**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.**

**FORM 10-K**

(Annual Report Under Section 13of the Securities Exchange Act of 1934)

For the fiscal year ended December 31,2005

Commission File No. 001-16101

**BANCORP RHODE ISLAND, INC.**

(Exact Name of Registrantas Specified in Its Charter)

| **Rhode Island**                 |   | **05-0509802**       |
|----------------------------------|--------|----------------------|
| (State or Other  Jurisdiction of |   | (IRS Employer        |
| Incorporation or  Organization)  |   | Identification  No.) |

 

**ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903**

(Address of Principal ExecutiveOffices)

**(401) 456-5000**

(Issuer’s TelephoneNumber, Including Area Code)

**Securitiesregistered pursuant to Section 12(b) of the Act:  None**

**Securitiesregistered pursuant to Section 12(g) of the Act:**

Common Stock, par value $0.01 per share

(Title of Class)

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. .    Yes    o    No    x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.    Yes    o   No    x

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13of the Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the Registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.Yes    x No   o

Indicate by checkmark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statement incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer, as defined in Section 12b-2 of the ExchangeAct of 1934.

Large acceleratedfiler o          Acceleratedfiler x           Non-acceleratedfiler o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Act).Yes    o    No    x

As of June 30, 2005,the aggregate market value of the voting common equity of the Registrant heldby non-affiliates of the Registrant, based on the closing price on the NasdaqStock Market was $124,344,181.

As of February 28,2006, there were 4,755,886 shares of common stock (par value $0.01 per share)of the Registrant issued and outstanding.

**Documents incorporated byreference:**

Portions of Bancorp RhodeIsland’s Definitive Proxy Statement for the 2006 Annual Meeting of Shareholdersare incorporated by reference into Parts II and III of this Form 10-K.

See pages 56-58 forthe exhibit index.

 

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**Bancorp Rhode Island, Inc.**

**Annual Report on Form 10-K**

**Table of Contents**

| Description   | ** ** | ** ** | ** ** | ** **                                                                                                         | ** ** | **Page  Number** |
|---------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|------------------|
| Part I.  |       | Item 1     | —     | Business                                                                                                           |       | 1                |
|          |       | Item 1A    | —     | Risk Factors                                                                                                       |       | 15               |
|          |       | Item 1B    | —     | Unresolved Staff Comments                                                                                          |       | 20               |
|          |       | Item 2     | —     | Properties                                                                                                         |       | 20               |
|          |       | Item 3     | —     | Legal Proceedings                                                                                                  |       | 21               |
|          |       | Item 4     | —     | Submission of Matters to a Vote of Security Holders                                                                |       | 21               |
| Part II. |       | Item 5     | —     | Market for the Company’s Common Stock, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       | 22               |
|          |       | Item 6     | —     | Selected Consolidated Financial Data                                                                               |       | 23               |
|          |       | Item 7     | —     | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       | 24               |
|          |       | Item 7A    | —     | Qualitative and Quantitative Disclosures About Market  Risk                                                        |       | 51               |
|          |       | Item 8     | —     | Financial Statements and Supplementary Data                                                                        |       | 53               |
|          |       | Item 9     | —     | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |       | 53               |
|          |       | Item 9A    | —     | Controls and Procedures                                                                                            |       | 53               |
|          |       | Item  9B   | —     | Other  Information                                                                                                 |       | 53               |
| Part III |       | Item 10    | —     | Directors and Executive Officers of the Company                                                                    |       | 54               |
|          |       | Item 11    | —     | Executive Compensation                                                                                             |       | 55               |
|          |       | Item 12    | —     | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |       | 55               |
|          |       | Item 13    | —     | Certain Relationships and Related Transactions                                                                     |       | 55               |
|          |       | Item 14    | —     | Principal Accountant Fees and Services                                                                             |       | 55               |
| Part IV  |       | Item 15    | —     | Exhibits and Financial Statement Schedules                                                                         |       | 56               |
|          |       | Signatures |       | 59                                                                                                                 |

 

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**PART I**

**SPECIALNOTE REGARDING FORWARD LOOKING STATEMENTS**

We make certainforward looking statements in this Annual Report on Form 10-K and inother documents that we incorporate by reference into this report that arebased upon our current expectations and projections about current events. Weintend these forward looking statements to be covered by the safe harborprovisions for “forward looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, and we are including this statement forpurposes of these safe harbor provisions. You can identify these statements byreference to a future period or periods by our use of the words “estimate,” “project,”“may,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similarterms or variations of these terms. These forward looking statements include:

·       statementsof our goals, intentions and expectations;

·       statementsregarding our business plans and prospects and growth and operating strategies;

·       statementsregarding the quality of our products and our loan and investment portfolios;and

·       estimatesof our risks and future costs and benefits.

Actual results may differmaterially from those set forth in forward looking statements as a result ofthese and other risks and uncertainties, including those detailed herein underItem 1A, “Risk Factors”, and from time to time in other filings with theFederal Deposit Insurance Corporation (“FDIC”) and the Securities and ExchangeCommission (“SEC”). We have included important factors in the cautionarystatements included or incorporated in this document, particularly under Item1A, “Risk Factors”, that we believe could cause actual results or events todiffer materially from the forward looking statements that we make. Our forwardlooking statements do not reflect the potential impact of any futureacquisitions, mergers, dispositions, joint ventures or investments we may make.We do not assume any obligation to update any forward looking statements.

**ITEM 1*.*BUSINESS**

**Introduction**

Bancorp Rhode Island, Inc. (“we” or the “Company”),a Rhode Island corporation, is the holding company for Bank Rhode Island (the “Bank”).The Company has no significant assets other than the common stock of the Bank. Forthis reason, substantially all of the discussion in this document relates tothe operations of the Bank and its subsidiaries.

The Bank is a commercialbank chartered as a financial institution in the State of Rhode Island and wasformed in 1996 as a result of the acquisition of certain assets and liabilitiesdivested in connection with the merger of Fleet Financial Group, Inc. andShawmut National Corporation. Headquartered in Providence, Rhode Island, theBank conducts business through 16 full-service branches, with 11 located inProvidence County, 4 located in Kent County and 1 located in Washington County.The Bank augments its branch network through online banking services andautomatic teller machines (“ATMs”), both owned and leased, located throughoutRhode Island.

The Bank provides acommunity banking alternative in the greater Providence market which isdominated by three large banking institutions, one national and two regional. Basedon total deposits as of June 30, 2005 (excluding one bank that draws itsdeposits primarily from the internet), the Bank is the fifth largest bank inRhode Island and the only mid-sized commercially focused bank headquartered inProvidence, the State’s capital. The Bank offers a wide variety of commercialreal estate, business, residential and consumer loans and leases, depositproducts, nondeposit investment products, cash management and online bankingservices, and other banking products and services, designed to meet thefinancial needs of individuals and small- to mid-sized businesses. As afull-service community bank, the 

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Bankseeks to differentiate itself from its large bank competitors through superiorpersonal service, responsiveness and local decision-making. The Bank’s depositsare insured by the FDIC, subject to regulatory limits.

One of the Bank’s principal subsidiaries, BRIInvestment Corp., a Rhode Island corporation wholly-owned by the Bank, engagesin the maintenance and management of intangible investments and the collectionand distribution of the income from such investments.

The Company’s headquarters and executive managementare located at One Turks Head Place, Providence, Rhode Island 02903 and itstelephone number is (401) 456-5000. The Bank also maintains an internetwebsite at http://www.bankri.com.

The Company makesavailable free of charge through its website at http://www.bankri.com allreports it electronically files with, or furnishes to, the SEC, including itsAnnual Report on Form 10-K, Quarterly Reports on Form 10-Qand Current Reports on Form 8-K, as well as any amendments to thosereports, as soon as reasonably practicable after those documents are filedwith, or furnished to, the SEC. These filings are also accessible on the SEC’swebsite at http://www.sec.gov.

**Overview**

The Company, through the Bank, concentrates itsbusiness efforts in three main areas. First, the Bank emphasizes commerciallending. The high concentration of small to mid-size businesses in ourpredominately urban franchise makes deployment of funds in the commerciallending area practicable. Moreover, the Bank believes it can attract commercialcustomers from larger competitors through a higher level of service and itsability to set policies and procedures, as well as make decisions, locally. Second,the Bank has sought to grow its demand deposit, savings and othertransaction-based accounts, collectively referred to as “core deposits”. TheBank has stressed development of full relationships with customers, includingits commercial customers, all of whom tend to be more relationship orientedthan those who are seeking stand-alone or single transaction products. Third,the Bank seeks to leverage its knowledge and customer base to develop relatedlines of business. Thus, the Bank has grown its consumer loan portfolio, addedsales of investment products and acquired an equipment leasing company in orderto increase the Bank’s higher-yielding assets, increase its fee income anddiversify its products and services.

The past year marked a period of significant activity,change and challenge for the Company. During the second quarter of 2005, theCompany consummated an offering of approximately 628,400 shares of its commonstock, realizing net proceeds of approximately $21.5 million. These offeringproceeds are intended to provide the regulatory capital base required forfuture expansion of the Company and other general purposes. Also, the Companyundertook a leverage program in 2005, in an aggregate amount of approximately$90 million, in an effort to offset the earnings per share dilution related tothe issuance of additional shares of common stock, prior to a more profitabledeployment of the capital.

The Bank opened two new branches in 2005; one inLincoln, Rhode Island and the other in East Greenwich, Rhode Island. The Bankalso added two new lines of business; one, through the Company’s firstacquisition and the other through organic means.

In May 2005, the Company, through its newlyformed subsidiary, Macrolease Corporation, purchased substantially all of theoperating assets of Macrolease International Corporation, a privately heldnational equipment leasing company based on Long Island in Plainview, New York.The Company will use the Macrolease platform to increase its portfolio of equipmentleases, but expects to generate additional income by originating equipmentleases for third parties. The Company has also introduced Macrolease to theBank’s commercial customers, thereby expanding the Bank’s product offerings.

Also in May 2005, the Company launched a privatebanking group and entered into a formal affiliation agreement with CoastlineTrust Company (“Coastline”). Coastline is a local privately held trust 

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company offeringinvestment management, custodial and estate planning and administrationservices. It is the Company’s intention to capitalize on its high touch, highservice model to attract, as new customers, more high net worth individuals, aswell as to more fully service existing customers and principals of the Bank’sbusiness customers.

In December 2005, the Company announced it woulddefer the opening of two new branches it had planned for 2006 (one in Pawtucketand the other in Narragansett, Rhode Island) to 2007. The interest rateenvironment has resulted in a decline in the net interest margin over the pastyear. As a result, new branches have taken longer to achieve profitability. In2006, the Company plans to invest its resources to drive “same store sales”.

While the Company experienced 9% growth in itscommercial loan portfolio in 2005, the Company historically had achievedcommercial loan growth at a double-digit pace and is directing its effortstoward restoring that level of growth. In January 2006, the Companyannounced it had successfully recruited two experienced business lenders fromthe State’s leading regional bank. One lender was named to the newly createdposition of Director of Corporate Banking and the other now heads the Bank’sbusiness lending unit.

Additionally, the Bank experienced changes andtransitions in executive management during 2005, with the addition of both newChief Financial and Operating Officers in the second half of the year. The Bank’sTreasurer, Linda Simmons, was promoted to Chief Financial Officer in July 2005.In September 2005, the Bank realigned its executive ranks with thepromotion of the Bank’s Executive Vice President—Retail Banking, JamesDeRentis, to Chief Business Officer. All externally focused lines of businessnow report to him.

The Bank’s new ChiefOperating Officer, Jeffrey Angus, joined the Company in November 2005,with responsibility for operations, technology and human resources. He brings astrong information technology and management background to the Company.

**Lending Activities**

The Bank’s business strategy has been to grow itscommercial and consumer loan portfolios while allowing its residential mortgageloan portfolio to decline gradually (as a percent of total loans) as the Bankis able to replace residential mortgage loans with higher yielding commercialand consumer loans. The Bank has allocated substantial resources to itscommercial and consumer lending functions to facilitate and promote such growth.From December 31, 2000, until December 31, 2005, commercial loan andlease outstandings have increased $225.5 million, or 106%, and consumer loanoutstandings have increased $148.4 million, or 255%. Commercial loans andleases increased from 41.0% of total loans and leases at December 31,2000, to 46.1% of total loans and leases at December 31, 2005, andconsumer and other loans increased from 11.2% of total loans and leases at December 31,2000, to 21.7% of total loans and leases at December 31, 2005. Meanwhile,residential mortgage loans decreased from 47.8% of total loans and leases at December 31,2000, to 32.2% of total loans and leases at December 31, 2005.

The Bank offers a variety of loan facilities to serveboth commercial and consumer borrowers primarily within the State of RhodeIsland and nearby areas of Massachusetts. Approximately 73% of Rhode Islandbusinesses and 79% of Rhode Island jobs are located in Providence and KentCounties. More than 95% of Rhode Island businesses have fewer than 100employees. The Bank believes the financing needs of these businesses generallymatch the Bank’s lending profile and that the Bank’s branches are wellpositioned to facilitate the generation of loans from this customer base.

The Bank’s commercial lending function is organizedinto three groups. The commercial real estate group originatesnonowner-occupied commercial real estate, multi-family residential real estateand construction loans. The business lending group originates owner-occupiedcommercial real estate loans, 

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term loans, revolvinglines of credit, and the recently acquired capacity to originate equipmentleases through Macrolease. The small business group originates a variety ofreal estate and non-real estate loans for business lending relationships ofapproximately $250,000 or less.

The Bank satisfies a variety of consumer credit needsby providing home equity term loans, home equity lines of credit, directautomobile loans, savings secured loans and personal loans, in addition toresidential mortgage loans.

The Bank has tiered lending authorities. Certainsenior executives have lending approval authority of up to $1.0 million. Allextensions of credit of more than $1.0 million (up to the Bank’s house lendinglimit of $7.0 million) per customer relationship require the approval of theCredit Committee, which consists of members of the Bank’s senior management andone outside director. Exceptions to the Bank’s house lending limit require theapproval of a committee of the Board of Directors. Other officers have limitedlending authorities that can be exercised subject to lending policy guidelinesto facilitate volume production and process flow.

The Bank issues loan commitments to prospectiveborrowers subject to various conditions. Commitments generally are issued inconjunction with commercial loans and residential mortgage loans and typicallyare for periods up to 90 days. The proportion of the total value of commitmentsderived from any particular category of loan varies from time to time anddepends upon market conditions. At December 31, 2005, the Bank had $214.9million of aggregate loan commitments outstanding to fund a variety of loans.

Overall, loans and leases produced total interestincome of $53.8 million, or 77.4% of total interest and dividend income, in2005 and $47.1 million, or 81.6%, of total interest and dividend income, during2004.

*Commercial Real Estateand Multi-Family Loans*—TheBank originates loans secured by mortgages on owner-occupied andnonowner-occupied commercial and multi-family residential properties. At December 31,2005, owner-occupied commercial real estate loans totaled $113.0 million, or11.9% of the total loan portfolio. Many of these customers have othercommercial borrowing relationships with the Bank, as the Bank finances theirother business needs. Generally these customer relationships are handled in theBank’s business lending group. Nonowner-occupied commercial real estate loanstotaled $95.8 million, or 10.1% of the total loan portfolio, andmulti-family residential loans totaled $33.7 million, or 3.5% of the totalloan portfolio, and are generally handled in the Bank’s commercial real estategroup. These real estate secured commercial loans are offered as both fixed andadjustable rate products. The Bank typically charges higher interest rates onthese loans than those charged on adjustable rate loans secured by one- tofour-family residential units. Additionally, the Bank may charge originationfees on these loans.

The Bank’s underwriting practices for commercial realestate and multi-family residential loans are intended to assure that theproperty securing these loans will generate a positive cash flow afteroperating expenses and debt service payments. The Bank requires appraisalsbefore making a loan and generally requires the personal guarantee of theborrower. Permanent loans on commercial real estate and multi-family propertiesgenerally are made at a loan-to-value ratio of no more than 80%.

Loans secured by nonowner-occupied commercial realestate and multi-family properties involve greater risks than owner-occupiedproperties because repayment generally depends on the rental income generatedby the property. In addition, because the payment experience on loans securedby nonowner-occupied properties is often dependent on successful operation andmanagement of the property, repayment of the loan is usually more subject toadverse conditions in the real estate market or the general economy than is thecase with owner-occupied real estate loans. Also, the nonowner-occupiedcommercial 

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real estate andmulti-family residential business is cyclical and subject to downturns, over-buildingand local economic conditions.

*Commercial andIndustrial Loans—*The Bankoriginates non-real estate commercial loans that, in most instances, aresecured by equipment, accounts receivable or inventory, as well as the personalguarantees of the principal owners of the borrower. Unlike many communitybanks, the Bank is able to offer asset-based commercial loan facilities thatmonitor advances against receivables and inventories on a formula basis. Anumber of commercial and industrial loans are granted in conjunction with theU.S. Small Business Administration’s (“SBA”) loan guaranty programs and includesome form of SBA credit enhancement. Commercial lending activities aresupported by noncredit products and services, such as letters of credit and cashmanagement services, which are responsive to the needs of the Bank’s commercialcustomers.

At December 31, 2005, commercial and industrialloans totaled $73.6 million, or 7.7% of the total loan portfolio. Generally,commercial and industrial loans have relatively shorter maturities thanresidential and commercial real estate loans, or are at adjustable rateswithout interest rate caps. Unlike residential and commercial real estateloans, which generally are based on the borrower’s ability to make repaymentfrom employment and rental income and which are secured by real property whosevalue tends to be relatively easily ascertainable, commercial and industrialloans are typically made on the basis of the borrower’s ability to makerepayment from the cash flow of the business and are generally secured bybusiness assets, such as accounts receivable, equipment and inventory. As aresult, the availability of funds for the repayment of commercial andindustrial loans may be significantly dependent on the success of the businessitself. Further, the collateral securing the loans may be difficult to value,fluctuate in value based on the success of the business and deteriorate overtime.

*Leases—*The Bank historically has purchased equipment leasesfrom originators outside of the Bank. The principal lessees were the U.SGovernment and its agencies for the vast majority of leases. These “government”leases generally have maturities of five years or less and were not dependenton residual collateral values. With the addition of Macrolease in the secondquarter of 2005, the Bank is now originating equipment leases for its ownportfolio, as well as originating leases for third parties as a new source ofnoninterest income. At December 31, 2005, leases totaled $46.1 million, or4.8% of the total loan and lease portfolio, with $25.8 million of governmentleases and $20.3 million of Macrolease-generated leases.

*Small BusinessLoans—*The Bank utilizes theterm “small business loans” to describe business lending relationships ofapproximately $250,000 or less which it originates through business developmentofficers and its branch network. These loans are generally secured by theassets of the business, as well as the personal guarantees of the business’principal owners. A number of these loans are granted in conjunction with theSBA’s Low-Doc and Express programs and include some form of SBA creditenhancement. At December 31, 2005, small business loans totaled $38.6million, or 4.1% of the total loan portfolio. Generally, small business loansare granted at higher rates than commercial and industrial loans. These loanshave relatively short-term maturities or are at adjustable rates withoutinterest rate caps.

The Bank’s underwriting practices for small businessloans are designed to provide quick turn-around and minimize the fees andexpenses to the customer. Accordingly, the Bank utilizes a credit scoringprocess to assist in evaluating potential borrowers. In some cases, the Bankemploys traditional underwriting practices, similar to those for commercial andindustrial loans, to provide a more balanced and judgmentally-based creditdecision. The Bank distinguishes itself from larger financial institutions byproviding personalized service through a branch manager or business developmentofficer assigned to the customer relationships. Lending to small businesses mayinvolve additional risks as a result of their more limited financial andpersonnel resources.

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*Construction Loans—*The Bank originates residential construction loans toindividuals and professional builders to construct one- to four-familyresidential units, either as primary residences or for resale. The Bank alsomakes construction loans for the purpose of constructing multi-family orcommercial properties. At December 31, 2005, outstanding constructionloans totaled $37.8 million, or 4.0% of the total loan portfolio. Currently,the Bank offers interest-only construction loans during the constructionperiod.

The Bank’sunderwriting practices for construction loans are similar to those forcommercial real estate loans, but they also are intended to assure completionof the project and take into account the feasibility of the project, amongother things. As a matter of practice, the Bank generally lends an amountsufficient to pay a percentage of the property’s acquisition costs and amajority of the construction costs but requires that the borrower have equityin the project. The Bank requires property appraisals and generally thepersonal guarantee of the borrower, as is the case with commercial real estateloans.

The risksassociated with construction lending are greater than those with commercialreal estate lending and multi-family lending on existing properties for avariety of reasons. The Bank seeks to minimize these risks by, among otherthings, often using the inspection services of a consulting engineer forcommercial construction loans, advancing money during stages of completion andgenerally lending for construction of properties within its market area to borrowerswho are experienced in the type of construction for which the loan is made, aswell as by adhering to the lending standards described above. In addition, theBank does not usually lend to fund the construction of property being built forspeculative purposes.

*ResidentialMortgage Loans—*The Bank’sone- to four-family residential mortgage loan portfolio consists primarily ofwhole loans purchased from other financial institutions. Currently, the Bankpurchases fixed- and adjustable-rate (“ARM”) mortgage whole loans from otherfinancial institutions both in New England and elsewhere in the country. TheBank anticipates continuing to purchase residential mortgage loans until suchtime as its commercial and consumer loan originations are sufficient to utilizeavailable cash flows. With the exception of one pool of mortgages ofapproximately $32 million, servicing rights related to the whole loan mortgageportfolio are retained by the mortgage servicing companies. The Bank pays aservicing fee ranging from .25% to .375% to the mortgage servicing companiesfor administration of the loan portfolios. As of December 31, 2005,approximately 28% of the residential mortgage loan portfolio consisted of loanssecured by real estate outside of New England.

Additionally, largely as an accommodation to the Bank’scustomers, fixed- and variable-rate mortgages are offered throughout the Bank’sbranch network. The majority of these mortgages are transferred to the Bank’scorrespondent third parties under precommitments to fund these transactions. However,the Bank does retain a portion of these residential mortgages for its ownportfolio. In 2005, fees from these loans originated for third partiesincreased by $113,000, or 159%, to $184,000, compared to $71,000 in the prioryear. Overall, the Bank anticipates that its residential mortgage loanportfolio will decline long-term as it focuses its resources on commercial andconsumer lending.

At December 31, 2005, one- to four-familyresidential mortgage loans totaled $306.0 million, or 32.2% of the total loanportfolio. The fixed rate portion of this portfolio totaled $101.6 million andhad original maturities of 15 to 30 years. The adjustable rate portion of thisportfolio totaled $202.2 million and generally had original maturities of 30years. Interest rates on adjustable rate loans are set for an initial period ofone, three, five, seven or ten years with annual adjustments for the remainderof the loan. These loans have periodic rate adjustment caps of primarily 2% andlifetime rate adjustment caps of either 5% or 6%. There are no prepaymentpenalties for the one- to four-family residential mortgage loans.

Although adjustable rate mortgage loans allow the Bankto increase the sensitivity of its assets to changes in market interest rates,the terms of such loans include limitations on upward and downward rate 

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adjustments. Theselimitations increase the likelihood of prepayments due to refinancings duringperiods of falling interest rates, particularly if rate adjustment caps keep theloan rate above market rates. Additionally, these limitations could keep themarket value of the portfolio below market during periods of rising interestrates, particularly if rate adjustment caps keep the loan rate below marketrates.

*Consumer and Other Loans—*The Bank originates a variety of term loans and lineof credit loans for consumers. At December 31, 2005, the consumer loanportfolio totaled $206.5 million, or 21.7% of the total loan portfolio, and wascomprised primarily of home equity term loans and home equity lines of credit. Theseloans and lines of credit are generally offered for up to 80% of the appraisedvalue of the borrower’s home, less the amount of the remaining balance of theborrower’s first mortgage. The Bank also offers direct automobile loans,savings secured loans and personal loans.

