $
    3,519
    
    
    $
    3,686
 Capital losses on the sale of securities resulted in capital loss
carryforwards. A deferred tax valuation allowance on capital loss
carryforwards is required to reduce the potential deferred tax asset when it is
more likely than not that all or some portion of the potential deferred tax
asset will not be realized due to the lack of sufficient capital gains in the
carryforward period. At December 31, 2003, the Company has $161 thousand of
capital loss carryforwards available that expire between 2004 and 2007. 37




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##### Table of Contents



(8) Income Taxes  (continued) At December 31, 2003, the Bank would need to generate approximately $10.4
million of future net taxable income to realize the net deferred income tax
asset. Management believes that it is more likely than not that the net
deferred income tax asset at December 31, 2003 will be realized based upon
recent operating results. It should be noted, however, that factors beyond Managements control, such as
the general state of the economy and real estate values, can affect future
levels of taxable income and that no assurance can be given that sufficient
taxable income will be generated to fully absorb gross deductible temporary
differences. The unrecaptured base year tax reserves as of October 31, 1998 will not be
subject to recapture as long as the institution continues to carry on the
business of banking. In addition, the balance of the pre-1988 bad debt tax
reserves continue to be subject to a provision of the current law that requires
recapture in the case of certain excess distribution to shareholders. The tax
effect of pre-1988 bad debt tax reserves subject to recapture in the case of
certain excess distributions is approximately $1.1 million. (9) Stockholders Equity The Company and the Bank are regulated by federal and state regulatory
agencies. Failure by the Company or the Bank to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by federal or state regulators that, if undertaken, could
have a direct material effect on the Companys Consolidated Financial
Statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors. Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of
Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to
average assets (Leverage ratio). There are two categories of capital under the
guidelines. Tier 1 capital as it applies to the Company and the Bank, includes
stockholders equity exclusive of the net unrealizable gains/losses on
investment securities available for sale and the deferred tax asset is
disallowed. Tier 2 capital includes the allowance for loan losses, subject to
guideline limitations. At December 31, 2003 and 2002, the Company and the Bank not only exceeded each
of the minimum capital requirements but also met the definition of well
capitalized as defined by the FRB and the FDIC under the regulatory framework
for prompt corrective action. To be categorized as well capitalized the
Company or the Bank must maintain Tier 1 Total, and Leverage ratios as set
forth in the table below. There are no conditions or events that management
believes have changed the Companys or the Banks classification as well
capitalized. The Companys and the Banks actual capital ratios and amounts at December 31, 2003 and 2002, follow: Risk-Based RatiosTier 1 Capital
    
    Total Capital
    
    Leverage Capital2003
    
    2002
    
    2003
    
    2002
    
    2003
    
    2002(Dollars in Thousands)Capital Ratios:Adequately capitalized
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    8.00
    %
    
    
    8.00
    %
    
    
    4.00
    %
    
    
    4.00
    %Well capitalized
    
    
    6.00
    %
    
    
    6.00
    %
    
    
    10.00
    %
    
    
    10.00
    %
    
    
    5.00
    %
    
    
    5.00
    %LSB Corporation
    
    
    19.25
    %
    
    
    16.49
    %
    
    
    20.50
    %
    
    
    17.74
    %
    
    
    12.11
    %
    
    
    12.10
    %Lawrence Savings Bank
    
    
    19.00
    %
    
    
    15.68
    %
    
    
    20.25
    %
    
    
    16.93
    %
    
    
    11.94
    %
    
    
    11.49
    %Capital Amounts:Adequately capitalizedLSB Corporation
    
    $
    11,421
    
    
    $
    12,799
    
    
    $
    22,842
    
    
    $
    25,599
    
    
    $
    18,163
    
    
    $
    17,445Lawrence Savings Bank
    
    
    11,392
    
    
    
    12,720
    
    
    
    22,784
    
    
    
    25,441
    
    
    
    18,125
    
    
    
    17,356Well capitalizedLSB Corporation
    
    
    17,132
    
    
    
    19,199
    
    
    
    28,553
    
    
    
    31,999
    
    
    
    22,703
    
    
    
    21,807Lawrence Savings Bank
    
    
    17,088
    
    
    
    19,081
    
    
    
    28,480
    
    
    
    31,801
    
    
    
    22,656
    
    
    
    21,695Actual Amounts:LSB Corporation
    
    
    54,969
    
    
    
    52,775
    
    
    
    58,546
    
    
    
    56,777
    
    
    
    54,969
    
    
    
    52,775Lawrence Savings Bank
    
    
    54,100
    
    
    
    49,869
    
    
    
    57,668
    
    
    
    53,846
    
    
    
    54,100
    
    
    
