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standards. Bank regulators use a number of different analytics to determine the strength ofbank capital. In current vogue with the financial press is tangible capital to total assets. Manyof the largest banks frequently in the headlines have ratios well below 4%. Commentators andregulators have indicated that a reasonable minimum level for safe operation should be 4%.     Bank regulators count the recently distributed CPP preferred stock funds as regulatorycapital. Including the Company’s recently acquired $15 million of those funds, the Company’stangible capital to total assets ratio is a robust 9.0% at year-end. Should the Company returnthose funds or, should the reader not really consider those funds as capital, the Company’stangible capital ratio is still a very strong 7.1%.**Market Expansion**     In January 2009, we expanded our geographic market with a new branch in Derry, New Hampshire.It is already living up to hopes for deposit generation. Elsewhere throughout the branches,deposits are also increasing. We are benefiting from both a secular shift by the public out ofriskier investments into the safety of bank deposits and from a gain in deposit market share. Inthe quarter ended September 30, 2008, the most recent period for which competitive data isavailable, our core deposits grew by 23% and total deposits by 24% versus 4% and 5%, respectively,for all bank deposits in Essex County.**Federal Government Action**     Between December 2007 and March 2008, the Bank purchased approximately $10 million of newlyissued preferred stock equally divided between Fannie Mae and Freddie Mac, both U.S. Governmentsponsored agencies. The offerings were S&P rated AA- and Moody’s rated Aa3, the second highestinvestment grades. They were upgraded to the highest rating of AAA on March 21, 2008. Both issueshad been outstanding for only nine months and had paid only two quarterly dividends when onSeptember 12, 2008, the U.S. Treasury placed both Fannie Mae and Freddie Mac into conservatorship.The Treasury also suspended payments of all preferred stock dividends, effectively destroying theirvalue. Hundreds of community banks across the country owned an estimated $16 billion of thepreferred shares. At a time when the Treasury was concerned with increasing bank capital tosupport increased lending, this one misguided action probably destroyed more capital in more banksat one time than any other single event ever. This loss of bank capital was the ultimate cause ofseveral bank failures and hurried mergers across the country. It worked at exactly cross-purposesto the Treasury’s overriding goal of increasing bank capital to support increased bank lending.     After providing immediate, much-needed capital for several ailing, major financial andautomotive firms, the U.S. Treasury Department created the Capital Purchase Program (“CPP”) withinTARP. The expressed purpose of this voluntary program was to provide additional regulatory capitalto strong, healthy banks across the country in order to increase their ability to make loans.     Management and the Boards of the Company and the Bank deliberated extensively over theadvisability of applying for CPP funding. In November, 2008, qualifying banks were
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encouraged toapply for the funds. Because loan conduits have disappeared from the market and because severallarge, multi-national competitors have reduced their lending activity in our market, the Bank hasbeen presented with increased credit-worthy lending opportunities. To take advantage of thoseimproved opportunities with their increased earnings potential and to better serve the localcommunity, the Company applied for and was awarded $15 million of regulatory capital in the form ofpreferred stock. That $15 million was quickly put to work supporting in excess of $15 million ofnew loans.     In a very short time, both the media and political leaders in Washington have twisted aprogram available only to healthy banks into a perceived bail-out program for weak banks. To addinsult to injury, as part of the February 2009 stimulus legislation Congress added severeafter-the-fact restrictions on all banks receiving TARP funding and made no distinction betweenlarge troubled banks needing TARP funding to survive and healthy banks in CPP that were encouragedto accept funding to stimulate economic activity. What we entered as a positive program supportingincreased loan growth to benefit both the Bank and our local economy has turned into a negativerestricting our ability to operate successfully and putting our reputation for strength at risk.Management and the Board of Directors are presently considering whether the Company is betterserved by returning the TARP funding earlier than anticipated and exiting the program.**Earnings**     Hopefully, the discussion above has conveyed the impression that activities and results withinour control were positive for the year but that extraneous events, chiefly the loss in Fannie Maeand Freddie Mac preferred shares, overwhelmed otherwise respectable results. ReconstructingCompany earnings without the impact of that single investment loss would show a significantincrease in 2008 earnings over 2007. It is discouraging to have seen the agreed upon strategy andtactics for the year executed well and yet still report a loss of $2.7 million.**Prospects for 2009**     As we begin 2009, the Company’s balance sheet is strong. Loan delinquencies are minimal andinvestments are conservative and highly rated (for whatever that is worth). Because of thedisappearance of conduit lenders and the seeming withdrawal from the market of the largemulti-national banks, loan demand remains robust and offers us the opportunity to carefully growthe corporate loan portfolio, selecting from numerous potential borrowers. New loans are writtenat attractive rates and with floors on the rates charged.     Almost all of our existing repricing loans and assets have already repriced to current levelsand it is hard to envision prime or other indices moving lower from here. Thus, yield on assetsshould have stabilized. The prospect of loan yields rising slowly based on the higher rates of newcommercial lending activity may be offset by retail mortgage loans being prepaid and rewritten atsomewhat lower rates. Deposit costs, which always lag asset yields in a decliningrate environment, are trending down. The combination of stable asset yields and fallingliability costs gives hope for an increasing spread.
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**More Clouds from Washington**     Again in 2009, events under our own control portend well while action by governmental entitiespose significant threats. The FDIC is looking to replenish its coffers from losses in numerousbank failures by massively increasing insurance premiums on the remaining banks across the country.This large increase in our operating costs is exacerbated by a significant reduction in earningsfrom the cessation of all dividends on our Federal Home Loan Bank of Boston stock.     The worsening economic climate makes it difficult enough to plan and operate. The gyrationsand unexpected actions by various governmental agencies further complicate planning and diminishearnings. Nevertheless, the Company has the financial strength to both weather these storms andselectively seize opportunities for future growth and improved market position so that when betterdays arrive, the Company’s prospects will be that much greater.**Closing**     Our goals for 2009 are to maintain the momentum of increasing both local, especially core,deposits and local, credit-worthy loans. Of course, the platform and necessary precondition forcontinued balance sheet expansion is a strong capital base. Given the threat to the investment andloan portfolios that continuing deterioration of the national and local economies presents, thepreservation of a strong capital position must take precedence over all other uses of capital,including dividends.     I wish to thank the Directors and employees for the dedication of their talents and theexpenditure of their time and conscientious effort to improve the Company by serving well ourcustomers and local communities. I also wish to thank our shareholders for their continuedsupport.      Very truly yours,