**Investment Activities**

Investments, an important component of the Company’sdiversified asset structure, are a source of earnings in the form of interestand dividends, and provide a source of liquidity to meet lending demands andfluctuations in deposit flows. Overall, the portfolio, comprised primarily ofovernight investments, U.S. agency securities, corporate debt securities,mortgage-backed securities (“MBSs”), collateralized mortgage obligations (“CMOs”)and Federal Home Loan Bank of Boston (“FHLB”) stock, represents $412.2 million,or 28.6% of total assets, as of December 31, 2005. The vast majority ofthese securities are rated investment grade by at least one major ratingagency.

Loans and leases generally provide a better returnthan investments, and accordingly, the Company seeks to emphasize theirgeneration rather than increasing its investment portfolio. The investments aremanaged by the Bank’s Chief Financial Officer and Treasurer, subject to thesupervision and review of the Asset/Liability Committee and are made incompliance with the Investment Policy approved by the Bank’s Board of Directors.Prior to 2005, the Company had retained the services of an outside investmentadvisory firm to provide interest-rate risk management services and to assistin the management of the investment portfolio. The Company discontinued theservices of this firm effective January 1, 2005.

Overall, investmentsproduced total interest and dividend income of $15.7 million, or 22.6% of totalinterest and dividend income, in 2005 and $10.6 million, or 18.4%, of totalinterest and dividend income, during 2004.

**Deposits**

Deposits are the principal source of funds for use inlending and for other general business purposes. The Bank attracts depositsfrom businesses and the general public by offering a variety of depositproducts ranging in maturity from demand-type accounts to certificates ofdeposit (“CDs”). The Bank relies mainly on quality customer service and diversifiedproducts, as well as competitive pricing policies and advertising, to attractand retain deposits. The Bank emphasizes retail deposits obtained locally.

The Bank seeks to develop relationships with itscustomers in order to become their primary bank. In order to achieve this, theBank has stressed growing its core deposit account base. Core deposits remainedessentially consistent on a dollar amount basis compared to the prior year(down $4.2 million, or 0.7%). However, the balance sheet mix changed from theprior year due to the growth in CD balances. Core deposits as percentage oftotal deposits decreased to 64.0% at December 31, 2005 from 71.8% atDecember 31, 2004.

As a by-product of the Bank’s continuing emphasis onchecking account growth, service charges on deposit accounts (which includeinsufficient funds (“NSF”) fees) have also grown over the years and representthe largest source of noninterest income for the Company. Service charges ondeposit accounts showed a moderate increase of $47,000, or 1.0%, from $4.5million for 2004, to $4.6 million for 2005.

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Although the Bank would prefer growth in coreaccounts, the trend first evidenced in late 2004 continued as customersdisplayed their preference for higher-yielding term deposit accounts. As aresult, the Bank offered competitively priced CDs and ran special offers forcertain periods during the year. CD balances grew to $353.0 million at December 31,2005, compared to $248.5 million at December 31, 2004, an increase of$104.5 million, or 42.1%.

The Bank generally charges early withdrawal penaltieson its CDs in an amount equal to three months’ interest on accounts withoriginal maturities of one year or less and six months’ interest on accountswith original maturities longer than one year. Interest credited to an accountduring any term may be withdrawn without penalty at any time during the term. Uponrenewal of a CD, only interest credited during the renewal term may bewithdrawn without penalty during the renewal term. The Bank’s withdrawalpenalties are intended to offset the potentially adverse effects of thewithdrawal of funds during periods of rising interest rates.

As a general policy, theBank systematically reviews the deposit accounts it offers to determine whetherthe accounts continue to meet customers’ needs and the Bank’s asset/liabilitymanagement goals. This review is the responsibility of the Pricing Committee,which meets weekly to determine, implement and monitor pricing policies andpractices consistent with the Bank’s Asset and Liability Committee’s strategy,as well as overall earnings and growth goals. The Pricing Committee analyzesthe cost of funds and also reviews the pricing of deposit related fees andcharges.

**Borrowings**

The Bank also derives cash flows from several sources,including loan repayments, deposit inflows and outflows, sales of investmentsecurities and FHLB and other borrowings. Loan repayments and deposit inflowsand outflows are significantly influenced by prevailing interest rates,competition and general economic conditions. Sales of investment securities aregenerally infrequent and nonrecurring.

The Bank utilizesborrowings on both a shorter- and longer-term basis to compensate forreductions in normal sources of funds on a daily basis. Additionally, during2005, the Company undertook a leverage program to partially offset the dilutionof earnings per share caused by the issuance of additional common stock duringthe second quarter of 2005. The Company concluded the leverage program in thefourth quarter of 2005. Also, in 2005, the Bank entered into wholesale repurchaseagreements with financial institutions, aggregating $20.0 million in borrowingsby year-end. At December 31, 2005, total borrowings stood at $344.8million compared to $271.4 million at December 31, 2004.

**NondepositInvestment Products and Services**

Since January 2001,the Bank has managed a nondeposit investment program through which it makesavailable to its customers a variety of mutual funds, fixed- andvariable-annuities, stocks, bonds and other fee-based products. Theseinvestment products are offered through an arrangement with Commonwealth EquityServices, Inc., of Waltham, Massachusetts (“Commonwealth”). Commissions onnondeposit investment products for the years ending December 31, 2005,2004 and 2003 were $849,000, $973,000 and $875,000, respectively.

**Employees**

At December 31, 2005,the Company had 251 full-time and 58 part-time employees. The Company’semployees are not represented by any collective bargaining unit, and theCompany believes its employee relations are good. The Company maintains abenefit program that includes health and dental insurance, life and long-termdisability insurance and a 401(k) plan.

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**Supervision and Regulation**

*Overview—*The Company and the Bank are subject to extensivegovernmental regulation and supervision. Federal and state laws and regulationsgovern numerous matters affecting the Bank and/or the Company, includingchanges in the ownership or control, maintenance of adequate capital, financialcondition, permissible types, amounts and terms of extensions of credit andinvestments, permissible non-banking activities, the level of reserves againstdeposits and restrictions on dividend payments. These regulations are intendedprimarily for the protection of depositors and customers, rather than for thebenefit of shareholders. Compliance with such regulation involves significantcosts to the Company and the Bank and may restrict their activities. Inaddition, the passage of new or amended federal and state legislation couldresult in additional regulation of, and restrictions on, the operations of theCompany and/or the Bank. The Company cannot predict whether any legislationcurrently under consideration will be adopted or how such legislation or anyother legislation that might be enacted in the future would affect the businessof either the Company or the Bank. The following descriptions of applicablestatutes and regulations are not intended to be complete descriptions of theseprovisions or their effects on the Company and the Bank, but are briefsummaries which are qualified in their entirety by reference to such statutesand regulations.

The Company and the Bank are subject to extensiveperiodic reporting requirements concerning financial and other information. Inaddition, the Bank and the Company must file such additional reports as theregulatory and supervisory authorities may require. The Company also is subjectto the reporting and other dictates of the Securities Exchange Act of 1934, asamended (the “Exchange Act”), and the Sarbanes-Oxley Act of 2002. Recent SEC rules haveaccelerated the reporting of numerous internal events and increased the Company’sfiling obligations and related costs.

The Company is a bank holding company registered underthe Bank Holding Company Act of 1956, as amended (the “BHC Act”). As a bankholding company, the Company is regulated by the Board of Governors of theFederal Reserve System (the “FRB”), and also is subject to certain laws of theState of Rhode Island.

The Bank is a Rhode Islandchartered non-member bank of the Federal Reserve System. The Bank’s depositsare insured by the Bank Insurance Fund (the “BIF”) of the FDIC. Accordingly,the Bank is subject to the supervision and regulation of the FDIC and the RhodeIsland Department of Business Regulation (the “Department of BusinessRegulation”).

**Rhode Island Regulation**

As a state chartered financial institution, the Bankis subject to the continued regulation and supervision and periodic examinationby the Department of Business Regulation. Rhode Island law also imposes reportingrequirements on the Bank. Rhode Island statutes and regulations govern amongother things, investment powers, deposit activity, trust powers and borrowings.The approval of the Department of Business Regulation is required to establish,close or relocate a branch, merge with other banks, amend the Bank’s Charter orBy-laws and undertake certain other enumerated activities.

If it appears to the Department of Business Regulationthat a Rhode Island bank has violated its charter, or any law or regulation, oris conducting its business in an unauthorized or unsafe manner, or that thebank has been notified by its federal insurer of such insurer’s intent toterminate deposit insurance, the Director of the Department of BusinessRegulation (the “Director”) may, under certain circumstances, restrict thewithdrawal of deposits, order any person to cease violating any Rhode Islandstatutes or rules and regulations or cease engaging in any unsafe, unsoundor deceptive banking practice, order that capital be restored, or suspend orremove directors, committee members, officers or employees who have violatedthe Rhode Island banking statutes, or a rule or regulation or orderthereunder, or who are reckless or incompetent in the conduct of the bank’sbusiness.

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Rhode Island law also requires any person or personsdesiring to acquire “control”, as defined in the BHC Act, of any Rhode Islandfinancial institution to file an extensive application with the Director. Theapplication requires detailed information concerning the Bank, the transactionand the principals involved. The Director may disapprove the acquisition if theproposed transaction would result in a monopoly, the financial stability of theinstitution would be jeopardized, the proposed management lacks competence, orthe acquisition would not promote public convenience and advantage. The Companyis also subject to the Rhode Island Business Combination Act.

In addition, whenever theDepartment of Business Regulation considers it advisable, the Department mayconduct an examination of a Rhode Island bank holding company, such as theCompany. Every Rhode Island bank holding company also must file an annualfinancial report with the Department of Business Regulation.

**Federal Supervision: FDIC**

*Overview—*The FDIC issues rules and regulations, conductsperiodic inspections, requires the filing of certain reports and generallysupervises the operations of its insured state chartered banks, that, like theBank, are not members of the Federal Reserve System. The FDIC’s powers havebeen enhanced in the past decade by federal legislation. With the passage ofthe Financial Institutions Reform, Recovery and Enforcement Act of 1989, theCrime Control Act of 1990, and the Federal Deposit Insurance CorporationImprovement Act of 1991 (“FDICIA”), federal bank regulatory agencies, includingthe FDIC, were granted substantial additional enforcement powers to restrictthe activities of financial institutions and to impose or seek the impositionof increased civil and/or criminal penalties upon financial institutions andthe individuals who manage or control such institutions.

The Bank is subject to the FDIC regulatory capitalrequirements. An FDIC-insured bank also must conform to certain standards,limitations, and collateral requirements with respect to certain transactionswith affiliates such as the Company. Further, an FDIC-insured bank is subjectto laws and regulations that limit the amount of, and establish requiredapproval procedures, reporting requirements and credit standards with respectto, loans and other extensions of credit to officers, directors and principalshareholders of the Company, the Bank, and any subsidiary of the Bank, and totheir related interests. FDIC approval also is required prior to the Bank’sredemption of any stock. The prior approval of the FDIC or, in somecircumstances, another regulatory agency, is required for mergers andconsolidations. In addition, notice to the FDIC is required prior to theclosing of any branch office, and the approval of the FDIC is required in orderto establish or relocate a branch facility.

Proceedings may be instituted against any FDIC-insuredbank, or any officer or director or employee of such bank and any otherinstitution affiliated parties who engage in unsafe and unsound practices,breaches of any fiduciary duty, or violations of applicable laws, regulations,regulatory orders and agreements. The FDIC has the authority to terminateinsurance of accounts, to issue orders to cease and desist, to remove officers,directors and other institution affiliated parties, and to impose substantialcivil money penalties.

*Deposit Insurance—*The Bank’s deposits are insured by the BIF of theFDIC to the legal maximum of $100,000 for each separately insured depositor. TheFederal Deposit Insurance Act, as amended (the “FDI Act”) provides that theFDIC shall set deposit insurance assessment rates on a semiannual basis andrequires the FDIC to increase deposit insurance assessments whenever the ratioof BIF reserves to insured deposits in the BIF is less than 1.25%.

The FDIC has established a risk-based bank assessmentsystem the rates of which are determined on the basis of a particularinstitution’s supervisory rating and capital level. The assessment system isbased upon three supervisory categories and three capital categories, resultingin risk-based premiums which range from the current 0 basis points (subject toa $2,000 minimum annual fee) for the most highly-rated, 

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well capitalized banks to27 basis points per $100 of domestic deposits for troubled banks which areundercapitalized (as discussed below). The Bank currently pays the minimumassessment.

The FDIC may terminate the deposit insurance of anyinsured depository institution if the FDIC determines that the institution hadengaged in or is engaging in unsafe or unsound practices, is in an unsafe orunsound condition to continue operations, or has violated any applicable law,regulation, order or any condition imposed by the FDIC.

*Capital Adequacy—*FDIC-insured institutions must meet specified minimalcapital requirements and are subject to varying regulatory restrictions basedupon their capital levels. All banks are subject to restrictions on capitaldistributions (such as dividends, stock repurchases and redemptions) andpayment of management fees if, after making such distributions or payment, theinstitution would be undercapitalized. FDIC- insured banks that have thehighest regulatory rating and are not anticipating or experiencing significantgrowth are required to maintain a leverage capital ratio (calculated using Tier1 capital, as defined below, to total assets) of at least 3.0%. All other banksare required to maintain a minimum leverage capital ratio of 1.0% to 2.0% above3.0%, with a minimum of 4.0%.

In addition, the FDIC has adopted capital guidelinesbased upon ratios of a bank’s capital to total assets adjusted for risk, whichrequire FDIC-insured banks to maintain a total capital-to-risk weighted assetsratio (“Risk-Based Capital Ratio”) of at least 8.0% and a Tier 1 Risk-BasedCapital Ratio of at least 4.0%. The guidelines provide a general framework forassigning assets and off-balance sheet items (such as standby letters ofcredit) to broad risk categories and provide procedures for the calculation ofthe Risk-Based Capital Ratio. Tier 1 (sometimes referred to as “core”) capitalconsists of common shareholders’ equity, qualifying, non-cumulative perpetualpreferred stock, and minority interests in the equity accounts of consolidatedsubsidiaries. “Supplementary” or Tier 2 capital includes perpetual debt,mandatory convertible debt securities, a limited amount of subordinated debt,other preferred stock, and a limited amount of loan loss reserves. Certainintangible assets are deducted in computing the Capital Ratios.

*Prompt Corrective ActionProvisions—*In order toresolve the problems of undercapitalized institutions, FDICIA established asystem known as “prompt corrective action”. Under prompt corrective actionprovisions and implementing regulations, every institution is classified intoone of five categories reflecting the institution’s capitalization. Thesecategories are the following: well capitalized, adequately capitalized,undercapitalized, significantly undercapitalized and criticallyundercapitalized. For an institution to be well capitalized, it must have atotal Risk-Based Capital Ratio of at least 10%, a Tier 1 Risk- Based CapitalRatio of at least 6% and a Tier 1 leverage ratio of at least 5% and not besubject to any specific capital order or directive. In contrast, an institutionwill be deemed to be significantly undercapitalized if it has a totalRisk-Based Capital Ratio that is less than 6%, or a Tier 1 Risk-Based CapitalRatio that is less than 3%, or a leverage ratio that is less than 3%, and willbe deemed to be critically undercapitalized if the bank has a ratio of tangibleequity to total assets that is equal to or less than 2%.

As of December 31, 2005, the Bank’s Tier 1leverage ratio was 6.67%, its total Risk-Based Capital Ratio was 10.26% and itsTier 1 Risk-Based Capital Ratio was 11.51%. Based upon the above ratios, theBank is considered “well capitalized” for regulatory capital purposes.

The activities in which a depository institution mayengage and the remedies available to federal regulators vary depending upon thecategory described above into which an institution’s level of capital falls. Ateach successive downward capital level, institutions are subject to morerestrictions on their activities. For example, only “well capitalized” institutionsmay accept brokered deposits without prior regulatory approval (brokereddeposits are defined to include deposits with an interest rate which is 75basis points above prevailing rates paid on similar deposits in an institution’snormal market area).

The FDIC has broad powers to take prompt correctiveaction to resolve problems of insured depository institutions, depending upon aparticular institution’s level of capital. For example, a bank 

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which does not meetapplicable minimum capital requirements or is deemed to be in a “troubled”condition may be subject to additional restrictions, including a requirement ofwritten notice to federal regulatory authorities prior to certain proposedchanges in senior management or directors of the institution. Undercapitalized,significantly undercapitalized and critically undercapitalized institutionsalso are subject to a number of other requirements and restrictions.

*Safety and SoundnessStandards—*The FDI Act alsodirects each federal banking agency to prescribe standards for safety andsoundness for insured depository institutions and their holding companiesrelating to operations, management, asset quality, earnings and stockvaluation.

*Examination—*FDICrequires that nearly all insured depository institutions have annual, on-siteregulatory examinations and annual audits by an independent public accountant. Managementmust prepare an annual report, attested to by the independent publicaccountant, confirming management’s responsibility in preparing financial statements,maintaining internal controls for financial reporting and complying with safetyand soundness standards. The audit process must be overseen by an independentaudit committee composed of outside directors, provided that the federalbanking agencies may permit the committee to include inside directors if thebank is unable to find competent outside directors, so long as outsidedirectors comprise a majority of the committee.

**Federal Supervision: FRB**

The BHC Act mandates that the prior approval of theFRB must be obtained in order for the Company to engage in certain activitiessuch as acquiring or establishing additional banks or non-banking subsidiariesor merging with other institutions.

In addition to the needfor obtaining the approval of the FRB for particular kinds of transactions, abank holding company is required by the FRB to adhere to certain capitaladequacy standards. It is the position of the FRB that a bank holding company,such as the Company, should be a source of financial strength to its subsidiarybanks such as the Bank. In general, the FRB has adopted substantially identicalcapital adequacy guidelines as the FDIC. Such standards are applicable to bankholding companies and their bank subsidiaries on a consolidated basis for holdingcompanies, like the Company, with consolidated assets in excess of $150 million.If a bank holding company’s capital levels fall below the minimum requirementsestablished by the capital adequacy guidelines, the holding company will beexpected to develop and implement a plan, acceptable to the FRB, to achieveadequate levels of capital within a reasonable time. Until such capital levelsare achieved, the holding company may be denied approval by the FRB for certainactivities such as those described in the preceding paragraph. As of December 31,2005, on a consolidated basis, the Company’s Tier 1 Leverage Ratio was 8.21%,its total Risk-Based Capital Ratio was 12.62% and its Tier 1 Risk-Based CapitalRatio was 13.87%. Based upon the above ratios, the Company is considered “wellcapitalized” for regulatory capital purposes.

**Restrictionson Transactions with Affiliates and Insiders**

The Bank is subject to certain federal statuteslimiting transactions with non-banking affiliates and insiders. Section 23Aof the Federal Reserve Act limits loans or other extensions of credit to, assetpurchases with and investments in affiliates of the Bank, such as the Company,to ten percent (10%) of the Bank’s capital and surplus. Further, such loans andextensions of credit, as well as certain other transactions, are required to besecured in specified amounts. Section 23B of the Federal Reserve Act,among other things, requires that certain transactions between the Bank and itsaffiliates must be on terms substantially the same, or at least as favorable tothe Bank, as those prevailing at the time for comparable transactions with orinvolving other nonaffiliated persons. In the absence of comparabletransactions, any transaction between the Bank and its affiliates must be onterms and under circumstances, including credit standards that in good faithwould be offered to or would apply to nonaffiliated persons.

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The restrictions on loans to officers, directors,principal shareholders and their related interests (collectively referred toherein as “insiders”) contained in the Federal Reserve Act and Regulation Oapply to all institutions and their subsidiaries. These restrictions includelimits on loans to one borrower and conditions that must be met before suchloans can be made. Loans made to insiders and their related interests cannotexceed the institution’s total unimpaired capital and surplus. Insiders aresubject to enforcement actions for knowingly accepting loans in violation ofapplicable restrictions. All extensions of credit by the Bank to its insidersare in compliance with these restrictions and limitations.

Loans outstanding toexecutive officers and directors of the Bank, including their immediatefamilies and affiliated companies (“related parties”), aggregated $5.6 millionat December 31, 2005 and $5.0 million at December 31, 2004. Loans torelated parties are made in the ordinary course of business under normal creditterms, including interest rates and collateral, prevailing at the time oforigination for comparable transactions with other persons, and do notrepresent more than normal credit risk.

**Interstate Banking**

The Riegle-Neal InterstateBanking and Branching Efficiency Act of 1994 facilitated the interstateexpansion and consolidation of banking organizations by permitting (i) bankholding companies such as the Company, that are adequately capitalized andmanaged, to acquire banks located in states outside their home statesregardless of whether such acquisitions are authorized under the law of thehost state, (ii) the interstate merger of banks after June 1, 1997,subject to the right of individual states to “opt in” early or “opt out” ofthis authority prior to such date, (iii) banks to establish new brancheson an interstate basis provided that such action is specifically authorized bythe law of the host state, (iv) foreign banks to establish, with approvalof the appropriate regulators in the United States, branches outside their homestates to the same extent that national or state banks located in such statewould be authorized to do so and (v) banks to receive deposits, renew timedeposits, close loans and receive payments on loans and other obligations asagent for any bank or thrift affiliate, whether the affiliate is located in thesame or different state. Rhode Island adopted “opt in” legislation, whichpermits full interstate banking acquisition and branching.

**Gramm-Leach-Bliley Act**

In late 1999, Congress enacted the Gramm-Leach-BlileyAct (the “G-L-B Act”), which repealed provisions of the 1933 Glass-Steagall Actthat required separation of the commercial and investment banking industries. TheG-L-B Act expands the range of non-banking activities that certain bank holdingcompanies may engage in while preserving existing authority for bank holding companiesto engage in activities that are closely related to banking. In order to engagein these new non-banking activities, a bank holding company must qualify andregister with the FRB as a “financial holding company” by demonstrating thateach of its banking subsidiaries is “well capitalized” and “well managed” andhas a rating of “Satisfactory” or better under the Community Reinvestment Actof 1977.

Under the G-L-B Act and its implementing regulations,financial holding companies may engage in any activity that (i) isfinancial in nature or incidental to a financial activity under the G-L-B Actor (ii) is complementary to a financial activity and does not impose asubstantial risk to the safety and soundness of depository institutions or thefinancial system generally. The G-L-B Act and its accompanying regulationsspecify certain activities that are financial in nature such as acting asprincipal, agent or broker for insurance; underwriting, dealing in or making amarket in securities; and providing financial and investment advice. The newfinancial activities authorized by the G-L-B Act may also be engaged in by a “financialsubsidiary” of a national or state bank, except for insurance or annuityunderwriting, insurance company portfolio investments, real estate investmentsand development and merchant banking, which must be conducted in a financialholding company. The FRB and the Secretary of the Treasury have the authorityto decide whether other activities are also financial in nature or incidental thereto,taking into 

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account changes intechnology, changes in the banking marketplace, competition for bankingservices and other pertinent factors. Although the Company may meet thequalifications to become a financial holding company, it has no current plansto elect such status.

The G-L-B Act also establishes a system of functionalregulation, under which the federal banking agencies will regulate the bankingactivities of financial holding companies and banks’ financial subsidiaries,the SEC will regulate their securities activities and state insuranceregulators will regulate their insurance activities. In addition, the G-L-B Actprovides protections against the transfer and use by financial institutions ofconsumers’ nonpublic, personal information. The G-L-B Act contains a variety ofadditional provisions, which, among others, impose additional regulatoryrequirements on certain depository institutions and reduce certain otherregulatory burdens, modify the laws governing the Community Reinvestment Act of1977, and address a variety of other legal and regulatory issues affecting bothday-to-day operations and long-term activities of financial institutions.