    49,869
 38




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##### Table of Contents



(9) Stockholders Equity  (continued) Stockholders Rights Plan In 1996, the Board of Directors adopted a stockholder rights plan declaring a
dividend of one preferred stock purchase right for each share of outstanding
common stock. The rights will remain attached to the common stock and are not
exercisable except under limited circumstances relating to (i) acquisition of
beneficial ownership of more than 10% of the outstanding shares of common
stock, or (ii) a tender offer or exchange offer that would result in a person
or group beneficially owning more than 10% of the outstanding share of common
stock. The rights are not exercisable until those aforementioned circumstances
occur. The rights expire in 2006. Until a right is exercised, the holder has no
rights to vote or to receive dividends. The rights are not taxable to
stockholders until exercisable. (10) Employee Benefits The Company provides pension benefits for its employees through membership in
the Savings Bank Employees Retirement Association (the Plan). The Plan is a
multiple-employer, non-contributory, defined benefit plan. Bank employees
become eligible after attaining age 21 and completing one year of service.
Additionally, benefits become fully vested after three years of eligible
service. The Companys annual contribution to the Plan is based upon standards
established by the Employee Retirement Income Security Act. The contribution is
based on an actuarial method intended to provide not only for benefits
attributable to service to date, but also for those expected to be earned in
the future. The Company expects to contribute approximately $372 thousand
during the Plan Year ending at October 31, 2004.
The following table sets forth the Plans funded status and amounts recognized
in the Companys Consolidated Financial Statements through the Plans latest
valuation dates which were October 31, 2003 and 2002. 2003
    
    2002(In Thousands)Change in benefit obligation:Benefit obligation at beginning of year
    
    $
    6,042
    
    
    $
    5,396Service cost
    
    
    355
    
    
    
    319Interest cost
    
    
    408
    
    
    
    377Actuarial loss
    
    
    332
    
    
    
    157Benefits paid
    
    
    (377
    )
    
    
    (207
    )Benefit obligation at end of year
    
    $
    6,760
    
    
    $
    6,042Change in plan assets:Fair value of plan assets at beginning of year
    
    $
    5,308
    
    
    $
    5,710Actual return on plan assets
    
    
    789
    
    
    
    (550
    )Employer contribution
    
    
    340
    
    
    
    355Benefits paid
    
    
    (377
    )
    
    
    (207
    )Fair value of plan assets at end of year
    
    $
    6,060
    
    
    $
    5,308Funded status
    
    $
    (700
    )
    
    $
    (734
    )Unrecognized net actuarial gain
    
    
    (168
    )
    
    
    (136
    )Unrecognized prior service cost
    
    
    (28
    )
    
    
    (32
    )Accrued benefit cost included in other liabilities
    
    $
    (896
    )
    
    $
    (902
    )Accumulated benefit obligation
    
    $
    4,424
    
    
    $
    4,127
 The discount rate and rate of increase in future compensation levels used in
determining the actuarial present value of the projected benefit obligation
were 6.25% and 4.50% for 2003 and 6.75% and 4.50% for 2002. The Plan assets are an integral part of the Companys defined benefit plan and
the asset mix between debt and equity securities plays an important factor in
the determination of the funded status and net periodic pension cost based on
Plan assumptions, interest rates and the overall economic climate. The
following table shows the allocation of assets between debt and equity for the
Plan as of October 31: 2003
    
    2002Debt securities
    
    
    45
    %
    
    
    38
    %Equity securities
    
    
    55
    %
    
    
    62
    %Total Plan assets
    
    
    100
    %

    
    
    100
    %
 39




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##### Table of Contents



(10) Employee Benefits  (continued) The Plans assets are distributed to Plan participants in the form of benefits.
The Plan paid $377 thousand and $207 thousand for the Plan years ended October
31, 2003 and 2002, respectively. The Company anticipates that the Plan is
expected to pay benefits of $355 thousand, $1.3 million, $96 thousand, $103
thousand and $209 thousand during the Plan year ended October 31, 2004, 2005,
2006, 2007 and 2008, respectively. The aggregate benefits expected to be paid
in the five-year period from 2009-2013 are $2.4 million. These expected
benefits to be paid are based on the same assumptions used to measure the
Companys benefit obligation at October 31, 2003 and include estimated future
employee services. Net pension cost components for the years ended October 31, follow: 2003
    
    2002
    
    2001(In Thousands)Service cost
    
    $
    355
    
    
    $
    319
    
    
    $
    280Interest cost
    
    
    408
    
    
    
    377
    
    
    
    360Expected return on plan assets
    
    
    (425
    )
    
    
    (456
    )
    
    
    (518
    )Amortization of net gains
    
    
    
    
    
    
    (81
    )
    
    
    (240
    )Net amortization and deferrals
    
    
    (4
    )
    
    
    (4
    )
    