In granting other types offinancial institutions more flexibility, the G-L-B Act may increase the numberand type of institutions engaging in the same or similar activities as those ofthe Company and the Bank, thereby creating a more competitive atmosphere.However, management believes this legislation and implementing regulations havehad a more substantial impact on regional and national holding companies andbanks than on community-based institutions engaged principally in traditionalbanking activities.

**OtherAspects of Federal and State Laws**

*Community Reinvestment Act—*The Community Reinvestment Act of 1977 (“CRA”) and theregulations issued thereunder are intended to encourage banks to help meet thecredit needs of their service area, including low and moderate incomeneighborhoods, consistent with the safe and sound operations of the banks. UnderCRA, banks are rated on their performance in meeting these credit needs and therating of a bank’s performance is public. In connection with the filing of anapplication to conduct certain transactions, the CRA performance record of thebanks involved are reviewed. Under the Bank’s last CRA examination, the Bankreceived a “Satisfactory” rating.

*USA PATRIOT Act—*The USA PATRIOT Act of 2001 (the “Patriot Act”),designed to deny terrorists and others the ability to obtain anonymous accessto the United States financial system, has significant implications fordepository institutions, brokers, dealers and other businesses involved in thetransfer of money. The Patriot Act requires financial institutions to implementadditional policies and procedures with respect to, or additional measuresdesigned to address, the following matters, among others:  money laundering; suspicious activities andcurrency transaction reporting; and currency crimes.

*Sarbanes-Oxley Act of 2002—*In July 2002, Congress enacted the Sarbanes-OxleyAct of 2002 (“Sarbanes-Oxley”) which imposed significant additionalrequirements and restrictions on publicly-held companies, such as the Company. Theseprovisions include requirements governing the independence, composition andresponsibilities of audit committees, financial disclosures and reporting andrestrictions on personal loans to directors and officers. Sarbanes-Oxley, amongother things, mandates chief executive and chief financial officercertifications of periodic financial reports, additional financial disclosuresconcerning off-balance sheet items, and speedier transaction reportingrequirements for executive officers, directors and 10% shareholders.Rules promulgated by the SEC pursuant to Sarbanes-Oxley impose obligationsand restrictions on auditors and audit committees intended to enhance theirindependence from management. In addition, penalties for non-compliance withthe Exchange Act are heightened. The Company has not experienced anysignificant difficulties in complying with this legislation. However, theCompany has incurred, and expects to continue to incur, costs in connectionwith its compliance with Section 404 of Sarbanes-Oxley which requiresmanagement to undertake an assessment of the adequacy and effectiveness of theCompany’s internal controls over financial reporting and requires the Company’s

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*auditorsto attest to, and report on, management’s assessment and the operatingeffectiveness of these controls.*

*Insurance Sales—*Rhode Island legislation enacted in 1996 permits financialinstitutions to participate in the sale of insurance products, subject tocertain restrictions and license requirements. The regulatory approvalsrequired from the Department of Business Regulation and the FDIC depend uponthe form and structure used to engage in such activities.

*Check 21—*The Check Clearing for the 21st Century Act, or “Check 21” as itis commonly known, became effective in late 2004. Check 21 facilitates checkcollection by creating a new negotiable instrument called a “substitute check”,which permits, but does not require, banks to replace original checks withsubstitute checks or information from the original check and process checkinformation electronically. Banks that do use substitute checks must complywith certain notice and recredit rights. Check 21 is expected to cut the timeand cost involved in physically transporting paper items and reduce float,i.e., the time between the deposit of a check in a bank and payment, especiallyin cases in which items were not already being delivered same-day or overnight.The Bank is currently implementing the Check 21 authority and expects to incurminimal additional costs until all banks have adopted Check 21.

*Miscellaneous—*TheCompany and/or the Bank also are subject to federal and state statutory andregulatory provisions covering, among other things, reserve requirements,security procedures, currency and foreign transactions reporting, insider andaffiliated party transactions, management interlocks, sales of non-depositinvestment products, loan interest rate limitations, truth-in-lending,electronic funds transfers, funds availability, truth-in-savings, home mortgagedisclosure and equal credit opportunity.

**Effect of Governmental Policy**

The Company’s revenuesconsist of cash dividends paid to it by the Bank. Such payments are restrictedpursuant to various state and federal regulatory limitations. Banking is abusiness that depends heavily on interest rate differentials. One of the mostsignificant factors affecting the Bank’s earnings is the difference between theinterest rates paid by the Bank on its deposits and its other borrowings, onthe one hand, and, on the other hand, the interest rates received by the Bankon loans extended to its customers and on securities held in the Bank’sportfolio. The value and yields of its assets and the rates paid on itsliabilities are sensitive to changes in prevailing market rates of interest. Thus,the earnings and growth of the Bank will be influenced by general economicconditions, the monetary and fiscal policies of the federal government, andpolicies of regulatory agencies, particularly the FRB, which implement nationalmonetary policy. The nature and impact on the Bank of any future changes insuch policies cannot be predicted.

**ITEM 1A.**        RISKFACTORS

**Overview**

Investing in our commonstock involves a degree of risk. The risks and uncertainties described beloware not the only ones facing our Company. Additional risks and uncertaintiesmay also impair our business operations. If any of the following risks actuallyoccur, our business, financial condition or results of operations would likelysuffer.

**Risks Related to Our Business**

***Competitionwith other financial institutions could adversely affect our franchise growthand profitability.***

We face significant competition from a variety oftraditional and nontraditional financial service providers both within andoutside of Rhode Island, both in making loans and generating deposits. Our mostsignificant competition comes from one national and two large regional bankinginstitutions that have significant market share positions in Rhode Island. Theselarge banks have well-established, broad 

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distribution networks andgreater financial resources than we do, which have enabled them to market theirproducts and services extensively, offer access to a greater number oflocations and products, and price competitively.

We also face competitionfrom a number of local financial institutions with branches in Rhode Island andin nearby Massachusetts, some of which have been acquired by both local andout-of-state service providers. Additionally, we face competition fromout-of-state financial institutions which have established loan productionoffices in our marketplace, and from non-bank competitors. Competition fordeposits also comes from short-term money market funds, other corporate andgovernment securities funds and non-bank financial institutions such asbrokerage firms, insurance companies and credit unions, the latter of whichhave recently experienced a resurgence in this market. Many of our non-bankcompetitors have fewer regulatory constraints as those imposed on federallyinsured state chartered banks, which gives these competitors an advantage overus in providing certain services. Such competition may limit our growth andprofitability in the future.

***Changesin regional and national economic conditions could adversely affect ourprofitability.***

The population in our market area is growing slowlyand economic growth in the Rhode Island area has been slow to moderate over thepast several years. New England, hard hit by the 2001 recession, has trailedother parts of the nation in terms of general economic growth. Additionally,Rhode Island businesses, like many companies throughout the United States, arestruggling with rapidly increasing health care costs, which may adverselyaffect the earnings and growth potential for such companies, which may in turnnegatively impact Rhode Island’s ability to attract and retain businesses inthe state.

Our borrowers’ ability tohonor their repayment commitments is generally dependent upon the level ofeconomic activity and general health of the regional economy. Furthermore,economic conditions beyond our control, such as the strength of credit demandby customers and changes in the general levels of interest rates, may have asignificant impact on our operations, including decreases in the value ofcollateral securing loans. Therefore, an economic recession in this market areaadversely affecting growth could cause significant increases in nonperformingassets, thereby reducing operating profits or causing operating losses,impairing liquidity and eroding capital.

*Fluctuations ininterest rates could adversely impact our net interest margin.*

Our earnings and cashflows are heavily dependent on net interest margin, which is the differencebetween interest income that we earn on loans and investments and the interestexpense paid on deposits and other borrowings. When maturities of assets andliabilities are not balanced, a rapid increase or decrease in interest ratescould have an adverse effect on our net interest margin and results ofoperation. Interest rates are highly sensitive to factors that are beyond ourcontrol, including general economic conditions, inflation rates, flattening ofthe yield curve, business activity levels, money supply and the policies ofvarious government and regulatory authorities. For example, increases in thediscount rate by the Board of Governors of the Federal Reserve System usuallylead to rising interest rates, which affects interest income, interest expenseand investment portfolio. In addition, governmental policies such as thecreation of a tax deduction for individual retirement accounts could increasesavings rates and may affect our cost of funds. The nature, timing and effectof any future changes in interest rates on us and our future results ofoperations are not predictable.

*Change in thecomposition of our loan and lease portfolio may result in greater risk oflosses.*

At December 31, 2005,46.1% of our loan and lease portfolio consisted of commercial real estate,business, construction loans and leases, a slight increase from 45.4% of ourloan and lease portfolio at December 31, 2004. We intend to continue toemphasize the origination of these types of loans and leases. 

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Theseloans generally have greater risk of nonpayment and loss than residentialmortgage loans because repayment of these types of loans often depends on thesuccessful business operation and income stream of the borrowers. Such loanstypically involve larger loan balances to single borrowers or groups of relatedborrowers than do individual one-to four-family residential loans. Consequently,an adverse development with respect to one loan or one credit relationship canexpose us to a significantly greater risk of loss compared to an adversedevelopment with respect to a single one-to four-family residential mortgageloan.

*Our allowance forloan and lease losses may be insufficient to cover actual loan and leaselosses.*

The risk of loan and leaselosses varies with, among other things, general economic conditions, thecharacter and size of the portfolio, delinquency trends, industry lossexperience, nonperforming loan trends, the creditworthiness of borrowers and,in the case of a collateralized loan, the value of the collateral. Based uponsuch factors, our management arrives at an appropriate allowance for loan andlease losses by maintaining a risk rating system that classifies all loans andleases into varying categories by degree of credit risk, and establishes alevel of allowance associated with each category. As part of our ongoingevaluation process, including a formal quarterly analysis of allowances, wemake various subjective judgments as to the appropriate level of allowance withrespect to each category, judgments as to the categorization of any individualloan or lease, as well as additional subjective judgments in ascertaining theprobability and extent of any potential losses. If our subjective judgments proveto be incorrect, our allowance for loan and lease losses may not cover inherentlosses in our loan and lease portfolio, or if bank regulatory officials orchanges in economic conditions require us to increase the allowance for loanand lease losses, earnings could be significantly and adversely affected.Material additions to our allowance would materially decrease net income. At December 31,2005, the allowance for loan and lease losses totaled $12.2 million,representing 1.28% of total loans.

*Our growth strategymay limit increases in profitability.*

We have sought to increasethe size of our franchise by pursuing business development opportunities andhave grown substantially since inception. To the extent additional branches areopened, through the current expansion plan or otherwise, we are likely toexperience higher operating expenses relative to operating income from the newbranches, which may limit increases in profitability over the course of theexpansion plan. The ability to increase profitability by establishing newbranches is dependent on our ability to identify advantageous branch locationsand generate new deposits and loans from those locations that will create anacceptable level of net income. There can be no assurance that new and relocatedbranches will generate an acceptable level of net income or that we will beable to successfully establish new branch locations in the future. In addition,there can be no assurance that we will be successful in developing new businesslines or that any new products or services introduced will be profitable.

*Our growth issubstantially dependent on our management team.*

Our future success andprofitability are substantially dependent upon the management and bankingabilities of our senior executives, who have substantial background andexperience in banking and financial services, as well as personal contacts, inthe Rhode Island market and the region generally. Competition for suchpersonnel is intense, and there is no assurance we will be successful inretaining such personnel. Changes in key personnel and their responsibilitiesmay be disruptive to business and could have a material adverse effect on ourbusiness, financial condition and results of operations.

*Our operatinghistory is not necessarily indicative of future operating results.*

The Company, as theholding company of the Bank, has no significant assets other than the commonstock of the Bank. While we have operated profitably since the first fullquarter of operations, future operating results may be affected by manyfactors, including regional economic conditions, interest rate 

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fluctuationsand other factors that may affect banks in general, all of which factors maylimit or reduce our growth and profitability. For example, in the past, we haveconsistently grown our core deposit base, including checking account balances. However,customers indicated a preference for higher-yielding term deposit products in2005 and core deposits remained essentially flat. We cannot predict whetherthis increased demand for CD’s is temporary or reflects a longer-term trend. Similarly,nonperforming asset levels and loan and lease losses have been low sinceinception. Industry experience suggests that this is unlikely to continueindefinitely.

*Our controls and proceduresmay fail or be circumvented.*

Management regularlyreviews and updates our internal controls, disclosure controls and proceduresand corporate governance policies and procedures. Systems of controls are basedupon certain assumptions and can only provide reasonable, not absolute,assurance that system objectives are met. Potential failure or circumvention ofour controls and procedures or failure to comply with regulations related tocontrols and procedures could have an adverse effect on our business, resultsof operations and financial condition.

*We face varioustechnological risks.*

We rely heavily oncommunication and information systems to conduct business. Potential failures,interruptions or breaches in system security could result in disruptions orfailures in our key systems, such as general ledger, deposit or loan systems. Wehave developed policies and procedures aimed at preventing and limiting theeffect of failure, interruption or security breaches of information systems;however, there cannot be assurance that these incidences will not occur, or ifthey do occur, that they will be appropriately addressed. The occurrence of anyfailures, interruptions or security breaches of our information systems coulddamage our reputation, result in the loss of business, subject us to increasedregulatory scrutiny or subject us to civil litigation and possible financialliability, any of which could have an adverse effect on our results ofoperation and financial condition.

*We encountertechnological change continually.*

The financial servicesindustry continually undergoes technological change. Effective use oftechnology increases efficiency and enables banks and financial servicesinstitutions to better serve customers and reduce costs. Our future successdepends, in part, upon our ability to meet the needs of customers byeffectively using technology to provide the products and services that satisfycustomer demands, as well as create operational efficiencies. Additionally,many of our competitors have greater resources to invest in technologicalimprovements. Inability to keep pace with technological change affecting thefinancial services industry could have an adverse impact on our business and asa result, our financial condition and results of operation.

*Extensivegovernment regulation and supervision have a significant impact on ouroperations.*

We operate in a highly regulated industry and aresubject to examination, supervision and comprehensive regulation by variousregulatory agencies. These regulations are intended primarily for theprotection of depositors and customers, rather than for the benefit ofinvestors. Our compliance with these regulations is costly and restrictscertain activities, including payment of dividends, mergers and acquisitions,investments, loans and interest rates charged, interest rates paid on depositsand locations of offices. We are also subject to capitalization guidelinesestablished by regulators, which require maintenance of adequate capital tosupport growth. Furthermore, the addition of new branches requires the approvalof the FDIC as well as state banking authorities in Rhode Island.

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The laws and regulationsapplicable to the banking industry could change at any time. There is no way topredict the effects of these changes on our business and profitability. Becausegovernment regulation greatly affects the business and financial results of allcommercial banks and bank holding companies, the cost of compliance with newlaws and regulations applicable to the banking industry could adversely affectoperations and profitability.

**Risks Related tothe Company’s Common Stock**

*Our common stock haslimited liquidity.*

Even though the our common stock is currently tradedon the Nasdaq Stock Market’s National Market System, it has less liquidity thanthe average stock quoted on a national securities exchange. Because of thislimited liquidity, it may be more difficult for investors to sell a substantialnumber of shares and any such sales may adversely affect the stock price.

We cannot predict theeffect, if any, that future equity offerings, issuance of common stock inacquisition transactions, or the availability of shares of common stock forsale in the market, will have on the market price of our common stock. Wecannot give assurance that sales of substantial amounts of common stock in themarket, or the potential for large amounts of sales in the market, would notcause the price of our common stock to decline or impair future ability toraise capital through sales of common stock.

*Fluctuations in theprice of our stock could adversely impact your investment.*

The market price of ourcommon stock may be subject to significant fluctuations in response tovariations in the quarterly operating results, changes in management,announcements of new products or services by us or competitors, legislative orregulatory changes, general trends in the industry and other events or factorsunrelated to our performance. The stock market has experienced price and volumefluctuations which have affected the market price of the common stock of manycompanies for reasons frequently unrelated to the operating performance ofthese companies, thereby adversely affecting the market price of thesecompanies’ common stock. Accordingly, there can be no assurance that the marketprice of our common stock will not decline.

*There arelimitations on our ability to pay dividends.*

Our ability to paydividends is subject to the financial condition of the Bank, as well as otherbusiness considerations. Payment of dividends by the Company is also restrictedby statutory limitations. These limitations could have the effect of reducing theamount of dividends we can declare.

*Shareholders mayexperience dilution if we issue additional stock in the future.*

If our Board of Directorsshould determine in the future that there is a need to obtain additionalcapital through the issuance of additional shares of our common stock orsecurities convertible into shares of common stock, such issuances could resultin dilution to shareholders. Similarly, if the Board of Directors decides togrant additional stock options for the purchase of shares of common stock, theaddition of such stock options may expose shareholders to dilution.

*CertainAnti-Takeover measures affect the ability of shareholders to effect takeovertransactions.*

We are subject to the Rhode Island BusinessCombination Act which, subject to certain exceptions, prohibits businesscombinations involving certain shareholders of publicly held corporations for aperiod of five years after such shareholders acquire 10% or more of theoutstanding voting stock of the corporation. In addition, our Articles ofIncorporation and By-laws, among other things, provide that, in addition to any

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vote required by law, theaffirmative vote of two-thirds of the holders of our voting stock, voting as asingle class, is required for approval of all business combinations.

Our Board of Directorsalso has the authority, without further action by shareholders, to issueadditional preferred stock in one or more series and to fix by resolution, therights, preferences and privileges of such series to the extent permitted bylaw. Our Board could designate certain rights and privileges for such preferredstock which would discourage unsolicited tender offers or takeover proposals orhave anti-takeover effects. Our Articles also provide for three classes ofdirectors to be elected for staggered three year terms, which make it moredifficult to change the composition of our Board. All of these provisions maymake it more difficult to effect a takeover transaction.

*Directors andexecutive officers own a significant portion of our common stock.*

Our directors andexecutive officers, as a group, beneficially owned approximately 18.2% of ouroutstanding common stock as of December 31, 2005. As a result of theirownership, the directors and executive officers would have the ability, if theyvote their shares in a like manner, to significantly influence the outcome ofall matters submitted to shareholders for approval, including the election ofdirectors.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

There are no writtencomments received from the SEC staff 180 days or more before the end ofthe fiscal year relating to the Company’s periodic or current reports under theExchange Act.

**ITEM 2.**                PROPERTIES

The Bank presently has a network of 16 branch officeslocated in Providence, Kent and Washington Counties. Seven of these branchoffice facilities are owned and nine are leased. Facilities are generallyleased for a period of one to ten years with renewal options. The terminationof any short-term lease would not have a material adverse effect on theoperations of the Bank. The Company’s offices are in good physical conditionand are considered appropriate to meet the banking needs of the Bank’scustomers.

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Thefollowing are the locations of the Bank’s offices:

| **Location**                                        | ** ** | ** ** | ** ** | **Size  (Square feet)** | ** ** | **Year Opened  or Acquired** | ** ** | **Owned or  Leased** | ** ** | **Lease  Expiration Date** | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------------------------|------------|----------------------------------------|------------|---------------------------|------------|---------------------------------|------------|
| Branch offices:                                     |       |       |       |                         |       |                                   |       |                      |       |                            |       |   |   |   |   |
| 1047 Park Avenue,  Cranston, RI.                    |       |       | 4,700      |                         |       |                                   | 1996       |                      |       | Owned                           |       |   | N.A. |   |   |
| 383 Atwood  Avenue, Cranston, RI.                   |       |       | 4,700      |                         |       |                                   | 1996       |                      |       | Owned                           |       |   | N.A. |   |   |
| 2104 Plainfield  Pike, Cranston, RI.                |       |       | 700        |                         |       |                                   | 2002       |                      |       | Owned                           |       |   | N.A. |   |   |
| 1269 South County  Trail, East Greenwich, RI.  |       |       | 2,600      |                         |       |                                   | 2005       |                      |       | Leased                          |       |   | 5/31/25 |   |   |
| 999 South  Broadway, East Providence, RI.           |       |       | 3,200      |                         |       |                                   | 1996       |                      |       | Leased                          |       |   | 11/30/12 |   |   |
| 195 Taunton  Avenue, East Providence, RI.           |       |       | 3,100      |                         |       |                                   | 1996       |                      |       | Leased                          |       |   | 2/28/08 |   |   |
| 1440 Hartford  Avenue, Johnston, RI.                |       |       | 4,700      |                         |       |                                   | 1996       |                      |       | Land  Leased                    |       |   | 12/31/07 |   |   |
| 625 G. Washington  Highway, Lincoln, RI.            |       |       | 1,000      |                         |       |                                   | 2005       |                      |       | Leased                          |       |   | 12/31/12 |   |   |
| Ten Rod Road,  North Kingstown, RI.                 |       |       | 4,000      |                         |       |                                   | 2004       |                      |       | Land  Leased                    |       |   | 6/30/19 |   |   |
| One Turks Head  Place, Providence, RI.              |       |       | 5,000      |                         |       |                                   | 1996       |                      |       | Leased                          |       |   | 4/30/09 |   |   |
| 165 Pitman  Street, Providence, RI.                 |       |       | 3,300      |                         |       |                                   | 1998       |                      |       | Leased                          |       |   | 10/18/08 |   |   |
| 445 Putnam Pike,  Smithfield, RI.                   |       |       | 3,500      |                         |       |                                   | 1996       |                      |       | Leased                          |       |   | 7/31/09 |   |   |
| 1062 Centerville Road,  Warwick, RI.                |       |       | 2,600      |                         |       |                                   | 1996       |                      |       | Owned                           |       |   | N.A. |   |   |
| 1300 Warwick  Avenue, Warwick, RI.                  |       |       | 4,200      |                         |       |                                   | 1996       |                      |       | Leased                          |       |   | 6/30/09 |   |   |
| 2975 West Shore  Road, Warwick, RI.                 |       |       | 3,500      |                         |       |                                   | 2000       |                      |       | Leased                          |       |   | 3/31/10 |   |   |
| 1175 Cumberland  Hill Road, Woonsocket, RI.    |       |       | 3,300      |                         |       |                                   | 1998       |                      |       | Owned                           |       |   | N.A. |   |   |
| Administrative and operational offices:             |       |       |       |                         |       |                                   |       |                      |       |                            |       |   |   |   |   |
| 625 G. Washington  Highway, Lincoln, RI.            |       |       | 23,600     |                         |       |                                   | 2003       |                      |       | Leased                          |       |   | 12/31/12 |   |   |
| One Turks Head  Place, Providence, RI.              |       |       | 20,600     |                         |       |                                   | 1999       |                      |       | Leased                          |       |   | 6/30/09 |   |   |
| One Ames Court,  Plainview, NY                      |       |       | 4,400      |                         |       |                                   | 2005       |                      |       | Leased                          |       |   | 1/31/08 |   |   |
| Planned branch offices:                             |       |       |       |                         |       |                                   |       |                      |       |                            |       |   |   |   |   |
| 90 Point Judith  Road, Narragansett, RI             |       |       | (A)        |                         |       |                                   | N.A.       |                      |       | Leased                          |       |   | 6/30/25 |   |   |
| 499 Smithfield Avenue,  Pawtucket, RI.              |       |       | (A)        |                         |       |                                   | N.A.       |                      |       | Leased                          |       |   | 7/31/20 |   |   |

 

(A)  Facilitycurrently under construction or in planning.

**ITEM 3*.****               *LEGAL PROCEEDINGS

The Company is involvedonly in routine litigation incidental to the business of banking, none of whichthe Company’s management expects to have a material adverse effect on the Company.

**ITEM 4.**             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of securityholders in the fourth quarter of 2005.

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**PART II**

**ITEM 5.***               *MARKETFOR THE COMPANY’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

Ourcommon stock is traded on the Nasdaq Stock Marketâunder the symbol “BARI”. The following table sets forth certain information regardingour common stock for the periods indicated.

| ** **     | ** ** | **Stock Price** | ** ** | **Dividend** | ** ** |
|----------------|------------|----------------------|------------|--------------|------------|
| ** **     | ** ** | **High**             | ** ** | **Low**      | ** ** | **Paid** | ** ** |
| 2004:          |       |                 |       |         |       |   |   |   |   |
| First Quarter  |       | $                    | 33.70      |         | $          | 31.46 |   |   | $ | 0.14 |   |   |
| Second Quarter |       | 35.97                |       | 32.45        |       |   | 0.14 |   |   |
| Third Quarter  |       | 36.65                |       | 34.00        |       |   | 0.15 |   |   |
| Fourth Quarter |       | 40.71                |       | 35.20        |       |   | 0.15 |   |   |
| 2005:          |       |                 |       |         |       |   |   |   |   |
| First Quarter  |       | $                    | 40.00      |         | $          | 35.96 |   |   | $ | 0.15 |   |   |
| Second Quarter |       | 38.07                |       | 35.39        |       |   | 0.15 |   |   |
| Third Quarter  |       | 37.45                |       | 35.11        |       |   | 0.15 |   |   |
| Fourth Quarter |       | 36.55                |       | 33.29        |       |   | 0.15 |   |   |

 

As of February 28,2006, there were approximately 1,500 holders of record of our common stock.

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**ITEM 6.**                SELECTEDCONSOLIDATED FINANCIAL DATA

Thefollowing table represents selected consolidated financial data as of and forthe years ended December 31, 2005, 2004, 2003, 2002 and 2001. The selectedconsolidated financial data is derived from the Company’s ConsolidatedFinancial Statements, which have been audited by KPMG LLP. The selectedconsolidated financial data set forth below does not purport to be complete andshould be read in conjunction with, and are qualified in their entirety by, themore detailed information, including the Consolidated Financial Statements andrelated Notes, and “Management’s Discussion and Analysis of Financial Conditionand Results of Operations”, appearing elsewhere herein.

| ** **                                     | ** ** | **As of and for the year   ended December 31,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002(a)** | ** ** | **2001** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands, except Per Share Data)**    | ** ** |
| Statements of operations  data:                |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Interest income                                |       | $                                                                                  | 69,520     |   | $ | 57,719 |   | $ | 51,773 |   | $ | 53,507 |   | $ | 55,903 |   |
| Interest expense                               |       | 26,619                                                                             |       | 19,625 |   | 19,453 |   | 22,180 |   | 26,537 |   |
| Net interest income                            |       | 42,901                                                                             |       | 38,094 |   | 32,320 |   | 31,327 |   | 29,366 |   |
| Provision for loan and lease losses            |       | 1,474                                                                              |       | 900 |   | 1,600 |   | 1,875 |   | 1,669 |   |
| Noninterest income                             |       | 9,274                                                                              |       | 8,581 |   | 8,830 |   | 7,083 |   | 5,231 |   |
| Noninterest expense                            |       | 36,292                                                                             |       | 32,865 |   | 28,790 |   | 25,024 |   | 23,196 |   |
| Income before taxes                            |       | 14,409                                                                             |       | 12,910 |   | 10,760 |   | 11,511 |   | 9,732 |   |
| Income taxes                                   |       | 4,840                                                                              |       | 4,296 |   | 3,546 |   | 3,849 |   | 3,417 |   |
| Net income                                     |       | $                                                                                  | 9,569      |   | $ | 8,614 |   | $ | 7,214 |   | $ | 7,662 |   | $ | 6,315 |   |
| Per share data:                                |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Basic earnings per common share                |       | $                                                                                  | 2.14       |   | $ | 2.17 |   | $ | 1.89 |   | $ | 2.04 |   | $ | 1.69 |   |
| Diluted earnings per common share              |       | $                                                                                  | 2.04       |   | $ | 2.04 |   | $ | 1.77 |   | $ | 1.92 |   | $ | 1.62 |   |
| Dividends per common share                     |       | $                                                                                  | 0.60       |   | $ | 0.58 |   | $ | 0.56 |   | $ | 0.53 |   | $ | 0.48 |   |
| Dividend pay-out ratio                         |       | 29.4                                                                               | %          | 28.4 | % | 31.6 | % | 27.6 | % | 29.6 | % |
| Book value per common share                    |       | 22.21                                                                              |       | 19.68 |   | 18.53 |   | 17.59 |   | 15.74 |   |
| Tangible book value per common share           |       | $                                                                                  | 19.83      |   | $ | 16.99 |   | $ | 15.76 |   | $ | 14.73 |   | $ | 12.88 |   |
| Average common shares outstanding—Basic   |       | 4,478,081                                                                          |       | 3,975,413 |   | 3,819,232 |   | 3,758,214 |   | 3,730,910 |   |
| Average common shares outstanding—Diluted |       | 4,697,134                                                                          |       | 4,222,856 |   | 4,085,878 |   | 3,996,670 |   | 3,900,028 |   |
| Balance sheet data:                            |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Total assets                                   |       | $                                                                                  | 1,442,279  |   | $ | 1,239,069 |   | $ | 1,093,971 |   | $ | 1,012,877 |   | $ | 862,250 |   |
| Investment securities                          |       | 150,959                                                                            |       | 104,600 |   | 98,595 |   | 101,329 |   | 49,453 |   |
| Mortgage-backed securities                     |       | 234,858                                                                            |       | 159,946 |   | 106,618 |   | 156,114 |   | 150,650 |   |
| Total loans and leases receivable              |       | 950,806                                                                            |       | 886,301 |   | 814,282 |   | 670,658 |   | 610,964 |   |
| Allowance for loan and lease losses            |       | 12,168                                                                             |       | 11,906 |   | 11,078 |   | 10,096 |   | 8,524 |   |
| Goodwill, net                                  |       | 11,234                                                                             |       | 10,766 |   | 10,766 |   | 10,766 |   | 10,766 |   |
| Deposits                                       |       | 980,969                                                                            |       | 880,674 |   | 811,283 |   | 761,911 |   | 670,413 |   |
| Borrowings                                     |       | 344,769                                                                            |       | 271,386 |   | 203,622 |   | 179,305 |   | 129,398 |   |
| Common shareholders’ equity               |       | 104,832                                                                            |       | 78,923 |   | 72,107 |   | 66,427 |   | 59,097 |   |
| Total shareholders’ equity                |       | 104,832                                                                            |       | 78,923 |   | 72,107 |   | 66,427 |   | 59,097 |   |
| Average balance  sheet data:                   |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Total assets                                   |       | $                                                                                  | 1,347,132  |   | $ | 1,168,036 |   | $ | 1,046,741 |   | $ | 947,205 |   | $ | 818,905 |   |
| Investment securities                          |       | 131,711                                                                            |       | 102,827 |   | 91,153 |   | 71,481 |   | 49,881 |   |
| Mortgage-backed securities                     |       | 209,004                                                                            |       | 132,946 |   | 123,524 |   | 177,753 |   | 130,342 |   |
| Total loans and leases receivable              |       | 916,273                                                                            |       | 848,550 |   | 747,174 |   | 622,545 |   | 584,400 |   |
| Allowance for loan and lease losses            |       | 11,938                                                                             |       | 11,490 |   | 10,739 |   | 9,375 |   | 8,056 |   |
| Goodwill, net                                  |       | 11,067                                                                             |       | 10,766 |   | 10,766 |   | 10,766 |   | 11,373 |   |
| Deposits                                       |       | 928,374                                                                            |       | 858,739 |   | 779,540 |   | 706,338 |   | 644,795 |   |
| Borrowings                                     |       | 306,344                                                                            |       | 227,365 |   | 192,068 |   | 174,668 |   | 115,677 |   |
| Common shareholders’ equity               |       | 95,922                                                                             |       | 74,704 |   | 69,010 |   | 61,922 |   | 56,101 |   |
| Total shareholders’ equity                |       | 95,922                                                                             |       | 74,704 |   | 69,010 |   | 61,922 |   | 56,101 |   |
| Operating ratios:                              |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Interest rate spread                           |       | 2.92                                                                               | %          | 3.07 | % | 2.91 | % | 3.04 | % | 3.12 | % |
| Net interest margin                            |       | 3.35                                                                               | %          | 3.44 | % | 3.28 | % | 3.48 | % | 3.75 | % |
| Efficiency ratio (b)                           |       | 69.56                                                                              | %          | 70.41 | % | 69.96 | % | 65.15 | % | 67.05 | % |
| Return on average assets (c)                   |       | 0.71                                                                               | %          | 0.74 | % | 0.69 | % | 0.81 | % | 0.77 | % |
| Return on average  equity (c)                  |       | 9.98                                                                               | %          | 11.53 | % | 10.45 | % | 12.37 | % | 11.26 | % |

 

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| ** **                                                  | ** ** | **As of and for the year  ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                                                                          | ** ** | **2004** | ** ** | **2003** | ** ** | **2002(a)** | ** ** | **2001** | ** ** |
| ** **                                                  | ** ** | **(Dollars in thousands, except Per Share Data)**   | ** ** |
| Asset quality  ratios:                                      |       |                                                                              |       |   |   |   |   |   |   |   |   |
| Nonperforming loans to total loans                          |       | 0.04                                                                              | %          | 0.08 | % | 0.30 | % | 0.11 | % | 0.12 | % |
| Nonperforming assets to total assets                        |       | 0.03                                                                              | %          | 0.06 | % | 0.23 | % | 0.08 | % | 0.12 | % |
| Allowance for loan and lease losses to nonperforming  loans |       | 2,932.05                                                                          | %          | 1,624.28 | % | 449.96 | % | 1,371.74 | % | 1,132.01 | % |
| Allowance for loan and lease losses to total loans          |       | 1.28                                                                              | %          | 1.34 | % | 1.36 | % | 1.51 | % | 1.40 | % |
| Net loans charged-off to average loans outstanding          |       | 0.13                                                                              | %          | 0.01 | % | 0.08 | % | 0.05 | % | 0.08 | % |
| Capital ratios:                                             |       |                                                                              |       |   |   |   |   |   |   |   |   |
| Average shareholders’ equity to average total assets   |       | 7.11                                                                              | %          | 6.40 | % | 6.59 | % | 6.54 | % | 6.85 | % |
| Tier I leverage ratio                                       |       | 8.21                                                                              | %          | 7.06 | % | 6.76 | % | 6.19 | % | 5.93 | % |
| Tier I risk-based capital ratio                             |       | 12.62                                                                             | %          | 10.01 | % | 9.71 | % | 9.63 | % | 9.86 | % |
| Total risk-based  capital ratio                             |       | 13.87                                                                             | %          | 11.26 | % | 10.92 | % | 10.88 | % | 11.10 | % |

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(a)              Earnings for 2002 and subsequent years were positivelyimpacted by the Company’s adoption of Statement of Financial AccountingStandards (“SFAS”) 142, “*Goodwill andOther Intangible Assets*” and SFAS 147, “*Acquisitions of Certain Financial Institutions*”.These Statements required the Company to cease amortizing its goodwill andbegin reviewing it at least annually for impairment. In prior years, the amountof this amortization was $1.2 million annually. Also see discussion under “*Recent Accounting Developments*”.

(b)             Calculated by dividing total noninterest expenses bynet interest income plus noninterest income.

(c)              Excludes cumulative effect of change inaccounting principle, net of taxes.

**ITEM 7.**             MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Introduction**

Bancorp Rhode Island, Inc. (the “Company”), aRhode Island corporation, is the holding company for Bank Rhode Island (the “Bank”).The Company has no significant assets other than the common stock of the Bank. Forthis reason, substantially all of the discussion in this document relates tothe operations of the Bank and its subsidiaries.

The Bank is a commercialbank chartered as a financial institution in the State of Rhode Island. TheBank pursues a community banking mission and is principally engaged inproviding banking products and services to businesses and individuals in RhodeIsland and nearby areas of Massachusetts. The Bank is subject to competitionfrom a variety of traditional and nontraditional financial service providersboth within and outside of Rhode Island. The Bank offers a wide variety ofcommercial real estate, business, residential and consumer loans and leases,deposit products, nondeposit investment products, cash management and otherbanking products and services designed to meet the financial needs ofindividuals and small- to mid-sized businesses. The Bank also offers bothcommercial and consumer on-line banking products and maintains a web site at http://www.bankri.com. TheCompany and Bank are subject to the regulations of certain federal and stateagencies and undergo periodic examinations by those regulatory authorities. TheBank’s deposits are insured by the FDIC, subject to regulatory limits. The Bankis also a member of the FHLB.

**Overview**

The past year marked a period of significant activity,change, and challenge for the Company. The Company consummated a capitaloffering, acquired an equipment leasing subsidiary (“Macrolease”), started aprivate banking group and opened two new branches. In addition, there werechanges to the Company’s executive management team. For a fuller narrativecommentary on these matters, refer to Item 1, “Business”.

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The primary drivers of the Company’s operating incomeare net interest income, which is strongly affected by the net interest margin,and the quality of the Company’s assets.

The Company’s net interest income is the differencebetween its interest income and its cost of funds. Interest income depends onthe amount of interest-earning assets outstanding during the year and theinterest rates earned thereon. Cost of funds is a function of the averageamount of deposits and borrowed money outstanding during the year and theinterest rates paid thereon. Because the Company’s assets are not identical induration and in repricing dates to its liabilities, the spread between the twois vulnerable to changes in market interest rates as well as the overall shapeof the yield curve. These vulnerabilities are inherent to the business ofbanking and are commonly referred to as “interest rate risk”. How to measureinterest rate risk and, once measured, how much risk to take are based onnumerous assumptions and other subjective judgments. See discussion under “*Asset and Liability Management*”.

The quality of the Company’s assets also influencesits earnings. Loans and leases that are not being paid on a timely basis andexhibit other weaknesses can result in the loss of principal and/or loss ofinterest income. Additionally, the Company must make timely provisions to itsallowance for loan and lease losses as a result of its estimates as topotential future losses; these additions, which are charged against earnings,are necessarily greater when greater potential losses are expected. Finally,the Company will incur expenses as a result of resolving troubled assets. Allof these form the “credit risk” that the Company takes on in the ordinarycourse of its business and is further discussed under “*FinancialCondition—Asset Quality*”.

The Company’s business strategy has been toconcentrate its asset generation efforts on commercial and consumer loans andits deposit generation efforts on checking and savings accounts. These depositaccounts are commonly referred to as “core deposit accounts”. This strategy isbased on the Company’s belief that it can distinguish itself from its largercompetitors, and indeed attract customers from them, through a higher level ofservice and through its ability to set policies and procedures, as well as makedecisions, locally. The loan and deposit products referenced also tend to begeared more toward customers who are relationship oriented than those who areseeking stand-alone or single transaction products. The Company believes thatits service-oriented approach enables it to compete successfully forrelationship-oriented customers. Additionally, the Company is predominantly anurban franchise with a high concentration of businesses making deployment offunds in the commercial lending area practicable. Commercial loans areattractive, among other reasons, because of their higher yields. Similarly,core deposits are attractive because of their generally lower interest cost andpotential for fee income.

In recent years, the Company also has sought toleverage business opportunities presented by its customer base, franchisefootprint and resources. This year, the Bank formed a private banking divisionand completed its first acquisition with the acquiring of an equipment leasingcompany located in Long Island, New York (“Macrolease”). The Bank will use theMacrolease platform to increase its portfolio of equipment leases, but expectsto generate additional income by also originating equipment leases for thirdparties. The Company also has introduced Macrolease to the Bank’s commercialcustomers, thereby expanding the Bank’s product offerings.

The deposit market in Rhode Island is highlyconcentrated. The State’s three largest banks have an aggregate market share of85% (based upon June 2005 FDIC statistics, excluding one bank that drawsits deposits primarily from the internet) in Providence and Kent Counties, theBank’s primary marketplace. Competition for deposits has intensified during thepast few years. Institutions in the market have increased their advertising andpromotional product offerings, spurred on by the various new entrants into themarket.

In 2005, approximately 82.2% of the Company’s totalrevenues (defined as net interest income plus noninterest income) are derivedfrom its level of net interest income. The Company continued efforts todiversify its sources of revenue, with emphasis on expanding sources ofnoninterest income (primarily fees 

25

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and charges for productsand services the Bank offers). The Company has increased its percentage ofnoninterest income to total revenue from 12.0% in 2000, to 17.8% in 2005, asthe Company experienced growth in the area of commissions on loans and leasesoriginated for third parties and loan related fees.

During 2005, lower-yielding liquid savings accountssuch as money market and NOW accounts declined; however core deposits remainedflat due to moderate increases in demand deposit accounts. The Bank’s depositgrowth was centered in higher-yielding CD’s. This shift in deposit mix hasincreased the Bank’s cost of funds. The combination of the flattening yieldcurve and cost of funds increase resulted in significant pressure on the Bank’snet interest margin, which has negatively affected net interest income. TheBank experienced an overall decrease in net interest margin, as 2005’s netinterest margin of 3.35% was 9 basis points lower than 2004’s net interestmargin of 3.44%.

The Company anticipatesthat 2006, and in particular, the flattening yield curve and shift in thedeposit mix, will pose significant challenges to the Company. The futureoperating results of the Company will again depend on the ability to maintainand expand net interest margin, while minimizing exposure to credit risk, alongwith increasing sources of noninterest income, while controlling the growth ofnoninterest or operating expenses.

**Critical AccountingPolicies**

Accounting policiesinvolving significant judgments and assumptions by management, which have, orcould have, a material impact on the carrying value of certain assets or netincome, are considered critical accounting policies. The Company considers thefollowing to be its critical accounting policies: allowance for loan and leaselosses and review of goodwill for impairment. There have been no significantchanges in the methods or assumptions used in accounting policies that requirematerial estimates or assumptions.

*Allowance for loanand lease losses*

Arriving at an appropriatelevel of allowance for loan and lease losses necessarily involves a significantdegree of judgment. First and foremost in arriving at an appropriate allowanceis the creation and maintenance of a risk rating system that accuratelyclassifies all loans and leases into varying categories by degree of creditrisk. Such a system also establishes a level of allowance associated with eachcategory of loans and requires early identification and reclassification ofdeteriorating credits. Besides numerous subjective judgments as to the numberof categories, appropriate level of allowance with respect to each category andjudgments as to categorization of any individual loan or lease, additionalsubjective judgments are involved when ascertaining the probability as well asthe extent of any potential losses. The Company’s ongoing evaluation processincludes a formal analysis of the allowance each quarter, which considers,among other factors, the character and size of the loan and lease portfolio,business and economic conditions, loan growth, delinquency trends, nonperformingloan trends, charge-off experience and other asset quality factors. Thesefactors are based on observable information, as well as subjective assessmentand interpretation. Nonperforming commercial, commercial real estate and smallbusiness loans in excess of a specified dollar amount are deemed to be “impaired”.The estimated reserves necessary for each of these credits is determined byreviewing the fair value of the collateral, the present value of expectedfuture cash flows, and where available, the observable market price of theloans. Provisions for losses on the remaining commercial, commercial realestate, small business, residential mortgage and consumer loans and leases arebased on pools of similar loans or leases using a combination of paymentstatus, historical loss experience, industry loss experience, market economicfactors, delinquency rates and qualitative adjustments. Management usesavailable information to establish the allowance for loan and lease losses atthe level it believes is appropriate. However, future additions to theallowance may be necessary based on changes in estimates or assumptionsresulting from changes in economic conditions and other factors. In addition,various regulatory agencies, as an integral part of their examination process,periodically review the Company’s allowance for loan and lease losses. Suchagencies 

26

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mayrequire the Company to recognize adjustments to the allowance based on theirjudgments about information available to them at the time of their examination.

*Review of goodwillfor impairment*

In March 1996, the Bank acquired certain assetsand assumed certain liabilities from Fleet Financial Group, Inc. andrelated entities. This acquisition was accounted for utilizing the purchasemethod of accounting and generated $17.5 million of goodwill. Thisgoodwill was amortized in the years prior to 2002, resulting in a net balanceof $10.8 million on the Company’s balance sheet as of December 31,2001. Effective January 1, 2002, in accordance with Statement of FinancialAccounting Standards (“SFAS”) 142 “*Goodwill and OtherIntangible Assets*” and SFAS 147 “*Acquisitionsof Certain Financial Institutions*”, the Company ceased amortizingthis goodwill and began to review it at least annually for impairment.

On May 1, 2005, the Bank acquired certainoperating assets from Macrolease International Corporation. This acquisitionwas accounted for utilizing the purchase method of accounting and generated$468,000 of goodwill.

Goodwill is evaluated forimpairment using market value comparisons for similar institutions, such asprice to earnings multiples, price to deposit multiples and price to equitymultiples. This valuation technique utilizes verifiable market multiples, aswell as subjective assessment and interpretation. The application of differentmarket multiples, or changes in judgment as to which market transactions arereflective of the Company’s specific characteristics, could affect theconclusions reached regarding possible impairment. In the event that theCompany were to determine that its goodwill were impaired, the recognition ofan impairment charge could have an adverse impact on its results of operationsin the period that the impairment occurred or on its financial position.

**Results of Operations**

*Net Interest Income*

Net interest income for2005 was $42.9 million, compared to $38.1 million for 2004 and$32.3 million for 2003. The net interest margin decreased in 2005 to3.35%, compared to 3.44% in 2004. In 2003, the net interest margin was 3.28%. Theincrease in net interest income of $4.8 million, or 12.6%, during 2005 wasprimarily attributable to the continued growth of the Company. Average earningassets increased $172.4 million, or 15.6%, and average interest-bearingliabilities increased $143.4 million, or 15.6%, during 2005, compared to2004.