    
    (4
    )Net periodic pension cost
    
    $
    334
    
    
    $
    155
    
    
    $
    (122
    )
 Assumptions used to develop the net periodic pension cost were: 2003
    
    2002
    
    2001Discount rate
    
    
    6.75
    %
    
    
    7.00
    %
    
    
    7.75
    %Rate of increase in compensation levels
    
    
    4.50
    
    
    
    4.50
    
    
    
    4.50Expected long-term rate of return on assets
    
    
    8.00
    
    
    
    8.00
    
    
    
    8.00
 In general, the Company has selected the assumptions with respect to the
expected long-term rate of return based on prevailing yields on high quality
debt securities increased by a premium of 3% to 5% for equity securities. The Company provides an employee savings plan (the Savings Plan) through the
Savings Banks Employees Retirement Association. The Savings Plan qualifies as
a deferred salary arrangement under Section 401(k) of the Internal Revenue
Code. Under the Savings Plan, employees may defer a portion of their pretax
earnings, up to the Internal Revenue Service annual contribution limit.
Employees are eligible to participate in the Savings Plan immediately upon
employment with the Company provided they have attained 21 years of age.
Company employees become eligible for matching contributions after completing
one year of service with 1,000 hours or more. On an annual basis, the Company
determines whether or not to contribute to the Savings Plan. The Company
contributed $55 thousand and $104 thousand on behalf of the employees who were
in the Savings Plan in 2003 and 2002, respectively. The Board offers options on its common stock to Directors, Management and
Officers to purchase unissued common stock of the Company at a price equal to
the fair market value of the Companys common stock on the date of grant. All
options expire ten years from the date of grant. Under the 1986 and 1997 Stock
Option Plans, the Company may grant options to Directors, Officers or employees
up to 859,100 of which 238,270 shares have been exercised. As of December 31,
2003, 505,730 options were outstanding with 114,100 available for future use.
The vesting schedule provided for 50% of options granted are vested after the
first year and an additional 25% vest each year thereafter. Options are fully
vested three years after the grant date.
The summary of the status of the Stock Option Plan as of December 31, and
changes during the years ended follow: 2003
    
    2002
    
    2001Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    Average
    
    
    
    
    
    AverageNumber of
    
    Exercise
    
    Number of
    
    Exercise
    
    Number of
    
    ExerciseOptions
    
    Price
    
    Options
    
    Price
    
    Options
    
    PriceOutstanding at beginning of year
    
    
    586,330
    
    
    $
    8.69
    
    
    
    601,030
    
    
    $
    8.63
    
    
    
    452,030
    
    
    $
    6.67Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    165,000
    
    
    
    13.87Exercised
    
    
    (71,600
    )
    
    
    6.83
    
    
    
    (14,700
    )
    
    
    6.32
    
    
    
    (14,750
    )
    
    
    7.00Canceled
    
    
    (9,000
    )
    
    
    13.90
    
    
    
    
    
    
    
    
    
    
    
    (1,250
    )
    
    
    9.13Outstanding at end of year
    
    
    505,730
    
    
    
    8.86
    
    
    
    586,330
    
    
    
    8.69
    
    
    
    601,030
    
    
    
    8.63Options exercisable end of year
    
    
    466,730
    
    
    
    8.44
    
    
    
    503,830
    
    
    
    7.84
    
    
    
    397,530
    
    
    
    6.42Weighted average fair value of
options granted during the year
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    5.47
 40




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(10) Employee Benefits  (continued) The following table summarizes information about the Stock Option Plans based
on a range of exercise prices as of December 31, 2003. Options Outstanding
    
    Options ExercisableWeighted
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    Average
    
    
    
    
    
    AverageNumber of
    
    Exercise
    
    Remaining
    
    Number of
    
    ExerciseRange of Exercise Price
    
    Options
    
    Price
    
    Life
    
    Options
    
    Price$2.00 to $5.00
    
    
    77,230
    
    
    $
    4.37
    
    
    
    0.7
    years
    
    
    77,230
    
    
    $
    4.37$5.01 to $8.00
    
    
    158,000
    
    
    
    6.06
    
    
    
    2.5
    
    
    
    158,000
    
    
    
    6.06$8.01 to $11.00
    
    
    119,000
    
    
    
    9.13
    
    
    
    5.6
    
    
    
    119,000
    
    
    
    9.13$11.01 to $14.00
    
    
    151,500
    
    
    
    13.87
    
    
    
    7.6
    
    
    
    112,500
    
    
    
    13.87Outstanding at end of year
    
    
    505,730
    
    
    
    8.86
    
    
    
    4.5
    
    
    
    466,730
    
    
    