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*Average Balances,Yields and Costs*

Thefollowing table sets forth certain information relating to the Company’saverage balance sheet and reflects the average yield on assets and average costof liabilities for the years indicated. Such yields and costs are derived bydividing income or expense by the average balance of assets or liabilities. Averagebalances are derived from daily balances and include nonperforming loans.

| ** **      | ** ** | **Year ended December 31,** | ** ** |
|-----------------|------------|--------------------------------------------|------------|
| ** **      | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **      | ** ** | ** **                                 | ** ** | **Interest** | ** ** | ** ** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **      | ** ** | **Average**                                | ** ** | **earned/** | ** ** | **Average** | ** ** | **Average** | ** ** | **earned/** | ** ** | **Average** | ** ** | **Average** | ** ** | **earned/** | ** ** | **Average** | ** ** |
| ** **      | ** ** | **balance**                                | ** ** | **paid** | ** ** | **yield** | ** ** | **balance** | ** ** | **paid** | ** ** | **yield** | ** ** | **balance** | ** ** | **paid** | ** ** | **yield** | ** ** |
| ** **      | ** ** | **(Dollars in thousands)**       | ** ** |
| **Assets**      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Earning assets: |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

| Overnight investments                           |   | $         | 8,015     |   |   | $      | 201    |   |   |   | 2.51   | %         |   | $         | 12,286 |   |   | $      | 138    |   |   |    | 1.12   | %      |      | $      | 15,993 |   |   | $      | 170    |   |   |   | 1.06 | % |   |
|-------------------------------------------------|--------|-----------|-----------|--------|--------|--------|--------|--------|--------|--------|--------|-----------|--------|-----------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|-----------|--------|--------|--------|--------|--------|--------|--------|--------|--------|------|---|--------|
| Investment securities                           |   | 131,711   |      |   | 5,537  |   |   |   | 4.20   | %      |   | 102,827   |   |      | 4,452  |   |   |   | 4.33   | %      |   | 91,153  |   |   | 3,999     |   |   |   | 4.39   | %      |   |
| Mortgage-backed securities                      |   | 209,004   |      |   | 9,313  |   |   |   | 4.46   | %      |   | 132,946   |   |      | 5,709  |   |   |   | 4.29   | %      |   | 123,524 |   |   | 4,886     |   |   |   | 3.96   | %      |   |
| Stock in the FHLB                               |   | 14,842    |      |   | 647    |   |   |   | 4.36   | %      |   | 10,811    |   |      | 308    |   |   |   | 2.85   | %      |   | 8,633   |   |   | 262       |   |   |   | 3.03   | %      |   |
| Loans receivable:                               |   |      |      |   |   |   |   |   |   |   |   |      |   |      |   |   |   |   |   |   |   |    |   |   |      |   |   |   |   |   |   |
| Commercial loans and leases                     |   | 421,429   |      |   | 28,015 |   |   |   | 6.65   | %      |   | 369,263   |   |      | 23,092 |   |   |   | 6.25   | %      |   | 309,105 |   |   | 19,494    |   |   |   | 6.31   | %      |   |
| Residential mortgage loans                      |   | 307,659   |      |   | 15,670 |   |   |   | 5.09   | %      |   | 337,825   |   |      | 17,087 |   |   |   | 5.06   | %      |   | 334,754 |   |   | 17,677    |   |   |   | 5.28   | %      |   |
| Consumer and other loans                        |   | 187,185   |      |   | 10,137 |   |   |   | 5.42   | %      |   | 141,462   |   |      | 6,933  |   |   |   | 4.90   | %      |   | 103,315 |   |   | 5,285     |   |   |   | 5.12   | %      |   |
| Total earning assets                            |   | 1,279,845 |      |   | 69,520 |   |   |   | 5.43   | %      |   | 1,107,420 |   |      | 57,719 |   |   |   | 5.21   | %      |   | 986,477 |   |   | 51,773    |   |   |   | 5.25   | %      |   |
| Cash and due from banks                         |   | 25,218    |      |   |   |   |   |   |   |   |   | 23,170    |   |      |   |   |   |   |   |   |   | 24,902  |   |   |      |   |   |   |   |   |   |
| Allowance for loan and lease losses             |   | (11,938   | )         |   |   |   |   |   |   |   |   | (11,490   | )      |      |   |   |   |   |   |   |   | (10,739 | )      |   |      |   |   |   |   |   |   |
| Premises and equipment                          |   | 13,765    |      |   |   |   |   |   |   |   |   | 12,709    |   |      |   |   |   |   |   |   |   | 11,732  |   |   |      |   |   |   |   |   |   |
| Goodwill, net                                   |   | 11,067    |      |   |   |   |   |   |   |   |   | 10,766    |   |      |   |   |   |   |   |   |   | 10,766  |   |   |      |   |   |   |   |   |   |
| Accrued interest receivable                     |   | 5,174     |      |   |   |   |   |   |   |   |   | 4,584     |   |      |   |   |   |   |   |   |   | 4,554   |   |   |      |   |   |   |   |   |   |
| Bank-owned life insurance                       |   | 18,452    |      |   |   |   |   |   |   |   |   | 16,026    |   |      |   |   |   |   |   |   |   | 15,175  |   |   |      |   |   |   |   |   |   |
| Prepaid expenses and other assets               |   | 5,549     |      |   |   |   |   |   |   |   |   | 4,851     |   |      |   |   |   |   |   |   |   | 3,874   |   |   |      |   |   |   |   |   |   |
| Total assets                                    |   | $         | 1,347,132 |   |   |   |   |   |   |   |   |      | $      | 1,168,036 |   |   |   |   |   |   |   |    |   | $      | 1,046,741 |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**   |   |      |      |   |   |   |   |   |   |   |   |      |   |      |   |   |   |   |   |   |   |    |   |   |      |   |   |   |   |   |   |
| Interest-bearing  liabilities:                  |   |      |      |   |   |   |   |   |   |   |   |      |   |      |   |   |   |   |   |   |   |    |   |   |      |   |   |   |   |   |   |
| Deposits:                                       |   |      |      |   |   |   |   |   |   |   |   |      |   |      |   |   |   |   |   |   |   |    |   |   |      |   |   |   |   |   |   |
| NOW accounts                                    |   | $         | 94,296    |   |   | 590    |   |   |   | 0.63   | %      |      | $      | 123,064   |   |   | 1,172  |   |   |   | 0.95   | %       |   | $      | 114,767   |   |   | 1,363  |   |   |   | 1.19   | %      |   |
| Money market accounts                           |   | 17,577    |      |   | 235    |   |   |   | 1.34   | %      |   | 16,315    |   |      | 213    |   |   |   | 1.31   | %      |   | 11,587  |   |   | 121       |   |   |   | 1.04   | %      |   |
| Savings accounts                                |   | 337,756   |      |   | 4,734  |   |   |   | 1.40   | %      |   | 325,019   |   |      | 3,899  |   |   |   | 1.20   | %      |   | 301,667 |   |   | 4,043     |   |   |   | 1.34   | %      |   |
| Certificate of deposit accounts                 |   | 304,572   |      |   | 8,962  |   |   |   | 2.94   | %      |   | 225,381   |   |      | 5,638  |   |   |   | 2.50   | %      |   | 210,081 |   |   | 5,916     |   |   |   | 2.82   | %      |   |
| Overnight and short-term borrowings             |   | 23,019    |      |   | 652    |   |   |   | 2.83   | %      |   | 16,643    |   |      | 157    |   |   |   | 0.94   | %      |   | 18,324  |   |   | 140       |   |   |   | 0.76   | %      |   |
| Wholesale repurchase agreements                 |   | 9,417     |      |   | 276    |   |   |   | 2.93   | %      |   | —    |   |      | — |   |   |   | 0.00   | %      |   | —  |   |   | —    |   |   |   | 0.00   | %      |   |
| FHLB borrowings                                 |   | 255,350   |      |   | 9,898  |   |   |   | 3.88   | %      |   | 193,234   |   |      | 7,505  |   |   |   | 3.88   | %      |   | 163,155 |   |   | 7,185     |   |   |   | 4.40   | %      |   |
| Subordinated deferrable interest debentures     |   | 18,558    |      |   | 1,272  |   |   |   | 6.85   | %      |   | 17,487    |   |      | 1,041  |   |   |   | 5.95   | %      |   | —  |   |   | —    |   |   |   | 0.00   | %      |   |
| Capital trust and other subordinated securities |   | —    |      |   | — |   |   |   | 0.00   | %      |   | —    |   |      | — |   |   |   | 0.00   | %      |   | 10,589  |   |   | 685       |   |   |   | 6.47   | %      |   |
| Total interest-bearing liabilities              |   | 1,060,545 |      |   | 26,619 |   |   |   | 2.51   | %      |   | 917,143   |   |      | 19,625 |   |   |   | 2.14   | %      |   | 830,170 |   |   | 19,453    |   |   |   | 2.34   | %      |   |
| Noninterest-bearing deposits                    |   | 174,173   |      |   |   |   |   |   |   |   |   | 168,960   |   |      |   |   |   |   |   |   |   | 141,438 |   |   |      |   |   |   |   |   |   |
| Other liabilities                               |   | 16,492    |      |   |   |   |   |   |   |   |   | 7,229     |   |      |   |   |   |   |   |   |   | 6,123   |   |   |      |   |   |   |   |   |   |
| Total liabilities                               |   | 1,251,210 |      |   |   |   |   |   |   |   |   | 1,093,332 |   |      |   |   |   |   |   |   |   | 977,731 |   |   |      |   |   |   |   |   |   |
| Shareholders’ equity                       |   | 95,922    |      |   |   |   |   |   |   |   |   | 74,704    |   |      |   |   |   |   |   |   |   | 69,010  |   |   |      |   |   |   |   |   |   |
| Total liabilities and shareholders’ equity |   | $         | 1,347,132 |   |   |   |   |   |   |   |   |      | $      | 1,168,036 |   |   |   |   |   |   |   |    |   | $      | 1,046,741 |   |   |   |   |   |   |   |   |   |
| Net interest income                             |   |      |      |   | $      | 42,901 |   |   |   |   |   |      |   |      |   | $      | 38,094 |   |   |   |   |    |   |   |      |   | $      | 32,320 |   |   |   |   |   |   |
| Net interest rate spread                        |   |      |      |   |   |   |   |   | 2.92   | %      |   |      |   |      |   |   |   |   | 3.07   | %      |   |    |   |   |      |   |   |   | 2.91   | %      |   |
| Net interest rate  margin                       |   |      |      |   |   |   |   |   | 3.35   | %      |   |      |   |      |   |   |   |   | 3.44   | %      |   |    |   |   |      |   |   |   | 3.28   | %      |   |

 

*Rate/VolumeAnalysis*

Thefollowing table sets forth certain information regarding changes in the Company’sinterest income and interest expense for the periods indicated. For eachcategory of interest-earning assets and interest-bearing liabilities,information is provided on changes attributable to (i) changes in rate(changes in rate multiplied by old average balance) and (ii) changes involume (changes in average balances multiplied by 

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old rate). The net change attributable to the combinedimpact of rate and volume was allocated proportionally to the individual rateand volume changes.

| ** **                                      | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2005 vs. 2004**                | ** ** | **2004 vs. 2003** | ** ** |
| ** **                                      | ** ** | **Increase/(decrease) due to**   | ** ** | **Increase/(decrease) due to** | ** ** |
| ** **                                      | ** ** | **Rate**                                   | ** ** | **Volume** | ** ** | **Total** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Total** | ** ** |
| ** **                                      | ** ** | **(In thousands)**                    | ** ** |
| Interest income:                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Overnight investments                           |       | $                                          | 124        |   | $ | (61 | ) | $ | 63 |   | $ | 10 |   | $ | (42 | ) | $ | (32 | ) |
| Investment securities                           |       | (132                                       | )          | 1,217 |   | 1,085 |   | (53 | ) | 506 |   | 453 |   |
| Mortgage-backed securities                      |       | 223                                        |       | 3,381 |   | 3,604 |   | 435 |   | 388 |   | 823 |   |
| Stock in the FHLB                               |       | 199                                        |       | 140 |   | 339 |   | (17 | ) | 63 |   | 46 |   |
| Commercial loans and leases                     |       | 1,519                                      |       | 3,404 |   | 4,923 |   | (165 | ) | 3,763 |   | 3,598 |   |
| Residential mortgage loans                      |       | 118                                        |       | (1,535 | ) | (1,417 | ) | (751 | ) | 161 |   | (590 | ) |
| Consumer and other loans                        |       | 786                                        |       | 2,418 |   | 3,204 |   | (230 | ) | 1,878 |   | 1,648 |   |
| Total interest income                           |       | 2,837                                      |       | 8,964 |   | 11,801 |   | (771 | ) | 6,717 |   | 5,946 |   |
| Interest expense:                               |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                    |       | (346                                       | )          | (236 | ) | (582 | ) | (285 | ) | 94 |   | (191 | ) |
| Money market accounts                           |       | 5                                          |       | 17 |   | 22 |   | 35 |   | 57 |   | 92 |   |
| Savings accounts                                |       | 677                                        |       | 158 |   | 835 |   | (443 | ) | 299 |   | (144 | ) |
| Certificate of deposit accounts                 |       | 1,111                                      |       | 2,213 |   | 3,324 |   | (690 | ) | 412 |   | (278 | ) |
| Overnight & short-term borrowings      |       | 416                                        |       | 79 |   | 495 |   | 31 |   | (14 | ) | 17 |   |
| FHLB and other borrowings                       |       | (81                                        | )          | 2,750 |   | 2,669 |   | (909 | ) | 1,229 |   | 320 |   |
| Capital trust and other subordinated securities |       | 164                                        |       | 67 |   | 231 |   | (59 | ) | 415 |   | 356 |   |
| Total interest expense                          |       | 1,946                                      |       | 5,048 |   | 6,994 |   | (2,320 | ) | 2,492 |   | 172 |   |
| Net interest  income                            |       | $                                          | 891        |   | $ | 3,916 |   | $ | 4,807 |   | $ | 1,549 |   | $ | 4,225 |   | $ | 5,774 |   |

 

**Comparison of YearsEnded December 31, 2005 and December 31, 2004**

*General*

Net income for 2005increased $955,000, or 11.1%, to $9.6 million, from $8.6 million for 2004.Earnings per diluted common share (“EPS”) was the same both years at $2.04. Themain factor for the same level of EPS was the dilutive effect of the issuanceof approximately 628,000 shares in the second quarter of 2005. The 2005earnings represented a return on average assets of 0.71% and a return onaverage equity of 9.98% for 2005, as compared to a return on average assets of0.74% and a return on average equity of 11.53% for 2004.

*Net Interest Income*

For 2005, net interestincome was $42.9 million, compared to $38.1 million for 2004. The net interestmargin for 2005 was 3.35% compared to a net interest margin of 3.44% for 2004.The increase in net interest income of $4.8 million, or 12.6%, was primarilyattributable to the overall growth of the Company. Average earning assets increased$172.4 million, or 15.6%, and average interest-bearing liabilitiesincreased $143.4 million, or 15.6%, over the preceding year. The decreaseof 9 basis points in the net interest margin resulted primarily fromcompression in the interest rate environment, customer demand forhigher-yielding term deposit products and the leverage program the Companyundertook to partially offset the dilution of EPS caused by the issuance ofadditional common stock during the second quarter of 2005.

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*Interest Income—Investments*

Total investment income(consisting of interest on overnight investments, investment securities andMBSs, and dividends on FHLB stock) was $15.7 million for 2005, compared to$10.6 million for 2004. This increase in total investment income of $5.1million, or 48.0%, was attributable primarily to higher average balances in2005. While yields on total investments increased moderately during 2005, themajority of the increase in investment income relates to the leverage programreferred to above, which was concluded in the fourth quarter of 2005.

*Interest Income—Loansand Leases*

Interest from loans was $53.8 million for 2005, andrepresented a yield on total loans of 5.87%. This compares to $47.1 million ofinterest, and a yield of 5.55%, for 2004. Increased interest income resultingfrom growth in the average balance of loans of $67.7 million, or 8.0%, wasaugmented by an increase in the yield on loans of 32 basis points.

The average balance of thevarious components of the loan portfolio changed as follows:  commercial loans and leases increased $52.2million, or 14.1%; consumer and other loans increased $45.7 million, or 32.3%;and residential mortgage loans decreased $30.2 million, or 8.9%. The yield onthe various components of the loan portfolio changed as follows:  commercial loans and leases increased 40basis points, to 6.65%; consumer and other loans increased 52 basis points, to5.42%; and residential mortgage loans increased 3 basis points, to 5.09%. Theyields on loans and leases benefited primarily from the increases in short-terminterest rates that occurred throughout 2005.

*Interest Expense—Depositsand Borrowings*

Interest paid on deposits and borrowings increased by$6.9 million, or 35.6%, as short-term market interest rates increased duringthe past year. The overall average cost for interest-bearing liabilitiesincreased 37 basis points from 2.14% for 2004, to 2.51% for 2005. The averagebalance of total interest-bearing liabilities increased $143.4 million, or15.6%, from $917.1 million in 2004, to $1.06 billion in 2005. The growth indeposit average balances was centered primarily in certificate of deposit (“CD”)accounts (up $79.2 million, or 35.1%) and savings accounts (up $12.7 million,or 3.9%). These increases were somewhat offset by a decrease in NOW accounts(down $28.8 million, or 23.4%). Money market accounts remained consistent withprior year average balances, increasing $1.3 million, or 7.7%.

In addition, the Company increased its utilization ofFHLB borrowings (up $45.2 million, or 19.3%). The Company also entered intowholesale repurchase agreements in 2005, aggregating $20 million by the end ofthe year. The cost of nondeposit borrowings increased 11 basis points in 2005to 3.95%, compared to 3.84% in the prior year.

Customer demand for highercost CDs and the longer-term funding required for the leverage program were themain drivers of both the overall average cost and average balance levels ofinterest-bearing liabilities. Liability costs are dependent on a number offactors including general economic conditions, national and local interestrates, competition in the local deposit marketplace, interest rate tiersoffered and the Company’s cash flow needs.

*Provision for Loanand Lease Losses*

The provision for loan and lease losses was $1.5million for 2005, compared to $900,000 for 2004. The allowance, expressed as apercentage of total loans and leases, was 1.28% as of December 31, 2005,compared to 1.34% at the prior year-end and stood at 2932.1% of nonperformingloans and leases at December 31, 2005, compared to 1624.3% ofnonperforming loans and leases at December 31, 2004. Net charge-offs for2005 were $1.2 million, compared to $72,000 for 2004. The increase in netcharge-offs 

30

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occurred largely duringthe second quarter and was attributable to one asset-based credit. To resolvethe credit, the Bank sold the loan to a third party at a discount, resulting ina $1.2 million charge-off.

Management evaluatesseveral factors including new loan originations, actual and estimatedcharge-offs, risk characteristics of the loan and lease portfolio and generaleconomic conditions when determining the provision for loan and lease losses. Asthe loan and lease portfolio continues to grow and mature, or if economicconditions worsen, management believes it possible that the level ofnonperforming assets will increase, which in turn may lead to increases to theprovision for loan and lease losses. Also see discussion under “*Allowance for Loan and Lease Losses*”.

*Noninterest Income*

Total noninterest income increased $693,000, or 8.1%,from $8.6 million for 2004, to $9.3 million for 2005. Excluding gains on salesof premises and equipment and net gains on investment sales, noninterest incomeincreased $1.1 million or 14.3%. Deposit account service charges continue torepresent the largest source of noninterest income for the Company, showingmodest growth of $47,000, or 1.0%, to $4.6 million for 2005, compared to $4.5million in the prior year. Loan related fees increased $483,000, or 89.3%, asthe Bank experienced a higher level of prepayments in 2005 than in the previousyear. Additionally, growth occurred in commissions on loans originated forthird parties, with an increase of $113,000 from the prior year, or 159%. Commissionson leases originated for third parties of $245,000 and sales of Rhode Islandtax credits of $220,000 were the key drivers to the growth in Other Income. Ona net basis, gains on sales of investments and mortgage-backed securities wereup moderately by $91,000 from the prior year. These increases were offset bydeclines in commission on nondeposit investment products as income was down$124,000, or 12.7%.

Thefollowing table sets forth the components of noninterest income:

| ** **                                     | ** ** | **Year ended  December 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(In thousands)**                | ** ** |
| Service charges  on deposit accounts           |       | $                                      | 4,561      |   | $ | 4,514 |   |
| Loan related fees                              |       | 1,024                                  |       | 541 |   |
| Commissions on  nondeposit investment products |       | 849                                    |       | 973 |   |
| Income from  bank-owned life insurance         |       | 691                                    |       | 641 |   |
| Commissions on  loans originated for others    |       | 184                                    |       | 71 |   |
| Gain on sale of  Investments/MBSs              |       | 181                                    |       | 90 |   |
| Gain on sale of  premises and equipment        |       | —                                 |       | 535 |   |
| Other income                                   |       | 1,784                                  |       | 1,216 |   |
| Total noninterest  income                      |       | $                                      | 9,274      |   | $ | 8,581 |   |

 

*Noninterest Expense*

Noninterest expenses for 2005 increased a total of$3.4 million, or 10.4%, to $36.3 million. This increase was primarily due tohigher operating costs resulting from the continued growth of the Company asthe Bank opened two new branches in 2005 and acquired Macrolease. The increasewas centered in the following areas: Salaries and employee benefits (up $2.4 million, or 14.1%), Occupancycosts (up $457,000, or 17.1%), Marketing (up $155,000, or 10.8%), Loan workout(up $107,000, or 97.3%) and Other expenses (up $471,000, or 11.5%). The Companydid experience decreases in Loan servicing (down $124,000, or 11.4%) and Dataprocessing (down $73,000, or 2.6%). Professional services remained constantwith 2004 levels, showing a moderate increase of $52,000, or 2.6%, as costsincurred to comply with Sarbanes-Oxley Section 404 did not decrease. Overall,the Company’s efficiency ratio decreased slightly to 69.56% for 2005, from70.41% for 2004.

31

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Thefollowing table sets forth the components of noninterest expense:

| ** **                                | ** ** | **Year ended  December 31,** | ** ** |
|-------------------------------------------|------------|----------------------------------------|------------|
| ** **                                | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **(In thousands)**                | ** ** |
| Salaries and  employee benefits           |       | $                                      | 19,476     |   | $ | 17,072 |   |
| Occupancy and  equipment                  |       | 4,695                                  |       | 4,260 |   |
| Data processing                           |       | 2,759                                  |       | 2,832 |   |
| Professional  services                    |       | 2,017                                  |       | 1,965 |   |
| Marketing                                 |       | 1,584                                  |       | 1,429 |   |
| Loan servicing                            |       | 968                                    |       | 1,092 |   |
| Loan workout and  other real estate owned |       | 217                                    |       | 110 |   |
| Other expenses                            |       | 4,576                                  |       | 4,105 |   |
| Total noninterest  expense                |       | $                                      | 36,292     |   | $ | 32,865 |   |

 

*Income Tax Expense*

The Company recordedincome tax expense of $4.8 million for 2005, compared to $4.3 million for 2004.This represented total effective tax rates of 33.6% and 33.3%, respectively.Tax-favored income from BOLI, along with its utilization of a Rhode Island passiveinvestment company, has reduced the Company’s effective tax rate from the 40.9%combined statutory federal and state tax rates.

**Comparison of YearsEnded December 31, 2004 and December 31, 2003**

*General*

Net income for 2004,increased $1.4 million, or 19.4%, to $8.6 million, or $2.04 per diluted commonshare, from $7.2 million, or $1.77 per diluted common share, for 2003. Thisperformance represented a return on average assets of 0.74% and a return onaverage equity of 11.53% for 2004, as compared to a return on average assets of0.69% and a return on average equity of 10.45% for 2003.

*Net Interest Income*

For 2004, net interestincome was $38.1 million, compared to $32.3 million for 2003. The net interestmargin for 2004 was 3.44% compared to a net interest margin of 3.28% for 2003. Theincrease in net interest income of $5.8 million, or 17.9%, was primarilyattributable to the overall growth of the Company. Average earning assetsincreased $120.9 million, or 12.3%, and average interest-bearing liabilities increased$87.0 million, or 10.5%, over the preceding year. The increase of 16 basispoints in the net interest margin resulted from the Company’s assets benefitingfrom increases in the Prime Rate during 2004, while the Company also was ableto reduce the overall cost of its interest-bearing liabilities. Additionally,prepayment activity slowed considerably from the 2003 period, resulting in anincrease in the yield of mortgage-related assets.

*Interest Income—Investments*

Total investment income(consisting of interest on overnight investments, investment securities andMBSs, and dividends on FHLB stock) was $10.6 million for 2004, compared to $9.3million for 2003. This increase in total investment income of $1.3 million, or13.8%, was attributable to a 21 basis point increase in the overall yield oninvestments, from 3.89% in 2003, to 4.10% in 2004, in response to slowerprepayment activity in MBSs, coupled with a $19.6 million, or 8.2%, increase inthe average balance of investments.

32

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*Interest Income—Loansand Leases*

Interest from loans was$47.1 million for 2004, and represented a yield on total loans of 5.55%. Thiscompares to $42.5 million of interest, and a yield of 5.68%, for 2003. Increasedinterest income resulting from growth in the average balance of loans of $101.4million, or 13.6%, was partially offset by a decrease in the yield on loans of13 basis points. The average balance of the various components of the loanportfolio changed as follows:  commercialloans and leases increased $60.2 million, or 19.5%; consumer and other loansincreased $38.1 million, or 36.9%; and residential mortgage loans increased$3.1 million, or 0.9%. The yield on the various components of the loanportfolio changed as follows:  commercialloans and leases decreased 6 basis points, to 6.25%; consumer and other loansdecreased 22 basis points, to 4.90%; and residential mortgage loans decreased22 basis points, to 5.28%. The decrease in the yield on loans and leasesresulted primarily from a drop in market interest rates that occurred towardsthe end of 2003 and the beginning of 2004.

*Interest Expense—Depositsand Borrowings*

Interest paid on depositsand borrowings remained stable, increasing only $172,000, or 0.9%, as decreasesin market interest rates occurred over the past year and were offset by growthin deposit and borrowing balances. The overall average cost forinterest-bearing liabilities decreased 20 basis points from 2.34% for 2003, to2.14% for 2004. Deposit costs are dependent on a number of factors includinggeneral economic conditions, national and local interest rates, competition inthe local marketplace, interest rate tiers offered, and the Company’s cash flowneeds. Offsetting the effect of the decline in market interest rates, theaverage balance of interest-bearing liabilities increased $87.0 million, or10.5%, from $830.2 million in 2003, to $917.1 million in 2004. The growth indeposit average balances was centered in NOW accounts (up $8.3 million, or7.2%), savings accounts (up $23.4 million, or 7.7%) and certificates of depositaccounts (up $15.3 million, or 7.3%). In addition, the Company increased itsutilization of FHLB borrowings (up $30.1 million, or 18.4%) and subordinatedsecurities (up $6.9 million, or 65.1%).

*Provision for Loanand Lease Losses*

The provision for loan andlease losses was $900,000 for 2004, compared to $1.6 million for 2003. Theallowance, expressed as a percentage of total loans and leases, was 1.34% as ofDecember 31, 2004, compared to 1.36% at the prior year-end and stood at1624.3% of nonperforming loans and leases at December 31, 2004, comparedto 450.0% of nonperforming loans and leases at December 31, 2003. Netcharge-offs for 2004 were $72,000, compared to $618,000 for 2003. Managementevaluates several factors including new loan originations, actual and estimatedcharge-offs, risk characteristics of the loan and lease portfolio and generaleconomic conditions when determining the provision for loan and lease losses. Asthe loan and lease portfolio continues to grow and mature, or if economicconditions worsen, management believes it possible that the level ofnonperforming assets will increase, which in turn may lead to increases to theprovision for loan and lease losses. Also see discussion under “*Allowance for Loan and Lease Losses*”.

*Noninterest Income*

Total noninterest income decreased $249,000, or 2.8%,from $8.8 million for 2003, to $8.6 million for 2004. Excluding net gainsrealized, noninterest income increased $214,000, or 2.8%, as Service charges ondeposit accounts (which continues to represent the largest source ofnoninterest income for the Company) increased $599,000, or 15.3%, primarily asa result of enhancements to NSF item processing and increased debit cardactivity. Additionally, Commissions on nondeposit investment products increased$98,000, or 11.2%, as consumer interest in investment products rebounded, andOther income increased $257,000, or 26.8%, primarily from commissions generatedfrom sales of tax credits, along with increased credit card and tuition paymentactivity. Partially offsetting these increases, Commissions on loans originatedfor 

33

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others declined $284,000,or 80.0%, and prepayment penalties on commercial loans declined $394,000, or70.2%, from 2003 to 2004. Net Gains on sales of investment securities and MBSswere down $998,000, or 91.7%, from 2003 to 2004. Also during 2004, the Banksold its South Broadway, East Providence, office building (leasing back itsbranch office space). This transaction generated a total gain of $755,000 ofwhich $511,000 was recognized and $244,000 was deferred as a result of thesale-leaseback.

Thefollowing table sets forth the components of noninterest income:

| ** **                                     | ** ** | **Year ended  December 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| ** **                                     | ** ** | **(In thousands)**                | ** ** |
| Service charges  on deposit accounts           |       | $                                      | 4,514      |   | $ | 3,915 |   |
| Commissions on  nondeposit investment products |       | 973                                    |       | 875 |   |
| Income from  bank-owned life insurance         |       | 641                                    |       | 723 |   |
| Loan related fees                              |       | 541                                    |       | 915 |   |
| Commissions on  loans originated for others    |       | 71                                     |       | 355 |   |
| Gain on sale of  Investments/MBSs              |       | 90                                     |       | 1,088 |   |
| Gain on sale of  premises and equipment        |       | 535                                    |       | — |   |
| Other income                                   |       | 1,216                                  |       | 959 |   |
| Total noninterest  income                      |       | $                                      | 8,581      |   | $ | 8,830 |   |

 

*Noninterest Expense*

Noninterest expenses for 2004 increased a total of$4.1 million, or 14.2%, to $32.9 million. This increase was primarily due tohigher operating costs resulting from the continued growth of the Company andwas centered in the following areas: Salaries and employee benefits (up $2.6 million, or 17.8%), Occupancyand equipment (up $374,000, or 9.6%), Data processing (up $55,000, or 2.0%),Marketing (up $179,000, or 14.3%), Loan servicing (up $58,000, or 5.6%) andOther expenses (up $205,000, or 5.3%). In addition to increases resulting fromcontinued growth of the Company, Salaries and employee benefits for 2004 includedadditional incentive bonus accruals of $1.2 million that were not present in2003. Also, Professional services increased $591,000, or 43.0%, during 2004 asthe Company incurred costs for management training ($145,000), partialoutsourcing of its internal audit function ($185,000) and Sarbanes-Oxley Section 404compliance ($200,000) that were not present in 2003. The Company expects thatthe costs incurred to comply with Sarbanes-Oxley Section 404 during 2004will be incurred annually in future years. Overall, the Company’s efficiencyratio increased slightly to 70.41% for 2004, from 69.96% for 2003.

Thefollowing table sets forth the components of noninterest expense:

| ** **                      | ** ** | **Year ended  December 31,** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|
| ** **                      | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| ** **                      | ** ** | **(In thousands)**                | ** ** |
| Salaries and  employee benefits |       | $                                      | 17,072     |   | $ | 14,496 |   |
| Occupancy and  equipment        |       | 4,260                                  |       | 3,886 |   |
| Data processing                 |       | 2,832                                  |       | 2,777 |   |
| Marketing                       |       | 1,429                                  |       | 1,250 |   |
| Professional  services          |       | 1,965                                  |       | 1,374 |   |
| Loan servicing                  |       | 1,092                                  |       | 1,034 |   |
| Other real estate  owned        |       | 110                                    |       | 73 |   |
| Other expenses                  |       | 4,105                                  |       | 3,900 |   |
| Total noninterest  expense      |       | $                                      | 32,865     |   | $ | 28,790 |   |

 

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*Income Tax Expense*

The Company recordedincome tax expense of $4.3 million for 2004, compared to $3.5 million for 2003.This represented total effective tax rates of 33.3% and 33.0%, respectively.Tax-favored income from BOLI, along with its utilization of a Rhode Islandpassive investment company, has reduced the Company’s effective tax rate fromthe 40.9% combined statutory federal and state tax rates.

**Financial Condition**

*Loans and LeasesReceivable*

Total loans and leases were $950.8 million, or65.9% of total assets, at December 31, 2005, compared to$886.3 million, or 71.5% of total assets, at December 31, 2004, anincrease of $64.5 million, or 7.4%. This increase is centered incommercial and consumer loans (where the Company concentrates its originationefforts) and was partially offset by a slight decrease in residential mortgageloans (which the Company primarily purchases). Total loans and leases as of December 31,2005 are segmented in three broad categories: commercial loans and leases thataggregate $438.3 million or 46.1% of the portfolio; residential mortgagesthat aggregate $306.0 million, or 32.2% of the portfolio; and consumer andother loans that aggregate $206.5 million, or 21.7% of the portfolio.

The Company utilizes the term “small business loans”to describe business lending relationships of approximately $250,000 or less.

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Thefollowing is a summary of loans and leases receivable:

| ** **                                    | ** ** | **December 31,**   | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|
| ** **                                    | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                    | ** ** | **(In thousands)** | ** ** |
| Commercial loans and  leases:                 |       |                    |       |   |   |   |   |   |   |   |   |
| Commercial real estate—owner occupied    |       | $                       | 112,987    |   | $ | 93,027 |   | $ | 77,317 |   | $ | 59,249 |   | $ | 46,698 |   |
| Commercial real estate—nonowner occupied |       | 95,779                  |       | 90,716 |   | 78,083 |   | 81,242 |   | 73,369 |   |
| Commercial & industrial              |       | 73,620                  |       | 78,918 |   | 67,925 |   | 57,389 |   | 53,677 |   |
| Small business                                |       | 38,641                  |       | 37,820 |   | 30,429 |   | 28,750 |   | 24,122 |   |
| Multi-family                                  |       | 33,725                  |       | 32,415 |   | 28,730 |   | 18,952 |   | 14,927 |   |
| Construction                                  |       | 37,772                  |       | 32,319 |   | 30,632 |   | 18,101 |   | 14,027 |   |
| Leases and other                              |       | 49,342                  |       | 38,116 |   | 19,548 |   | 17,613 |   | 12,715 |   |
| Subtotal                                      |       | 441,866                 |       | 403,331 |   | 332,664 |   | 281,296 |   | 239,535 |   |
| Discount on leases acquired                   |       | (3,366                  | )          | (226 | ) | — |   | — |   | — |   |
| Net deferred loan origination fees            |       | (191                    | )          | (335 | ) | (398 | ) | (329 | ) | (171 | ) |
| Total commercial loans and leases             |       | 438,309                 |       | 402,770 |   | 332,266 |   | 280,967 |   | 239,364 |   |
| Residential mortgage  loans:                  |       |                    |       |   |   |   |   |   |   |   |   |
| One- to four-family adjustable rate           |       | 202,223                 |       | 199,031 |   | 232,543 |   | 277,265 |   | 285,589 |   |
| One- to four-family fixed rate                |       | 101,598                 |       | 115,350 |   | 131,743 |   | 19,310 |   | 23,306 |   |
| Subtotal                                      |       | 303,821                 |       | 314,381 |   | 364,286 |   | 296,575 |   | 308,895 |   |
| Premium on loans acquired                     |       | 2,257                   |       | 1,826 |   | 2,026 |   | 1,248 |   | 1,381 |   |
| Net deferred loan origination fees            |       | (62                     | )          | (72 | ) | (82 | ) | (60 | ) | (64 | ) |
| Total residential mortgage loans              |       | 306,016                 |       | 316,135 |   | 366,230 |   | 297,763 |   | 310,212 |   |
| Consumer and other  loans:                    |       |                    |       |   |   |   |   |   |   |   |   |
| Home equity—term loans                   |       | 134,932                 |       | 110,542 |   | 68,523 |   | 47,906 |   | 22,930 |   |
| Home equity—lines of credit              |       | 67,959                  |       | 53,551 |   | 42,067 |   | 37,381 |   | 28,460 |   |
| Automobile                                    |       | 157                     |       | 488 |   | 1,455 |   | 3,409 |   | 6,335 |   |
| Installment                                   |       | 365                     |       | 491 |   | 662 |   | 967 |   | 1,240 |   |
| Savings secured                               |       | 358                     |       | 439 |   | 631 |   | 602 |   | 656 |   |
| Unsecured and other                           |       | 1,271                   |       | 801 |   | 1,787 |   | 1,063 |   | 1,153 |   |
| Subtotal                                      |       | 205,042                 |       | 166,312 |   | 115,125 |   | 91,328 |   | 60,774 |   |
| Premium on loans acquired                     |       | 2                       |       | 15 |   | 44 |   | 103 |   | 192 |   |
| Net deferred loan origination costs           |       | 1,437                   |       | 1,069 |   | 617 |   | 497 |   | 422 |   |
| Total consumer and other loans                |       | 206,481                 |       | 167,396 |   | 115,786 |   | 91,928 |   | 61,388 |   |
| Total loans and  leases receivable            |       | $                       | 950,806    |   | $ | 886,301 |   | $ | 814,282 |   | $ | 670,658 |   | $ | 610,964 |   |

 

*Commercialloans and leases—**During* 2005, the commercial loanand lease portfolio (consisting of commercial real estate, commercial &industrial, equipment leases, multi-family real estate, construction and smallbusiness loans) increased $35.5 million, or 8.8%. The primary drivers ofthis growth occurred in the commercial real estate and equipment leasing areas.

The Company believes it is well positioned forcontinued commercial growth. Particular emphasis is placed on generation ofsmall- to medium-sized commercial relationships (those relationships with$7.0 million or less in total loan commitments). Unlike most communitybanks, the Bank is able to offer asset-based commercial loan facilities thatmonitor advances against receivables and inventories on a formula basis.

The Bank is also active in small business lending inwhich it utilizes credit scoring, in conjunction with traditional reviewstandards, and employs streamlined documentation. Small business loansrepresented 

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8.9% of the commercialloan and lease portfolio at December 31, 2005. The Bank is a participantin the U.S Small Business Administration (“SBA”) Preferred Lender Program inboth Rhode Island and Massachusetts.

The Bank historically has purchased equipment leasesfrom originators outside of the Bank. The principal lessees were the U.SGovernment and its agencies for the vast majority of leases. These “government”leases generally have maturities of five years or less and are not dependent onresidual collateral values. With the addition of Macrolease in the secondquarter of 2005, the Bank is now originating equipment leases for its ownportfolio, as well as originating leases for third parties as a new source ofnoninterest income. At December 31, 2005, leases totaled $46.1 million, or10.5% of the commercial loan and lease portfolio, with $25.8 million ofgovernment leases and $20.3 million of Macrolease-generated leases.

*Residentialmortgage loans—**Residential* mortgage loansdecreased $10.1 million, or 3.2%, as repayments ($71.2 million) exceededthe total of purchases ($56.5 million) and originations($5.0 million). Since inception, the Bank has concentrated its portfoliolending efforts on commercial and consumer lending opportunities, butoriginates mortgage loans for its own portfolio on a limited basis. The Bankdoes not employ any outside mortgage originators, but from time to time,purchases residential mortgage loans from third-party originators.  Until such time as the Bank can originatesufficient commercial and consumer loans to utilize available cash flow, itintends to continue purchasing residential mortgage loans as opportunitiesdevelop.

*Consumerloans—**During* 2005, consumer loanoutstandings increased $39.1 million, or 23.3%, to $206.5 million at December 31,2005, from $167.4 million at December 31, 2004. The Company believesthat these ten- and fifteen-year fixed-rate products, along with the floatinglines of credit, possess attractive cash flow characteristics in the currentinterest rate environment and the Company anticipates that growth in theseproducts will continue.

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Thetable below shows loan and lease originations, purchases, sales and repaymentactivities. Included within residential mortgage loan repayments isamortization of premium on purchased residential mortgages.

| ** **                                                      | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                      | ** ** | **(In thousands)**                    | ** ** |
| Originations and  principal additions:                          |       |                                       |       |   |   |   |   |   |   |   |   |
| Loans and leases purchased:                                     |       |                                       |       |   |   |   |   |   |   |   |   |
| Commercial loans and leases                                     |       | $                                          | 9,243      |   | $ | 3,257 |   | $ | — |   | $ | — |   | $ | — |   |
| Residential mortgage loans                                      |       | 56,512                                     |       | 55,273 |   | 249,656 |   | 166,935 |   | 186,013 |   |
| Consumer and other loans                                        |       | —                                     |       | — |   | — |   | — |   | 4,902 |   |
| Total loans and leases purchased                                |       | 65,755                                     |       | 58,530 |   | 249,656 |   | 166,935 |   | 190,915 |   |
| Loans and leases originated:                                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Commercial loans and leases                                     |       | 99,490                                     |       | 109,560 |   | 106,335 |   | 84,132 |   | 59,186 |   |
| Residential mortgage loans                                      |       | 5,009                                      |       | 9,635 |   | 28,371 |   | 9,345 |   | 18,037 |   |
| Consumer and other loans                                        |       | 82,426                                     |       | 90,655 |   | 65,831 |   | 51,951 |   | 22,332 |   |
| Total loans and leases originated                               |       | 186,925                                    |       | 209,850 |   | 200,537 |   | 145,428 |   | 99,555 |   |
| Principal  reductions:                                          |       |                                       |       |   |   |   |   |   |   |   |   |
| Net charge-offs/transfers to OREO:                              |       |                                       |       |   |   |   |   |   |   |   |   |
| Commercial loans and leases                                     |       | (1,205                                     | )          | (98 | ) | (565 | ) | (400 | ) | (981 | ) |
| Residential mortgage loans                                      |       | —                                     |       | — |   | — |   | (58 | ) | (304 | ) |
| Consumer and other loans                                        |       | (7                                         | )          | (51 | ) | (64 | ) | (93 | ) | (61 | ) |
| Total net charge-offs/transfers to OREO                         |       | (1,212                                     | )          | (149 | ) | (629 | ) | (551 | ) | (1,346 | ) |
| Principal payments:                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Commercial loans and leases                                     |       | (72,736                                    | )          | (42,052 | ) | (54,402 | ) | (41,971 | ) | (31,631 | ) |
| Residential mortgage loans                                      |       | (71,249                                    | )          | (114,813 | ) | (210,316 | ) | (188,542 | ) | (141,657 | ) |
| Consumer and other loans                                        |       | (42,978                                    | )          | (39,417 | ) | (41,970 | ) | (21,304 | ) | (23,928 | ) |
| Total principal payments                                        |       | (186,963                                   | )          | (196,282 | ) | (306,688 | ) | (251,817 | ) | (197,216 | ) |
| Change in total  loans and leases receivable (before net items) |       | $                                          | 64,505     |   | $ | 71,949 |   | $ | 142,876 |   | $ | 59,995 |   | $ | 91,908 |   |

 

The followingtable sets forth certain information at December 31, 2005, regarding theaggregate dollar amount of certain loans maturing in the loan portfolio basedon scheduled payments to maturity. Actual loan principal payments may vary fromthis schedule due to refinancings, modifications and other changes in loanterms. Demand loans and loans having no stated schedule of repayments and nostated maturity are reported as due in one year or less.

| ** **                                                 | ** ** | **Principal repayments contractually due** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                 | ** ** | ** **                                                | ** ** | **After one,** | ** ** | ** ** | ** ** |
| ** **                                                 | ** ** | **One year**                                         | ** ** | **but within** | ** ** | **After** | ** ** |
| ** **                                                 | ** ** | **or less**                                          | ** ** | **five years** | ** ** | **five years** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                                   | ** ** |
| Construction/permanent  loans                              |       | $                                                         | 23,420     |   |   | $ | 7,401 |   |   | $ | 6,951 |   |
| Commercial &  industrial loans (including leases) |       | 41,434                                                    |       |   | 56,707 |   |   | 21,547 |   |
| Home equity lines  of credit                               |       | 77                                                        |       |   | 56 |   |   | 68,469 |   |
| Interest-only  residential first mortgages                 |       | —                                                    |       |   | — |   |   | 33,248 |   |
| Small business  loans                                      |       | 16,054                                                    |       |   | 14,373 |   |   | 8,214 |   |
| Total                                                      |       | $                                                         | 80,985     |   |   | $ | 78,537 |   |   | $ | 138,429 |   |

 

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Thefollowing table sets forth as of December 31, 2005, the dollar amount ofcertain loans due after one year that have fixed interest rates or floating oradjustable interest rates.

| ** **                                                 | ** ** | **Loans due after one year** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                 | ** ** | ** **                                       | ** ** | **Floating or** | ** ** |
| ** **                                                 | ** ** | ** **                                       | ** ** | **adjustable** | ** ** |
| ** **                                                 | ** ** | **Fixed rates**                             | ** ** | **rates** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                          | ** ** |
| Construction/permanent  loans                              |       |                                             | $          | 5,044 |   |   |   | $ | 9,308 |   |   |
| Commercial &  industrial loans (including leases) |       |                                             | 63,926     |   |   |   | 14,328 |   |   |
| Home equity lines  of credit                               |       |                                             | —     |   |   |   | 68,525 |   |   |
| Interest-only  residential first mortgages                 |       |                                             | 4,859      |   |   |   | 28,389 |   |   |
| Small business  loans                                      |       |                                             | 12,647     |   |   |   | 9,940 |   |   |
| Total                                                      |       |                                             | $          | 86,476 |   |   |   | $ | 130,490 |   |   |

 

*Asset Quality*

The definition of nonperforming assets includesnonperforming loans and Other real estate owned (“OREO”). OREO consists of realestate acquired through foreclosure proceedings and real estate acquiredthrough acceptance of a deed in lieu of foreclosure. Nonperforming loans aredefined as nonaccrual loans, loans past due 90 days or more, but still accruingand impaired loans. Under certain circumstances, the Company may restructurethe terms of a loan as a concession to a borrower. These restructured loans areconsidered impaired loans. Included in nonaccrual loans at December 31,2005, 2004 and 2003, were $141,000, $671,000 and $2.1 million of impairedloans, respectively.

*NonperformingAssets—**At* December 31, 2005, theCompany had nonperforming assets of $415,000, or 0.03%, of total assets. Thiscompares to nonperforming assets of $733,000 or 0.06% of total assets, at December 31,2004, and nonperforming assets of $2.5 million, or 0.23% of total assets, at December 31,2003. Nonperforming assets at December 31, 2005, consisted of commercialloans aggregating $235,000, consumer loans aggregating $61,000 and residentialmortgage loans aggregating $119,000. Nonperforming assets at December 31,2004 and 2003 were primarily comprised of nonaccrual commercial loans andnonaccrual residential mortgage loans. The Company evaluates the underlyingcollateral of each nonperforming asset and continues to pursue the collectionof interest and principal. Management believes that the December 31, 2005level of nonperforming assets is low relative to the size of the Company’s loanportfolio. As the loan portfolio continues to grow and mature, or if economicconditions worsen, management believes it possible that the level ofnonperforming assets will increase, as will its level of charged-off loans.

Thefollowing table sets forth information regarding nonperforming assets.

| ** **                                                  | ** ** | **December 31,**                | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Nonaccrual loans                                            |       | $                                    | 415        |   | $ | 733 |   | $ | 2,462 |   | $ | 736 |   | $ | 753 |   |
| Loans past due 90  days or more, but still accruing         |       | —                               |       | — |   | — |   | — |   | — |   |
| Impaired loans  (not included in nonaccrual loans)          |       | —                               |       | — |   | — |   | — |   | — |   |
| Total nonperforming loans                                   |       | 415                                  |       | 733 |   | 2,462 |   | 736 |   | 753 |   |
| Other  nonperforming assets                                 |       | —                               |       | — |   | — |   | 58 |   | 264 |   |
| Total nonperforming assets                                  |       | $                                    | 415        |   | $ | 733 |   | $ | 2,462 |   | $ | 794 |   | $ | 1,017 |   |
| Nonperforming  loans as a percent of total loans and leases |       | 0.04                                 | %          | 0.08 | % | 0.30 | % | 0.11 | % | 0.12 | % |
| Nonperforming assets as  a percent of total assets          |       | 0.03                                 | %          | 0.06 | % | 0.23 | % | 0.08 | % | 0.12 | % |

 

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*NonaccrualLoans—**Accrual* of interest income on allloans is discontinued when concern exists as to the collectibility of principalor interest, or typically when a loan becomes over 90 days delinquent. Additionally,when a loan is placed on nonaccrual status, all interest previously accrued butnot collected is reversed against current period income. Residential mortgageloans are removed from nonaccrual when they become less than 90 days past due,and in the case of commercial and consumer loans, when concern no longer existsas to the collectibility of principal or interest. Interest collected onnonaccruing loans is either applied against principal or reported as incomeaccording to management’s judgment as to the collectibility of principal. At December 31,2005, nonaccrual loans totaled $415,000. Interest on nonaccrual loans thatwould have been recorded as additional income for the year ended December 31,2005, had the loans been current in accordance with their original terms,totaled $23,000. This compares with $29,000 and $298,000 of foregone interestincome on nonaccrual loans for the years ended December 31, 2004 and 2003,respectively.