    8.44
 In addition to the Companys defined benefit pension plan, the Company
sponsors a defined benefit post-retirement plan that provides limited
post-retirement medical benefits to certain full-time employees who retire
before age 65 and life insurance benefits to full-time employees who retire
after age 62 and after completing 10 years of service. The plan is
non-contributory. The Companys policy is to fund the cost of postretirement
benefits in amounts determined at the discretion of management.
The amounts of accrued postretirement benefit cost reported on the Companys
consolidated balance sheet were $338 thousand and $291 thousand as of December
31, 2003 and 2002, respectively. The Company has two supplemental executive retirement plans with one of its key
officers. At December 31, 2003 and 2002 the accrued liability was $1.2
million and $1.0 million, respectively. Expense associated with the plans was
$118 thousand, $143 thousand and $139 thousand for the years ended December 31,
2003, 2002 and 2001, respectively. (11) Contingencies The Bank is involved in various legal proceedings incidental to its business.
After review with legal counsel, management does not believe resolution of such
litigation will have a material adverse effect on the financial condition and
operating results of the Company. In one litigation matter, the Bank was awarded a $4.2 million judgment against
the debtor in 1997. On February 13, 2002, the debtor filed a petition in
bankruptcy under Chapter 7 of the Bankruptcy Code. Post-judgment interest
calculated from the date of judgment to the date of the bankruptcy filing is
approximately $1.9 million. In February 2004, the Bankruptcy Trustee filed a motion seeking Bankruptcy
Court approval to make an interim distribution to the creditors. After payment
to one other creditor and reserves for anticipated taxes and administrative
costs, the Trustee has proposed to make an interim distribution to the Bank of
approximately $2.6 million. The Bank has agreed to return any of the interim
distribution as would be necessary to pay additional taxes imposed on the
bankruptcy estate in the event reserves set aside for taxes are insufficient. The diluted earnings per share impact of the proposed interim distribution are
approximately $0.37 per share based on estimated average shares outstanding for
the first quarter of 2004. This distribution will be recognized in the
Companys reported financial results when the proposed interim distribution is
approved by the Bankruptcy court. It is managements opinion the collection of any remaining balance beyond the
amount of the proposed interim distribution is substantially uncertain and is
not susceptible to meaningful estimation at this time. Accordingly, no
recognition of this judgment or interim distribution has been recorded in the
Consolidated Financial Statements. (12) Financial Instruments with Off-Balance Sheet Risk The Company is a party to financial instruments with off-balance sheet risk.
These instruments, in the form of commitments to extend credit and financial
and standby letters of credit, are offered in the normal course of business to
meet the financing needs of customers. The company is exposed to varying
degrees of credit and interest rate risk in excess of amounts recognized in the
consolidated financial statements as a result of such transactions.
Commitments to extend credit are agreements to lend to a customer as long as
there is compliance with conditions established in the agreement. These
extensions of credit are based upon traditional underwriting standards and
generally have a fixed expiration date of less than five years. Letters of credit are documents issued by the Company on behalf of its
customers in favor of third parties, who can present requests for drafts from
the Company within specified terms and conditions. Letters of credit are
secured by cash deposits. Standby letters of credit are conditional
commitments issued by the Company to guarantee payment to a third party.
Outstanding letters of credit generally expire within one year. The credit
risk involved with these instruments is similar to the risk of extending loans
and, accordingly, the underwriting standards are also similar. It is expected
that most letters of credit will not require cash disbursements. 41




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(12) Financial Instruments with Off-Balance Sheet Risk  (continued) The components of financial instruments with off-balance sheet risk at December
31, follow: Fixed
    
    Variable2003
    
    Rate
    
    Rate
    
    Total(In Thousands)Financial instruments with contract amounts represent credit risk:Unused commitments to extend credit:Residential mortgages
    
    $
    1,327
    
    
    $
    377
    
    
    $
    1,704Home equity lines of credit
    
    
    1,615
    
    
    
    7,737
    
    
    
    9,352Personal lines of credit
    
    
    165
    
    
    
    
    
    
    
    165Commercial real estate mortgage
    
    
    6
    
    
    
    6,502
    
    
    
    6,508Construction
    
    
    
    
    
    
    17,160
    
    
    
    17,160Commercial loans
    
    
    10
    
    
    
    18,416
    
    
    
    18,426Total unused commitments
    
    $
    3,123
    
    
    $
    50,192
    
    
    $
    53,315Letters of credit and standby letters of credit
    
    $
    
    
    
    $
    851
    
    
    $
    851Forward commitments to sell mortgage loans
    
    $
    340
    
    
    $
    
    
    
    $
    340
 Fixed
    
    Variable2002
    
    Rate
    
    Rate
    
    Total(In Thousands)Financial instruments with contract amounts represent credit risk:Unused commitments to extend credit:Residential mortgages
    