Thefollowing table sets forth certain information regarding nonaccrual loans.

| ** **                  | ** ** | **December 31,**                |
|-----------------------------|------------|--------------------------------------|
| ** **                  | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** |
| ** **                  | ** ** | ** **                           | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** |
| ** **                  | ** ** | **Principal**                        | ** ** | **of Total** | ** ** | **Principal** | ** ** | **of Total** | ** ** | **Principal** | ** ** | **of Total** |
| ** **                  | ** ** | **Balance**                          | ** ** | **Loans** | ** ** | **Balance** | ** ** | **Loans** | ** ** | **Balance** | ** ** | **Loans** |
| ** **                  | ** ** | **(Dollars in thousands)** |
| Nonaccrual loans:           |       |                                 |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial loans and leases |       | $                                    | 235 |   | 0.02 | % | $ | 709 |   | 0.08 | % | $ | 2,256 |   |   | 0.28 | % |
| Residential mortgage loans  |       | 119                                  |   | 0.01 | % | 24 |   | 0.00 | % | 186 |   |   | 0.02 | % |
| Consumer and other loans    |       | 61                                   |   | 0.01 | % | — |   | 0.00 | % | 20 |   |   | 0.00 | % |
| Total nonaccrual  loans     |       | $                                    | 415 |   | 0.04 | % | $ | 733 |   | 0.08 | % | $ | 2,462 |   |   | 0.30 | % |

 

*Delinquencies—**At* December 31,2005, $5.3 million of loans were 30 to 89 days past due. This compares to $4.9million and $943,000 of loans 30 to 89 days past due as of December 31,2004 and 2003, respectively. The majority of these loans at December 31,2005 and 2004 were commercial loans and at December 31, 2003 wereresidential mortgage loans.

Management reviews delinquent loans frequently toassess problem situations and to quickly address these problems. In the case ofconsumer and commercial loans, the Bank contacts the borrower when a loan becomesdelinquent. When a payment is not made, generally within 10-15 days ofthe due date, a late charge is assessed. After 30 days of delinquency, a noticeis sent to the borrower advising that failure to cure the default may result informal demand for payment in full. In the event of further delinquency, thematter is generally referred to legal counsel to commence civil proceedings tocollect all amounts owed. In the case of residential mortgage loans,delinquency and collection proceedings are conducted by either the Bank, or itsmortgage servicers, in accordance with standard servicing guidelines. In anycircumstance where the Bank is secured by real property or other collateral,the Bank enforces its rights to the collateral in accordance with applicablelaw.

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Thefollowing table sets forth information as to loans delinquent for 30 to 89days.

| ** **                                 | ** ** | **December 31,**                | ** ** |              |
|--------------------------------------------|------------|--------------------------------------|------------|-------------------|
| ** **                                 | ** ** | **2005**                             | ** ** | **2004**          | ** ** | **2003** | ** ** |   |
| ** **                                 | ** ** | ** **                           | ** ** | **Percent**       | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                                 | ** ** | **Principal**                        | ** ** | **of Total** | ** ** | **Principal** | ** ** | **of Total** | ** ** | **Principal** | ** ** | **of Total** | ** ** |
| ** **                                 | ** ** | **Balance**                          | ** ** | **Loans**         | ** ** | **Balance** | ** ** | **Loans** | ** ** | **Balance** | ** ** | **Loans** | ** ** |
| ** **                                 | ** ** | **(Dollars in thousands)** | ** ** |              |
| Loans delinquent  for 30 to 59 days:       |       |                                 |       |              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial loans and leases                |       |                                 | $          | 4,509             |   |   |   | 0.48 | % |   |   | $ | 3,370 |   |   |   | 0.38 | % |   |   | $ | 49 |   |   |   | 0.01 | % |   |
| Residential mortgage loans                 |       |                                 | 399        |              |   |   | 0.04 | % |   |   | 951 |   |   |   | 0.11 | % |   |   | 250 |   |   |   | 0.03 | % |   |
| Consumer and other loans                   |       |                                 | 139        |              |   |   | 0.01 | % |   |   | 549 |   |   |   | 0.06 | % |   |   | 47 |   |   |   | 0.01 | % |   |
| Total loans delinquent 30 to 59 days  |       |                                 | 5,047      |              |   |   | 0.53 | % |   |   | 4,870 |   |   |   | 0.55 | % |   |   | 346 |   |   |   | 0.05 | % |   |
| Loans delinquent  for 60 to 89 days:       |       |                                 |       |              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial loans                           |       |                                 | —     |              |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Residential mortgage loans                 |       |                                 | 299        |              |   |   | 0.03 | % |   |   | — |   |   |   | — |   |   |   | 597 |   |   |   | 0.07 | % |   |
| Consumer and other loans                   |       |                                 | —     |              |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total loans delinquent 60 to 89 days  |       |                                 | 299        |              |   |   | 0.03 | % |   |   | — |   |   |   | — |   |   |   | 597 |   |   |   | 0.07 | % |   |
| Total loans  delinquent 30 to 89 days |       |                                 | $          | 5,346             |   |   |   | 0.56 | % |   |   | $ | 4,870 |   |   |   | 0.55 | % |   |   | $ | 943 |   |   |   | 0.12 | % |   |

 

*AdverselyClassified Assets—**The* Company’s management adverselyclassifies certain assets as “substandard”, “doubtful” or “loss” based oncriteria established under banking regulations. An asset is consideredsubstandard if inadequately protected by the current net worth and payingcapacity of the obligor or of the collateral pledged, if any. Substandardassets include those characterized by the “distinct possibility” that theinsured institution will sustain “some loss” if existing deficiencies are notcorrected. Assets classified as doubtful have all of the weaknesses inherent inthose classified substandard with the added characteristic that the weaknessespresent make “collection or liquidation in full”, on the basis of currentlyexisting facts, conditions, and values, “highly questionable and improbable”. Assetsclassified as loss are those considered “uncollectible” and of such littlevalue that their continuance as assets without the establishment of a specificloss reserve is not warranted.

At December 31, 2005,the Company had $6.8 million of assets that were classified as substandard.This compares to $5.8 million and $5.5 million of assets that wereclassified as substandard at December 31, 2004 and 2003, respectively. TheCompany had no assets that were classified as loss or doubtful at any of thesedates. Performing loans may or may not be adversely classified depending uponmanagement’s judgment with respect to each individual loan. At December 31,2005, included in the $6.8 million of assets that were classified assubstandard, were $6.4 million of performing loans. This compares to$5.1 million and $3.1 million of adversely classified performing assetsas of December 31, 2004 and 2003, respectively. These amounts constituteassets that, in the opinion of management, could potentially migrate tononperforming or doubtful status. Management believes that the December 31,2005 level of adversely classified assets is low relative to the size andcomposition of the Company’s loan portfolio. As the loan and lease portfoliocontinues to grow and mature, or if economic conditions worsen, managementbelieves it possible that the level of adversely classified assets willincrease. This in turn may necessitate an increase to the provision for loanand lease losses in future periods.

*Allowance for Loanand Lease Losses*

The allowance for loan and lease losses is establishedfor credit losses inherent in the loan portfolio through a charge to earnings. Loansdeemed uncollectible are charged against the allowance, while 

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recoveries of amountspreviously charged-off are added to the allowance. Amounts are charged-off oncethe probability of loss has been established, with consideration given to suchfactors as the customer’s financial condition, underlying collateral andguarantees, and general and industry economic conditions.

When an insured institution classifies problem loansas either substandard or doubtful, it is required to establish allowances forloan losses in an amount deemed prudent by management. Additionally, generalallowances represent loss allowances that have been established to recognizethe inherent risk associated with lending activities, and have not beenallocated to particular problem loans.

Thefollowing table represents the allocation of the allowance for loan and leaseslosses as of the dates indicated:

| ** **                   | ** ** | **December 31,**                | ** ** |
|------------------------------|------------|--------------------------------------|------------|
| ** **                   | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                   | ** ** | ** **                           | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                   | ** ** | ** **                           | ** ** | **of Loans** | ** ** | ** ** | ** ** | **of Loans** | ** ** | ** ** | ** ** | **of Loans** | ** ** | ** ** | ** ** | **of Loans** | ** ** | ** ** | ** ** | **of Loans** | ** ** |
| ** **                   | ** ** | ** **                           | ** ** | **in Each** | ** ** | ** ** | ** ** | **in Each** | ** ** | ** ** | ** ** | **in Each** | ** ** | ** ** | ** ** | **in Each** | ** ** | ** ** | ** ** | **in Each** | ** ** |
| ** **                   | ** ** | ** **                           | ** ** | **Category** | ** ** | ** ** | ** ** | **Category** | ** ** | ** ** | ** ** | **Category** | ** ** | ** ** | ** ** | **Category** | ** ** | ** ** | ** ** | **Category** | ** ** |
| ** **                   | ** ** | ** **                           | ** ** | **to Total** | ** ** | ** ** | ** ** | **to Total** | ** ** | ** ** | ** ** | **to Total** | ** ** | ** ** | ** ** | **to Total** | ** ** | ** ** | ** ** | **to Total** | ** ** |
| ** **                   | ** ** | **Amount**                           | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** |
| ** **                   | ** ** | **(Dollars in thousands)** | ** ** |
| Commercial loans  and leases |       | $                                    | 7,240      |   |   | 46.1 | % |   | $ | 6,503 |   |   | 45.4 | % |   | $ | 4,761 |   |   | 40.8 | % |   | $ | 5,250 |   |   | 41.9 | % |   |   | $ | 4,191 |   |   |   | 39.2 | % |   |   |
| Residential  mortgage loans  |       | 1,653                                |       |   | 32.2 | % |   | 1,644 |   |   | 35.7 | % |   | 1,922 |   |   | 45.0 | % |   | 1,757 |   |   | 44.4 | % |   |   | 1,835 |   |   |   | 50.8 | % |   |   |
| Consumer and other  loans    |       | 2,159                                |       |   | 21.7 | % |   | 1,745 |   |   | 18.9 | % |   | 1,248 |   |   | 14.2 | % |   | 1,027 |   |   | 13.7 | % |   |   | 787 |   |   |   | 10.0 | % |   |   |
| Unallocated                  |       | 1,116                                |       |   | NA |   |   | 2,014 |   |   | NA |   |   | 3,147 |   |   | NA |   |   | 2,062 |   |   | NA |   |   |   | 1,711 |   |   |   | NA |   |   |   |
| Total                        |       | $                                    | 12,168     |   |   | 100.0 | % |   | $ | 11,906 |   |   | 100.0 | % |   | $ | 11,078 |   |   | 100.0 | % |   | $ | 10,096 |   |   | 100.0 | % |   |   | $ | 8,524 |   |   |   | 100.0 | % |   |   |
|                              |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Assessing the appropriateness of the allowance forloan and leases losses involves substantial uncertainties and is based uponmanagement’s evaluation of the amounts required to meet estimated charge-offsin the loan portfolio after weighing various factors. Management’s methodologyto estimate loss exposure includes an analysis of individual loans deemed to beimpaired, reserve allocations for various loan types based on payment status orloss experience and an unallocated allowance that is maintained based onmanagement’s assessment of many factors including the growth, composition andquality of the loan portfolio, historical loss experiences, general economicconditions and other pertinent factors. Based on this evaluation, managementbelieves that the year-end allowance for loan and lease losses is appropriate.

A portion of the allowance for loan and lease lossesis not allocated to any specific segment of the loan portfolio. Thisnon-specific allowance is maintained for two primary reasons: (i) thereexists an inherent subjectivity and imprecision to the analytical processesemployed, and (ii) the prevailing business environment, as it is affectedby changing economic conditions and various external factors, may impact theportfolio in ways currently unforeseen. Management, therefore, has establishedand maintains a non-specific allowance for loan losses. The amount of thismeasurement imprecision allocation was $1.1 million at December 31,2005, compared to $2.0 million at December 31, 2004.

While management evaluates currently availableinformation in establishing the allowance for loan and lease losses, futureadjustments to the allowance may be necessary if conditions differsubstantially from the assumptions used in making the evaluations. In addition,various regulatory agencies, as an integral part of their examination process,periodically review a financial institution’s allowance for loan and leaselosses and carrying amounts of other real estate owned. Such agencies mayrequire the financial institution to recognize additions to the allowance basedon their judgments about information available to them at the time of theirexamination.

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During 2005, 2004 and 2003, the Bank made additions tothe allowance of $1.5 million, $900,000 and $1.6 million and experiencednet charge-offs of $1,212,000, $72,000 and $618,000, respectively. AtDecember 31, 2005, the allowance for loan and leases losses stood at$12.2 million and represented 2932% of nonperforming loans and 1.28% oftotal loans outstanding. This compares to an allowance for loan and leaselosses of $11.9 million, representing 1624% of nonperforming loans and1.34% of total loans outstanding at December 31, 2004.

Ananalysis of the activity in the allowance for loan and lease losses is asfollows:

| ** **                                                 | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                    | ** ** |
| Balance at  beginning of year                              |       | $                                          | 11,906     |   | $ | 11,078 |   | $ | 10,096 |   | $ | 8,524 |   | $ | 7,294 |   |
| Loans charged-off:                                         |       |                                       |       |   |   |   |   |   |   |   |   |
| Commercial loans and leases                                |       | (1,266)                                    |       | (98 | ) | (565 | ) | (400 | ) | (406 | ) |
| Residential mortgage loans                                 |       | —                                     |       | — |   | (17 | ) | — |   | — |   |
| Consumer and other loans                                   |       | (8                                         | )          | (52 | ) | (64 | ) | (93 | ) | (61 | ) |
| Total loans charged-off                                    |       | (1,274                                     | )          | (150 | ) | (646 | ) | (493 | ) | (467 | ) |
| Recoveries of loans  previously charged-off:               |       |                                       |       |   |   |   |   |   |   |   |   |
| Commercial loans and leases                                |       | 61                                         |       | 70 |   | 4 |   | 110 |   | — |   |
| Residential mortgage loans                                 |       | —                                     |       | — |   | — |   | 40 |   | — |   |
| Consumer and other loans                                   |       | 1                                          |       | 8 |   | 24 |   | 40 |   | 28 |   |
| Total recoveries of loans previously  charged-off          |       | 62                                         |       | 78 |   | 28 |   | 190 |   | 28 |   |
| Net (charge-offs) recoveries                               |       | (1,212                                     | )          | (72 | ) | (618 | ) | (303 | ) | (439 | ) |
| Provision for  loan losses charged against income          |       | 1,474                                      |       | 900 |   | 1,600 |   | 1,875 |   | 1,669 |   |
| Balance at end of  year                                    |       | $                                          | 12,168     |   | $ | 11,906 |   | $ | 11,078 |   | $ | 10,096 |   | $ | 8,524 |   |
| Net charge-offs  (recoveries) to average loans outstanding |       | 0.13                                       | %          | 0.01 | % | 0.08 | % | 0.05 | % | 0.08 | % |

 

*Investments*

Total investments (consisting of overnightinvestments, investment securities, MBSs, and FHLB stock) totaled$412.2 million, or 28.6% of total assets, at December 31, 2005. Thiscompares to total investments of $291.9 million, or 23.6% of total assets,as of December 31, 2004. The increase of $120.3 million, or 41.2%,was centered in growth in the investment securities, $46.4 million, and MBSs,$74.9 million. All $385.8 million of investment securities and MBSs at December 31,2005 and 2004 were classified as securities available for sale. At December 31,2005, the investment portfolio carried a total net unrealized loss of $5.0million, compared to $1.0 million of net unrealized gains at December 31,2004, with the primary driver of the change in unrealized gain/loss being theimpact of rising interest rates.

The increase in total investments was driven by twoprimary factors. First, leverage transactions were entered into during thesecond, third and fourth quarters of 2005. These transactions were undertakento partially offset the dilution in EPS resulting from the issuance ofadditional common stock during the second quarter of 2005. Second, cash flowswere temporarily held in investments before being redeployed in the Bank’s loanportfolio and market conditions made purchases of MBSs generally moreattractive than purchases of residential whole mortgage loans.

43

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Asummary of investment and mortgage-backed securities available for salefollows:

| ** **                             | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
|----------------------------------------|------------|-------------------------|------------|----------------|------------|------------|------------|
| ** **                             | ** ** | **Cost**                | ** ** | **Gains**      | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                             | ** ** | **(In thousands)** | ** ** |
| At December 31,  2005:            |       |                    |       |           |       |       |       |   |   |
| U.S. Agency obligations                |       | $                       | 125,915    |           | $          | —     |       | $ | (1,921 | ) | $ | 123,994 |   |
| Corporate debt securities              |       | 21,214                  |       | 57             |       | (608       | )          | 20,663 |   |
| Trust preferred securities             |       | 6,199                   |       | 108            |       | (5         | )          | 6,302 |   |
| U.S. Agency mortgage-backed securities |       | 174,542                 |       | 404            |       | (1,486     | )          | 173,460 |   |
| Collateralized mortgage obligations    |       | 62,907                  |       | —         |       | (1,509     | )          | 61,398 |   |
| Total                                  |       | $                       | 390,777    |           | $          | 569        |       | $ | (5,529 | ) | $ | 385,817 |   |
| At December 31,  2004:            |       |                    |       |           |       |       |       |   |   |
| U.S. Agency obligations                |       | $                       | 74,330     |           | $          | 219        |       | $ | (358 | ) | $ | 74,191 |   |
| Corporate debt securities              |       | 25,388                  |       | 528            |       | (43        | )          | 25,873 |   |
| Trust preferred securities             |       | 4,235                   |       | 301            |       | —     |       | 4,536 |   |
| U.S. Agency mortgage-backed securities |       | 97,210                  |       | 1,082          |       | (333       | )          | 97,959 |   |
| Collateralized mortgage obligations    |       | 62,371                  |       | 52             |       | (436       | )          | 61,987 |   |
| Total                                  |       | $                       | 263,534    |           | $          | 2,182      |       | $ | (1,170 | ) | $ | 264,546 |   |
| At December 31,  2003:            |       |                    |       |           |       |       |       |   |   |
| U.S. Agency obligations                |       | $                       | 57,855     |           | $          | 226        |       | $ | (153 | ) | $ | 57,928 |   |
| Corporate debt securities              |       | 34,704                  |       | 1,415          |       | —     |       | 36,119 |   |
| Trust preferred securities             |       | 4,269                   |       | 283            |       | (4         | )          | 4,548 |   |
| U.S. Agency mortgage-backed securities |       | 48,878                  |       | 629            |       | (26        | )          | 49,481 |   |
| Collateralized mortgage obligations    |       | 57,150                  |       | 254            |       | (267       | )          | 57,137 |   |
| Total                                  |       | $                       | 202,856    |           | $          | 2,807      |       | $ | (450 | ) | $ | 205,213 |   |

 

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The following table sets forth the contractualmaturities of investment and mortgage-backed securities available for sale andthe weighted average yields of such securities:

| ** **                             | ** ** | **Within one year**        | ** ** | **After one, but  within five years** | ** ** | **After five, but  within ten years** | ** ** | **After ten years** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------|------------|
| ** **                             | ** ** | **Fair  value**                      | ** ** | **Weighted  average  yield**                              | ** ** | **Fair  value**                                           | ** ** | **Weighted  average  yield**  | ** ** | **Fair  value** | ** ** | **Weighted  average  yield** | ** ** | **Fair  value** | ** ** | **Weighted  average  yield** | ** ** |
| ** **                             | ** ** | **(Dollars in thousands)** | ** ** |
| At December 31, 2005:             | ** ** | ** **                           |       |                                                      |       |                                                      |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Agency obligations                |       | $                                    | 14,815     |                                                      |       | 2.81                                                      | %          |                          | $          | 109,179 |   |   | 4.11 | % |   | $ | — |   |   | 0.00 | % |   | $ | — |   |   | 0.00 | % |   |
| Corporate debt securities              |       | 5,045                                |       |                                                      | 4.94       | %                                                         |       | 15,618                        |       |   | 4.86 | % |   | — |   |   | 0.00 | % |   | — |   |   | 0.00 | % |   |
| Trust preferred securities             |       | —                               |       |                                                      | 0.00       | %                                                         |       | —                        |       |   | 0.00 | % |   | — |   |   | 0.00 | % |   | 6,302 |   |   | 7.34 | % |   |
| U.S. Agency mortgage-backed securities |       | —                               |       |                                                      | 0.00       | %                                                         |       | —                        |       |   | 0.00 | % |   | 18,613 |   |   | 4.55 | % |   | 154,847 |   |   | 4.62 | % |   |
| Collateralized mortgage obligations    |       | —                               |       |                                                      | 0.00       | %                                                         |       | —                        |       |   | 0.00 | % |   | — |   |   | 0.00 | % |   | 61,398 |   |   | 4.52 | % |   |
| Total                                  |       | $                                    | 19,860     |                                                      |       | 3.35                                                      | %          |                          | $          | 124,797 |   |   | 4.21 | % |   | $ | 18,613 |   |   | 4.55 | % |   | $ | 222,547 |   |   | 4.67 | % |   |
| At  December 31, 2004:            | ** ** | ** **                           |       |                                                      |       |                                                      |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Agency obligations                |       | $                                    | —     |                                                      |       | 0.00                                                      | %          |                          | $          | 74,190 |   |   | 3.66 | % |   | $ | — |   |   | 0.00 | % |   | $ | — |   |   | 0.00 | % |   |
| Corporate debt securities              |       | 4,073                                |       |                                                      | 5.68       | %                                                         |       | 21,801                        |       |   | 4.88 | % |   | — |   |   | 0.00 | % |   | — |   |   | 0.00 | % |   |
| Trust preferred securities             |       | —                               |       |                                                      | 0.00       | %                                                         |       | —                        |       |   | 0.00 | % |   | — |   |   | 0.00 | % |   | 4,536 |   |   | 8.40 | % |   |
| U.S. Agency mortgage-backed securities |       | —                               |       |                                                      | 0.00       | %                                                         |       | —                        |       |   | 0.00 | % |   | — |   |   | 0.00 | % |   | 97,959 |   |   | 4.46 | % |   |
| Collateralized mortgage obligations    |       | —                               |       |                                                      | 0.00       | %                                                         |       | —                        |       |   | 0.00 | % |   | — |   |   | 0.00 | % |   | 61,987 |   |   | 4.41 | % |   |
| Total                                  |       | $                                    | 4,073      |                                                      |       | 5.68                                                      | %          |                          | $          | 95,991 |   |   | 3.94 | % |   | $ | — |   |   | 0.00 | % |   | $ | 164,482 |   |   | 4.54 | % |   |
| At December 31,  2003:            | ** ** | ** **                           |       |                                                      |       |                                                      |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Agency obligations                |       | $                                    | —     |                                                      |       | 0.00                                                      | %          |                          | $          | 48,413 |   |   | 3.73 | % |   | $ | 9,515 |   |   | 4.10 | % |   | $ | — |   |   | 0.00 | % |   |
| Corporate debt securities              |       | 4,119                                |       |                                                      | 3.87       | %                                                         |       | 32,000                        |       |   | 5.14 | % |   | — |   |   | 0.00 | % |   | — |   |   | 0.00 | % |   |
| Trust preferred securities             |       | —                               |       |                                                      | 0.00       | %                                                         |       | —                        |       |   | 0.00 | % |   | — |   |   | 0.00 | % |   | 4,548 |   |   | 8.40 | % |   |
| U.S. Agency mortgage-backed securities |       | —                               |       |                                                      | 0.00       | %                                                         |       | —                        |       |   | 0.00 | % |   | — |   |   | 0.00 | % |   | 49,481 |   |   | 3.67 | % |   |
| Collateralized mortgage obligations    |       | —                               |       |                                                      | 0.00       | %                                                         |       | —                        |       |   | 0.00 | % |   | 450 |   |   | 6.50 | % |   | 56,687 |   |   | 4.45 | % |   |
| Total                                  |       | $                                    | 4,119      |                                                      |       | 3.87                                                      | %          |                          | $          | 80,413 |   |   | 4.27 | % |   | $ | 9,965 |   |   | 4.21 | % |   | $ | 110,716 |   |   | 4.26 | % |   |

 

*Bank-Owned LifeInsurance*

The Bank has purchasedBOLI to protect itself against the loss of key employees due to death and tooffset the Bank’s future obligations to its employees under its retirement andbenefit plans. During 2005, 2004 and 2003, the Bank purchased $0, $2.0 millionand $0 of BOLI, respectively. The cash surrender value of these life insurancepolicies was $18.8 million and $18.1 million at December 31, 2005 and2004, respectively. The Bank recorded income from the BOLI policies of $691,000in 2005, $641,000 in 2004 and $723,000 in 2003.