    $
    2,866
    
    
    $
    1,311
    
    
    $
    4,177Home equity lines of credit
    
    
    1,919
    
    
    
    6,342
    
    
    
    8,261Personal lines of credit
    
    
    223
    
    
    
    
    
    
    
    223Commercial real estate mortgage
    
    
    3,199
    
    
    
    9,748
    
    
    
    12,947Construction
    
    
    345
    
    
    
    11,296
    
    
    
    11,641Commercial loans

    
    
    9,062
    
    
    
    16,669
    
    
    
    25,731Total unused commitments
    
    $
    17,614
    
    
    $
    45,366
    
    
    $
    62,980Letters of credit and standby letters of credit
    
    $
    
    
    
    $
    1,120
    
    
    $
    1,120Forward commitments to sell mortgage loans
    
    $
    5,349
    
    
    $
    
    
    
    $
    5,349
 Forward commitments to sell mortgage loans are contracts which the Company
enters into for the purpose of reducing the interest rate risk associated with
originating loans held for sale. Risk may arise from the possible inability of
the Company to originate loans to fulfill the contracts. (13) Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate
that value: Cash and Due From Banks, Short-Term Investments, Stock in Federal Home Loan
Bank of Boston, Accrued Interest Receivable and Accrued Interest Payable. The carrying amount of each of these assets and liabilities is a reasonable
estimate of fair value. Investment Securities For investment securities, fair values are based on quoted market prices or
dealer quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities. Loans Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as commercial, commercial
real estate, residential mortgage, and other consumer. Each loan category is
further segmented into fixed and adjustable rate interest terms and by
classified and non-classified categories. The fair value of non-classified loans is calculated by discounting scheduled
cash flows through the expected maturity using current rates at which similar
loans would be made to borrowers with similar credit ratings. For
non-classified residential mortgage loans, maturity estimates are based on
secondary market sources. 42




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##### Table of Contents



(13) Fair Value of Financial Instruments  (continued) Fair value for significant classified loans is based on recent external
appraisals. If appraisals are not available, estimated cash flows are
discounted using a rate commensurate with the risk associated with the
estimated cash flows. Assumptions regarding credit risk, cash flows, and
discount rates are judgmentally determined using available market information
and specific borrower information. Deposits and Mortgagors Escrow Accounts The fair value of demand deposits, NOW accounts, money market deposit accounts,
savings accounts, and mortgage escrow accounts of borrowers is the amount
payable on demand at the balance sheet date. The fair value of certificates of
deposit is based on the discounted value of contractual cash flows. The
discount rate is estimated using the rates currently offered for deposits of
similar remaining maturities. Borrowed Funds The fair value of borrowed funds is determined as the cost of extinguishing the
debt inclusive of any and all prepayment penalties. The prepayment penalties
are determined by the Federal Home Loan Bank of Boston. The estimated fair values of the Banks financial instruments at December 31, follow: 2003
    
    2002Carrying
    
    Fair
    
    Carrying
    
    FairValue
    
    Value
    
    Value
    
    Value(In Thousands)Financial assets:Cash and due from banks
    
    $
    7,872
    
    
    $
    7,872
    
    
    $
    7,136
    
    
    $
    7,136Short-term investments
    
    
    889
    
    
    
    889
    
    
    
    9,633
    
    
    
    9,633Investment securities
    
    
    232,878
    
    
    
    233,184
    
    
    
    166,409
    
    
    
    169,405Federal Home Loan Bank stock
    
    
    6,593
    
    
    
    6,593
    
    
    
    5,950
    
    
    
    5,950Accrued interest receivable
    
    
    2,552
    
    
    
    2,552
    
    
    
    2,459
    
    
    
    2,459Loans, net
    
    
    207,283
    
    
    
    210,457
    
    
    
    238,960
    
    
    
    240,311Financial liabilities:Deposits
    
    $
    272,540
    
    
    $
    273,248
    
    
    $
    279,465
    
    
    $
    281,216Borrowed funds
    
    
    133,352
    
    
    
    139,039
    
    
    
    101,591
    
    
    
    107,134Mortgagors escrow accounts
    
    
    450
    
    
    
    450
    
    
    
    518
    
    
    
    518Accrued interest payable
    
    
    369
    
    
    
    369
    
    
    
    431
    
    
    
    431
 Fair Value of Financial Instruments Off-Balance-Sheet Financial Instruments Off-balance sheet financial instruments generally have interest rates which
reflect current market rates. Management has determined that the difference between the carrying and fair
value of these instruments is not material. Limitations Fair value estimates are made at a specific point in time, based on relevant
market information about the financial instrument. These estimates do not
reflect any premium or discount that could result from offering for sale at one
time the Companys entire holdings of a particular financial instrument.
Because no active market exists for a portion of the Companys financial
instruments, fair value estimates are based on judgments regarding future
expected loss experience, current economic conditions, risk characteristics of
various financial instruments, and other factors. These estimates are
subjective in nature and involve uncertainties and matters of significant
judgment and therefore cannot be determined with precision. Changes in assumptions and market conditions could significantly affect these
estimates. Fair value estimates are based on existing on and off-balance-sheet financial
instruments without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments. Other significant assets that are not considered
financial assets include other real estate acquired, banking premises and
equipment, and core deposit and other intangibles. In addition, the tax
ramifications related to the realization of the unrealized gains and losses can
have a significant effect on fair value estimates and have not been considered
in any of the estimates. 43




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##### Table of Contents



(14) Condensed Parent Company Financial Statements The condensed financial statements for LSB Corporation, referred to as the
Parent Company for purposes of this Note only at and for the year ended
December 31, follow: Balance Sheets
    
    2003
    
    2002(In Thousands)Assets:Cash deposits in subsidiaries
    
    $
    159
    
    
    $
    958Investment securities held to maturity at amortized cost
    
    
    500
    
    
    
    1,999Investment in subsidiary, at equity
    
    
    54,133
    
    
    
    51,045Other assets
    
    
    217
    
    
    
    61Total assets
    
    $
    55,009
    
    
    $
    54,063Liabilities and Stockholders Equity:Liabilities:Accrued income taxes
    
    $
    (17
    )
    
    $
    (4
    )Accrued expenses
    
    
    24
    
    
    
    8Total liabilities
    
    
    7
    
    
    
    4Total stockholders equity
    
    
    55,002
    
    
    
    54,059Total liabilities and stockholders equity
    
    $
    55,009
    
    
    $
    54,063
 Statements of Operations
    
    2003
    
    2002
    
    2001(In Thousands)Dividends from bank subsidiary
    
    $
    518
    
    
    $
    4,547
    
    
    $
    3,320Total operating income
    
    
    518
    
    
    
    4,547
    
    
    
    3,320Non-interest expenses
    
    
    180
    
    
    
    235
    
    
    
    188Income before income taxes and undistributed earnings
    
    
    338
    
    
    
    4,312
    
    
    
    3,132Income tax benefit
    
    
    (51
    )
    
    
    (50
    )
    
    
    (7
    )Income before undistributed earnings of subsidiary
    
    
    389
    
    
    
    4,362
    
    
    
    3,139Equity in undistributed earnings of subsidiary
    
    
    3,747
    
    
    
    (1,262
    )
    
    
    218Net income
    
    $
    4,136
    
    
    $
    3,100
    
    
    $
    3,357
 The Parent Companys statements of changes in stockholders equity are
identical to the consolidated statements of changes in stockholders equity and
therefore are not presented here. Cash flows
    
    2003
    
    2002(In Thousands)Cash flows from operating activities:Net income
    
    $
    4,136
    
    
    $
    3,100Adjustments to reconcile net income to net cash provided by operating activities:Increase in deferred income tax asset
    
    
    
    
    
    
    (43
    )Net distributed earnings of subsidiaries
    
    
    (3,747
    )
    
    
    1,262(Increase) decrease in other assets
    
    
    (156
    )
    
    
    26Increase (decrease) in other liabilities
    
    
    3
    
    
    
    (12
    )Accretion of discounts
    
    
    (18
    )
    
    
    (47
    )Net cash provided by operating activities
    
    
    218
    
    
    
    4,286Cash flows from investing activities:Purchases of investment securities held to maturity
    
    
    (20,833
    )
    
    
    (50,153
    )Proceeds from maturities of investment securities held to maturity
    
    
    22,350
    
    
    
    50,200Net cash provided by investing activities
    
    
    1,517
    
    
    
    47Cash flows from financing activities:Proceeds from exercise of stock options
    
    
    511
    
    
    
    33Treasury stock purchased
    
    
    (1,022
    )
    
    
    (1,736
    )Dividends paid
    
    
    (2,023
    )
    
    
    (1,920
    )Net cash provided by financing activities
    
    
    (2,534
    )
    
    
    (3,623
    )Net (decrease) increase in cash and cash equivalents
    
    
    (799
    )
    
    
    710Cash and cash equivalents, beginning of year
    
    
    958
    
    
    
    248Cash and cash equivalents, end of year
    
    $
    159
    
    
    $
    958Supplemental cash flow information:Cash paid during the year for:Income taxes
    
    $
    5
    
    
    $
    30
 44




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##### Table of Contents



(15) Quarterly Results of Operations (Unaudited) 2003March
    
    June
    
    September
    
    December31
    
    30
    
    30
    
    31(In Thousands, Except Per Share Data)Interest and dividend income
    
    $
    5,662
    
    
    $
    5,314
    
    
    $
    4,977
    
    
    $
    5,381Interest expense
    
    
    2,399
    
    
    
    2,316
    
    
    
    2,165
    
    
    
    2,097Net interest income
    
    
    3,263
    
    
    
    2,998
    
    
    
    2,812
    
    
    
    3,284Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net interest income after provision for loan losses
    
    
    3,263
    
    
    
    2,998
    
    
    
    2,812
    
    
    
    3,284Non-interest income
    
    
    280
    
    
    
    383
    
    
    
    658
    
    
    
    287Lawsuit judgment collected
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,996Non-interest expense
    
    
    2,672
    
    
    
    2,372
    
    
    
    2,417
    
    
    
    2,277Income before income tax
    
    
    871
    
    
    
    1,009
    
    
    
    1,053
    
    
    
    3,290Income tax
    
    
    321
    
    
    
    374
    
    
    
    399
    
    
    
    993Net income
    
    $
    550
    
    
    $
    635
    
    
    $
    654
    
    
    $
    2,297Basic earnings per share
    
    $
    0.13
    
    
    $
    0.15
    
    
    $
    0.16
    
    
    $
    0.54Diluted earnings per share
    
    $
    0.13
    
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.52
 2002March
    
    June
    
    September
    
    December31
    
    30
    
    30
    
    31(In Thousands, Except Per Share Data)Interest and dividend income
    
    $
    6,421
    
    
    $
    6,480
    
    
    $
    6,158
    
    
    $
    6,079Interest expense
    
    
    3,103
    
    
    
    2,936
    
    
    
    2,923
    
    
    
    2,603Net interest income
    
    
    3,318
    
    
    
    3,544
    
    
    
    3,235
    
    
    
    3,476Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net interest income after provision for loan losses
    
    
    3,318
    
    
    
    3,544
    
    
    
    3,235
    
    
    
    3,476Non-interest income
    
    
    429
    
    
    
    349
    
    
    
    323
    
    
    
    392Non-interest expense
    
    
    2,459
    
    
    
    2,601
    
    
    
    2,529
    
    
    
    2,566Income before income tax
    
    
    1,288
    
    
    
    1,292
    
    
    
    1,029
    
    
    
    1,302Income tax
    
    
    472
    
    
    
    473
    
    
    
    334
    
    
    
    532Net income
    
    $
    816
    
    
    $
    819
    
    
    $
    695
    
    
    $
    770Basic earnings per share
    
    $
    0.19
    
    
    $
    0.19
    
    
    $
    0.16
    
    
    $
    0.18Diluted earnings per share
    
    $
    0.18
    
    
    $
    0.18
    
    
    $
    0.15
    
    
    $
    0.17
 45




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##### Table of Contents



Stockholders Information The Companys stock
trades on the Nasdaq Stock Market under the symbol LSBX.
Sales prices of the stock are reported in The Wall Street Journal as
LSXCorp.
Prior to July 1, 2001, the Banks common stock traded on the Nasdaq stock
market under the symbol LSBX. Prices of the Banks common stock were
reported in The Wall Street Journal as LawrenceSvg. The following table sets forth for the fiscal periods indicated certain
information with respect to the sales prices of the Companys common stock. PriceFiscal Year
    
    High
    
    Low2003First Quarter
    
    $
    13.00
    
    
    $
    12.01Second Quarter
    
    
    17.40
    
    
    
    12.60Third Quarter
    
    
    17.52
    
    
    
    15.31Fourth Quarter
    
    
    17.99
    
    
    
    16.002002First Quarter
    
    $
    13.20
    
    
    $
    12.00Second Quarter
    
    
    14.02
    
    
    
    12.26Third Quarter
    
    
    14.00
    
    
    
    12.00Fourth Quarter
    
    
    13.51
    
    
    
    11.002001First Quarter
    
    $
    11.86
    
    
    $
    9.81Second Quarter
    
    
    13.65
    
    
    
    10.50Third Quarter
    
    
    14.00
    
    
    
    9.81Fourth Quarter
    
    
    13.10
    
    
    
    10.11
 The Company declared and paid a cash dividend of $0.48 per share ($0.12 in each
quarter) during 2003. The Company expects to pay dividends during 2004. On December 31, 2003 there were approximately 1,006 holders of common stock.
This number does not reflect the number of persons or entities who hold their
stock in nominee or street name through various brokerage firms. The Annual Meeting of the stockholders of LSB Corporation will be held at 10:00
a.m. on Tuesday, May 4, 2004 at the Andover Country Club, Canterbury Street,
Andover, Massachusetts. Corporate Headquarters
LSB Corporation
30 Massachusetts Avenue
North Andover, MA 01845-3460Mailing Address
30 Massachusetts Avenue
North Andover, MA 01845-3460Investor Relations
Barbara A. Biondo
Telephone (978) 725-7556
Fax (978) 725-7593 A copy of the Companys Form 10-K as filed with the Securities and Exchange
Commission pursuant to the Securities and Exchange Act of 1934, is available
without charge upon written request to Investor Relations. Transfer Agent
EquiServe
P.O. Box 43010
Providence, RI 02940-3010 Independent Auditors
KPMG LLP
99 High Street
Boston, MA 02110 Legal Counsel
Goulston & Storrs, P.C.
400 Atlantic Avenue
Boston, MA 02110-3333 46




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##### Table of Contents



Directors Of
LSB Corporation and
Lawrence Savings Bank Eugene A. Beliveau, D.D.S.Dentist Kathleen Boshar ReynoldsPrudential/Howe and Doherty Malcolm W. BrawnExecutive Vice President & SecretaryThe Andover Companies Thomas J. BurkeChairman of the BoardLawrence Savings BankRegister of DeedsAttorney Byron R. Cleveland, Jr.PresidentJ. H. Horne & Sons Neil H. CullenChief Financial OfficerPhillips Academy Richard Hart Harrington, CPAChairmanGordon, Harrington & Osborn, P.C. Robert F. HatemBusiness Consultant Marsha A. McDonoughEducation Consultant Paul A. MillerPresident andChief Executive OfficerLawrence Savings Bank andLSB Corporation Officers of
LSB Corporation Paul A. MillerPresident andChief Executive Officer John E. SharlandSenior Vice President, Treasurer andChief Financial Officer Barbara A. BiondoSecretary Richard J. DAmbrosioAssistant Treasurer
Timothy L. FelterAssistant Treasurer andInvestment Officer Jeffrey W. LeedsAssistant Treasurer 47




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##### Table of Contents



Officers of
Lawrence Savings Bank Paul A. MillerPresident andChief Executive Officer Barbara A. BiondoClerk Carla M. FriedrichVice President andHuman Resources Officer Robyn K. LeBuffVice President andMarketing Officer Brenda MiskinisAssistant Vice President andMarketing Officer Lending DivisionJeffrey W. LeedsExecutive Vice President andChief Lending Officer Commercial BankingJacob KojaloSenior Vice President andSenior Lending Officer Robert J. DeLucaVice President Steven K. VentreVice President Scott P. McDuffeeCommercial Credit Officer Commercial Real Estate LendingFrederick P. MaloofVice President Paul M. VallaceVice President Credit Policy and AdministrationLee. D. DickeySenior Vice President John P. MalynnVice President Linda A. BaileyAssistant Vice President andCredit Administration Officer Consumer LendingMaureen McCarthyVice President andCompliance/CRA Officer Residential Mortgage LendingJohn P. TeoliVice President Susan M. CainAssistant Vice President andSenior Mortgage Underwriter Finance DivisionJohn E. SharlandSenior Vice President, Treasurer andChief Financial Officer Linda M. Chase BorrelliVice President and Controller Personal Banking DivisionTimothy L. FelterExecutive Vice President andInvestment Officer Gayle M. FiliVice President and BranchAdministration/Security Officer Cheryl A. ParentVice President andBranch Manager Susan M. DancauseAssistant Vice President andRetirement Services Officer Linda BuellAssistant Vice President andBranch Manager Paul M. FrankBranch Manager Carrie HigginbottomBranch Manager Johanny RodriguezBranch Manager Support Service DivisionRichard J. DAmbrosioSenior Vice President Carmela A. CutuliVice President andLoan Servicing Manager Cheryl A. ViningVice President andDeposit Servicing Manager Stanley R.Ward, Jr.Assistant Vice President Laura LaVoieAssistant Vice PresidentSenior Computer Network Engineer 46




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##### Table of Contents



Corporate Headquartersof LSB Corporation 30 Massachusetts Avenue
North Andover, MA 01845-3460
(978) 725-7500 Banking Offices ofLawrence Savings Bank Main Office:
30 Massachusetts Avenue
North Andover, MA 01845-3460
(978) 725-7500
Fax: (978) 725-7607 Branch Offices:
342 North Main Street
Andover, MA 01810
(978) 725-7590 300 Essex Street
Lawrence, MA 01840
(978) 725-7530 20 Jackson Street
Methuen, MA 01844
(978) 725-7545 148 Lowell Street
Methuen, MA 01844
(978) 725-7570 Lawrence Savings Bank
24 Hour Information
Phone: (978) 725-7700 Remote ATM Location: 36 Knipe Road
Haverhill, MA 01835 www.LawrenceSavings.com Member
FDIC
Member
DIF This Annual Report is printed on recycled paper.
    LSBCM-AR-03