*Deposits and Borrowings*

The Company continues to devote time and resources toits deposit-gathering network. The Company experienced a net increase of $100.3million, or 11.4%, in total deposits during 2005, to $981.0 million at December 31,2005, from $880.7 million at December 31, 2004. This increase intotal deposits is summarized as follows: demand deposit accounts were up $17.4million, or 10.4%, savings accounts were up $1.3 million, or 0.4%, and CDs wereup $104.5 million, or 42.1%. Meanwhile, NOW and money market accounts were down$18.6 million, or 17.2%, and $4.4 million, or 26.5%, respectively. The Companywas able to moderately increase demand deposit accounts throughout 2005 despitethe consumer preference 

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throughout the year forhigher yielding term deposit products in this rate environment. Overall, coredeposits remained essentially flat on a dollar basis year over year, with aslight decrease of $4.2 million, or 0.7%, from December 31, 2004 levels. However,the balance sheet mix changed from the prior year due to the growth in CDbalances. Core deposit accounts as percentage of total deposits decreased to64.0% at December 31, 2005 from 71.8% at December 31, 2004.

By comparison, total deposits increased $69.4 million,or 8.6%, during 2004 and can be summarized as follows:  demand deposit accounts increased $7.8million, or 4.9%, NOW and money market accounts decreased $21.7 million, or14.8%, savings accounts increased $47.6 million, or 16.3%, and CDs increased$35.8 million, or 16.8%, during 2004.

Thefollowing table sets forth certain information regarding deposits:

| ** **                       | ** ** | **December 31,**                | ** ** |
|----------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                       | ** ** | **Amount**                           | ** ** | **Percent  of  Total** | ** ** | **Weighted  Average  Rate** | ** ** | **Amount** | ** ** | **Percent  of  Total** | ** ** | **Weighted  Average  Rate** | ** ** | **Amount** | ** ** | **Percent  of  Total** | ** ** | **Weighted  Average  Rate** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| NOW accounts                     |       | $                                    | 89,594     |   |   | 9.1 | % |   |   | 0.54 | % |   | $ | 108,159 |   |   | 12.3 | % |   |   | 0.76 | % |   | $ | 129,398 |   |   | 16.0 | % |   |   | 1.13 | % |   |
| Money market  accounts           |       | 12,122                               |       |   | 1.2 | % |   |   | 1.31 | % |   | 16,489 |   |   | 1.9 | % |   |   | 1.22 | % |   | 16,937 |   |   | 2.1 | % |   |   | 1.29 | % |   |
| Savings accounts                 |       | 341,115                              |       |   | 34.8 | % |   |   | 1.66 | % |   | 339,836 |   |   | 38.6 | % |   |   | 1.25 | % |   | 292,277 |   |   | 36.0 | % |   |   | 1.18 | % |   |
| Certificate of  deposit accounts |       | 353,049                              |       |   | 36.0 | % |   |   | 3.34 | % |   | 248,508 |   |   | 28.2 | % |   |   | 2.55 | % |   | 212,755 |   |   | 26.2 | % |   |   | 2.55 | % |   |
| Total interest  bearing deposits |       | 795,880                              |       |   | 81.1 | % |   |   | 2.28 | % |   | 712,992 |   |   | 81.0 | % |   |   | 1.63 | % |   | 651,367 |   |   | 80.3 | % |   |   | 1.62 | % |   |
| Noninterest  bearing accounts    |       | 185,089                              |       |   | 18.9 | % |   |   | 0.00 | % |   | 167,682 |   |   | 19.0 | % |   |   | 0.00 | % |   | 159,916 |   |   | 19.7 | % |   |   | 0.00 | % |   |
| Total deposits                   |       | $                                    | 980,969    |   |   | 100.0 | % |   |   | 1.85 | % |   | $ | 880,674 |   |   | 100.0 | % |   |   | 1.32 | % |   | $ | 811,283 |   |   | 100.0 | % |   |   | 1.30 | % |   |

 

At December 31, 2005, CDs with balances greaterthan $100,000 aggregated $98.0 million, compared to $52.4 million and$31.0 million at December 31, 2004 and 2003, respectively.

Overnight and short-term borrowings, along with FHLBborrowings, increased $73.4 million, or 29.0%, during 2005, to$326.2 million, from $252.8 million at December 31, 2004. TheCompany had $190.2 million of borrowings outstanding at the end of 2003. Theincreases were the result of the Company utilizing borrowings to fund assetgrowth. The Company, through the Bank’s membership in the FHLB, has access to anumber of different funding structures. During 2005, the Bank also utilizedwholesale repurchase agreements because of favorable spreads compared to FHLBborrowings.

On a long-term basis, theCompany intends to continue concentrating on increasing its core deposits, butwill continue to utilize FHLB borrowings or wholesale repurchase agreements ascash flows dictate and opportunities present themselves.

**SubordinatedDeferrable Interest Debentures**

On both March 17,2004, and June 26, 2003, the Company issued $5.2 million ofsubordinated deferrable interest debentures to one of its statutory trustsubsidiaries bringing its total outstanding of subordinated deferrable interestdebentures to $18.6 million. The securities issued in March 2004 havea floating interest rate equal to 3 month LIBOR plus 2.79% and mature in 30years. The securities issued in June 2003 have a 5.55% coupon, fixed forthe first five years, then converting to a floating interest rate equal to 3month LIBOR plus 3.10% and mature in 30 years. The statutory trust subsidiarythen participated in the issuance of pooled trust preferred securities ofsimilar terms and maturity. The regulatory capital generated from issuing thetrust preferred securities helped support the Company’s 

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continuedasset growth. In accordance with Financial Accounting Standards Board (“FASB”)Interpretation 46-R *“Consolidation of VariableInterest Entities—Revised”*, the statutory trust subsidiariesutilized in the issuance of trust preferred securities were deconsolidated fromthe Company’s financial statements, effective December 31, 2003.

**Liquidity and Capital Resources**

*Liquidity*

Liquidity is defined as the ability to meet currentand future financial obligations of a short-term nature. The Company furtherdefines liquidity as the ability to respond to the needs of depositors andborrowers, as well as to earnings enhancement opportunities, in a changingmarketplace.

The primary source of funds for the payment ofdividends and expenses by the Company is dividends paid to it by the Bank. Bankregulatory authorities generally restrict the amounts available for payment ofdividends if the effect thereof would cause the capital of the Bank to bereduced below applicable capital requirements. These restrictions indirectlyaffect the Company’s ability to pay dividends. The primary sources of liquidityfor the Bank consist of deposit inflows, loan repayments, borrowed funds,maturing investment securities and sales of securities from the available forsale portfolio. Management believes that these sources are sufficient to fundthe Bank’s lending and investment activities.

Management is responsiblefor establishing and monitoring liquidity targets as well as strategies andtactics to meet these targets. In general, the Company maintains a high degreeof flexibility with a liquidity target of 10% to 30% of total assets. At December 31,2005, overnight investments, investment securities and mortgage-backedsecurities available for sale amounted to $396.2 million, or 27.5% oftotal assets. This compares to $278.6 million, or 22.5% of total assets,at December 31, 2004. The Bank is a member of the FHLB and, as such, hasaccess to both short- and long-term borrowings. In addition, the Bank maintainsa line of credit at the FHLB as well as a line of credit with a correspondentbank. There have been no adverse trends in the Company’s liquidity or capitalreserves. Management believes that the Company has adequate liquidity to meetits commitments.

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*Commitments andContingent Liabilities*

Thefollowing table sets forth the contractual obligations of the Company:

| ** **                                    | ** ** | **Payments due or  commitment expiring—by period** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **Total**                                               | ** ** | **Less than  one year** | ** ** | **One to  three years** | ** ** | **Four to  five years** | ** ** | **After  five years** | ** ** |
| ** **                                    | ** ** | **(In  thousands)**                                     | ** ** |
| Contractual cash  obligations:                |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| FHLB term borrowings                          |       | $                                                       | 279,973    |   | $ | 79,250 |   |   | $ | 69,797 |   |   | $ | 63,702 |   | $ | 67,224 |   |
| Subordinated deferrable interest debentures   |       | 18,558                                                  |       | — |   |   | — |   |   | — |   | 18,558 |   |
| Lease obligations                             |       | 13,468                                                  |       | 1,314 |   |   | 2,827 |   |   | 1,687 |   | 7,640 |   |
| Other:                                        |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Treasury, Tax and Loan payments               |       | 2,387                                                   |       | 2,387 |   |   | — |   |   | — |   | — |   |
| Retail repurchase agreements                  |       | 23,851                                                  |       | 23,851 |   |   | — |   |   | — |   | — |   |
| Wholesale repurchase agreements               |       | 20,000                                                  |       | — |   |   | — |   |   | — |   | 20,000 |   |
| Total contractual cash obligations            |       | $                                                       | 358,237    |   | $ | 106,802 |   |   | $ | 72,624 |   |   | $ | 65,389 |   | $ | 113,422 |   |
| Other commitments:                            |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Commitments to originate or purchase loans    |       | $                                                       | 37,623     |   | $ | 37,623 |   |   | $ | — |   |   | $ | — |   | $ | — |   |
| Unused lines of  credit and other commitments |       | 177,317                                                 |       | 74,255 |   |   | 14,942 |   |   | 545 |   | 87,575 |   |
| Letters of credit                             |       | 1,895                                                   |       | 1,526 |   |   | 369 |   |   | — |   | — |   |
| Supplemental retirement benefits              |       | 1,799                                                   |       | — |   |   | — |   |   | — |   | 1,799 |   |
| Total other  commitments                      |       | $                                                       | 218,634    |   | $ | 113,404 |   |   | $ | 15,311 |   |   | $ | 545 |   | $ | 89,374 |   |

 

In connection with the Macrolease acquisition, theCompany has an obligation to issue up to 20,342 shares of its common stock overthe next four years contingent upon Macrolease reaching specified performancecriteria.

The Company continues tomonitor a receivable recorded in the fourth quarter of 2005 that related to theunauthorized actions of a former employee, which could result in a futureimpairment charge. The Company’s maximum exposure at December 31, 2005 was$1.3 million. As of February 28, 2006, the Company’s estimated exposureranged from $0 to $900,000. The Company has notified its insurance carrierregarding the circumstances giving rise to the receivable and will seekrecovery from its carrier if it incurs a loss.

*Capital Resources*

Total shareholders’ equity of the Company at December 31,2005 was $104.8 million, as compared to $78.9 million at December 31,2004. Major activity in shareholders’ equity during 2005 can be summarized asfollows: the stock offering in the second quarter yielded $21.5 million, netincome for the year was $9.6 million, dividends paid on Common Stocktotaled $2.7 million, proceeds from the exercise of options totaled$1.2 million, Macrolease acquisition was $0.3 million and net unrealizedgains and losses on securities decreased $3.9 million.

All FDIC-insured institutions must meet specifiedminimal capital requirements. These regulations require banks to maintain aminimum leverage capital ratio. At December 31, 2005, the Bank’s Tier Ileverage ratio stood at 6.67%. In addition, the FDIC has adopted capitalguidelines based upon ratios of a bank’s capital to total assets adjusted forrisk. The risk-based capital guidelines include both a definition of capitaland a framework for calculating risk-weighted assets by assigning balance sheetassets and off-balance sheet items to broad risk categories. These regulationsrequire banks to maintain minimum capital levels for capital adequacy purposesand higher capital levels to be considered “well capitalized”. According tothese standards, the Bank had a Tier I risk-weighted capital ratio of 10.26%and a Total risk-weighted capital ratio of 11.51% at December 31, 2005.

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The FRB has also issued capital guidelines for bankholding companies. These guidelines require the Company to maintain minimum capitallevels for capital adequacy purposes. In general, the FRB has adoptedsubstantially identical capital adequacy guidelines as the FDIC. Such standardsare applicable to bank holding companies and their bank subsidiaries on aconsolidated basis. At December 31, 2005, the Company’s Tier I leverageratio was 8.21%, its Tier I Risk-based capital ratio was 12.62% and its TotalRisk-based capital ratio was 13.87%.

As of December 31, 2005, the Company and the Bankmet all applicable minimum capital requirements and were considered “wellcapitalized” by both the FRB and the FDIC.

The decision by the SEC torequire the deconsolidation of “special purpose entities” under FASBInterpretation 46-R, “*Consolidation of VariableInterest Entities—Revised*”, has led the FRB to further limit theinclusion of trust preferred securities in future Tier I capital calculations. Todate, the Company has issued a total of $18.0 million of trust preferredsecurities and utilized their proceeds as Tier I capital to help support theCompany’s growth. If trust preferred securities are not available as a sourceof future Tier I capital, the Company expects to use other forms of capital(e.g., common or preferred equity) to support its growth, which, because ofless favorable tax treatment, may be a somewhat more expensive source ofcapital than trust preferred securities.

**Impactof Inflation and Changing Prices**

The consolidated financialstatements and related notes thereto, included elsewhere herein, have beenprepared in accordance with U.S. GAAP, which requires the measurement offinancial position and operating results in terms of historical dollars,without considering changes in the relative purchasing power of money over timedue to inflation. Unlike many industrial companies, substantially all of theassets and liabilities of the Company are monetary in nature. As a result,interest rates have a more significant impact on the Company’s performance thanthe general level of inflation. Over short periods of time, interest rates may notnecessarily move in the same direction or in the same magnitude as inflation.

**Recent Accounting Developments**

In December 2005, the FASB issued Staff Position(“FSP”) Statement of Position (“SOP”) 94-6-1, “*Terms ofLoan Products That May Give Rise to a Concentration of Credit Risk*”.The FSP addresses the circumstances under which the terms of loan products giverise to a concentration of credit risk and related disclosures and accountingconsiderations. The FSP is intended to emphasize the requirement to assess theadequacy of disclosures for all lending products and the effect of changes inmarket or economic conditions on the adequacy of those disclosures. FSP SOP 94-6-1is effective for all periods after December 19, 2005. The adoption of thisFSP on December 31, 2005 did not materially impact the Company’s financialstatements.

In November 2005, the FASB issued FSP 115-1,“*The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments*”, which superseded EmergingIssues Task Force Issue (“EITF”) 03-1 and related amendments to EITF03-1. The guidance in FSP 115-1 outlines a three-step model foridentifying investment impairments regarding impairment measurement,other-than-temporary impairment evaluation and recognition of other-than-temporaryimpairment losses and subsequent accounting. The FSP also carries forward thedisclosure requirements of EITF 03-1. FSP 115-1 is effective forperiods beginning after December 15, 2005. The Company does not anticipateFSP 115-1 will materially impact its financial statements upon adoptionon January 1, 2006.

In May 2005, the FASBissued Statement of Financial Accounting Standard (“SFAS”) 154, “*AccountingChanges and Error Corrections*”.This statement replaces Accounting Principles Board Opinion (“APB”) 20, “*AccountingChanges*”, and SFAS 3, “*Reporting Accounting Changes in Interim Financial Statements*”, and changes the requirements for theaccounting for and reporting of a change in accounting 

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principle.SFAS 154 is effective for accounting changes and corrections of errorsmade in fiscal years beginning after December 15, 2005. The Company doesnot anticipate SFAS 154 will materially impact its financial statementsupon adoption on January 1, 2006.

In December 2004, the FASB issued SFAS 123-R,“*Share-Based Payment*”, which wassubsequently revised in April 2005 by delaying the implementation date.SFAS 123-R addresses the accounting for share-based payments to employeesand non-employees, including grants of employee stock options. Under the newstandard, companies will no longer be able to account for share-basedcompensation transactions using the intrinsic method in accordance with APB 25,“*Accounting for Stock Issued to Employees*”.Instead, companies will be required to account for such transactions using afair-value method and recognize the expense in the consolidated statements ofoperations. The Company adopted SFAS 123-R on January 1, 2006.

The calculation of compensation cost for share-basedpayment transactions after the effective date of SFAS 123-R may differfrom the calculation of compensation cost presented in the footnotes to thefinancial statements, but management has not yet quantified such differences. TheCompany expects that the adoption of SFAS 123-R will not have a material impacton its overall financial position. However, the Company will be required torecognize expense on new stock options granted, which may have a materialimpact on the Company’s statement of operations. The Company had fully vestedall previously granted options as of December 30, 2005.

In December 2003, the American Institute ofCertified Public Accountants (“AICPA”) issued SOP 03-3, “*Accounting for Certain Loans or Debt Securities Acquired in a Transfer*.”  SOP 03-3 requires loans acquiredthrough a transfer, such as a business combination, where there are differencesin expected cash flows and contractual cash flows due in part to credit qualitybe recognized at their fair value. The yield that may be accreted is limited tothe excess of the investor’s estimate of undiscounted expected principal,interest and other cash flows over the investor’s initial investment in theloan. The excess of contractual cash flows over expected cash flows is not tobe recognized as an adjustment of yield, loss accrual or valuation allowance. Valuationallowances cannot be created nor “carried over” in the initial accounting forloans acquired in a transfer of loans with evidence of deterioration of creditquality since origination. However, valuation allowances for non-impaired loansacquired in a business combination can be carried over. This SOP is effectivefor loans acquired in fiscal years beginning after December 15, 2004. Theadoption of SOP 03-3 did not have a material impact on the Company’sfinancial statements.

In December 2003, the FASB issued FASBInterpretation (“FIN”) 46-R, “*Consolidation of VariableInterest Entities—Revised*.” FIN 46-R revises FIN 46, “*Consolidation of Variable Interest Entities*” which is aninterpretation of Accounting Research Bulletin 51, “*ConsolidatedFinancial Statements*.”  FIN 46-Rprovides guidance regarding the consolidation of special purpose entities, andremoved uncertainty over whether FIN 46 required consolidation ordeconsolidation of special purpose entities that issue trust preferredsecurities. FIN 46-R clarified that even those entities that issue trustpreferred securities with call options must be deconsolidated. FIN 46-Ris effective for financial statements for periods ending after December 15,2003, with no requirement for restatement of previous periods. The Companyadopted FIN 46-R on December 31, 2003, and therefore hasdeconsolidated its statutory trust subsidiaries as of that date. Adoption ofthis Interpretation did not have a material impact on the Company’s financialstatements.

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**ITEM 7A.**        QUALITATIVEAND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

**Asset and Liability Management**

The principal objective of the Company’s asset andliability management process is to maximize profit potential while minimizingthe vulnerability of its operations to changes in interest rates by means ofmanaging the ratio of interest rate sensitive assets to interest rate sensitiveliabilities within specified maturity or repricing periods. The asset andliability management process is dependent on numerous assumptions, many ofwhich require significant judgments by the Company. The Company’s actions inthis regard are taken under the guidance of the Bank’s Asset/LiabilityCommittee (“ALCO”) that is comprised of members of senior management. The ALCOgenerally meets monthly and is actively involved in formulating the economicassumptions that the Company uses in its financial planning and budgetingprocess and establishes policies which control and monitor the sources, usesand pricing of funds. The Company has not engaged in any derivativetransactions in connection with hedging activities.

The ALCO manages the Company’s interest rate riskposition using both income simulation and interest rate sensitivity “gap”analysis. Simulation is used as the primary tool for measuring the interestrate risk inherent in the Company’s balance sheet at a given point in time byshowing the effect on net interest income, over a 24-month period, ofinterest rate ramps of up to 200 basis points. These simulations take into accountrepricing, maturity and prepayment characteristics of individual products. TheALCO reviews simulation results to determine whether the downside exposureresulting from changes in market interest rates remains within establishedtolerance levels over both a 12-month and 24-month horizon, anddevelops appropriate strategies to manage this exposure. The Company’sguidelines for interest rate risk specify that if interest rates were to shiftup or down 200 basis points over a 12-month period, estimated netinterest income for those 12 months and the subsequent 12 months, shoulddecline by no more than 5.0% or 10.0%, respectively. As of December 31,2005, net interest income simulation indicated that the Company’s exposure tochanging interest rates was within these tolerances. The ALCO reviews themethodology utilized for calculating interest rate risk exposure and will adoptchanges based upon changing market conditions or industry standards.

Thefollowing table presents the estimated impact of interest rate ramps onestimated net interest income over a 24-month period beginning January 1,2006:

| ** **                       | ** ** | **Estimated impact on**    | ** ** |
|----------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **net interest income**    | ** ** |
| ** **                       | ** ** | **Dollar**                           | ** ** | **Percent** | ** ** |
| ** **                       | ** ** | **change**                           | ** ** | **change** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| Initial Twelve Month  Period:    |       |                                 |       |   |   |   |   |
| Up 200 basis point ramp          |       | $                                    | 476        |   |   | 1.09 | % |   |
| Down 200 basis point ramp        |       | (698                                 | )          |   | (1.60 | )% |   |
| Subsequent Twelve Month  Period: |       |                                 |       |   |   |   |   |
| Up 200 basis point ramp          |       | $                                    | (1,710     | ) |   | (3.81 | )% |   |
| Down 200 basis  point ramp       |       | (1,328                               | )          |   | (2.96 | )% |   |

 

The Company also uses interest rate sensitivity “gap”analysis to provide a more general overview of its interest rate risk profile. Theinterest rate sensitivity gap is defined as the difference betweeninterest-earning assets and interest-bearing liabilities maturing or repricingwithin a given time period. A gap is considered positive when the amount ofinterest rate sensitive assets exceeds the amount of interest rate sensitiveliabilities. A gap is considered negative when the amount of interest ratesensitive liabilities exceeds interest rate sensitive assets. At December 31,2005, the Company’s cumulative one-year gap was a negative $140 million, or9.7% of total assets, compared to positive $3.0 million, or 0.2% of totalassets at the end of 2004.

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Thefollowing table presents the repricing schedule for interest-earning assets andinterest-bearing liabilities at December 31, 2005. To the extentapplicable, amounts of assets and liabilities that mature or reprice within aparticular period were determined in accordance with their contractual terms. Investmentsecurities are allocated based upon expected call dates. Loans and MBSs havebeen allocated based upon expected amortization and prepayment rates based onhistorical performance and market expectations. Savings, NOW and money marketdeposit accounts, which have no contractual term and are subject to immediaterepricing, are anticipated to behave more like core accounts and therefore arepresented as spread evenly over the first three years. Nonetheless, thispresentation does not reflect lags that may occur in the actual repricing ofthese deposits.

| ** **                                                                             | ** ** | **Within**                           | ** ** | **Over**            | ** ** | **Over Six**  | ** ** | **Over One**   | ** ** | ** **          | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|---------------------|------------|------------|------------|
| ** **                                                                             | ** ** | **Three**                            | ** ** | **Three to**   | ** ** | **to Twelve** | ** ** | **Year to**    | ** ** | **Over**            | ** ** | ** ** | ** ** |
| ** **                                                                             | ** ** | **Months**                           | ** ** | **Six months** | ** ** | **months**         | ** ** | **Five Years** | ** ** | **Five Years** | ** ** | **Total**  | ** ** |
| ** **                                                                             | ** ** | **(Dollars in thousands)** | ** ** |
| Interest-earning assets:                                                               |       |                                 |       |                |       |               |       |                |       |                |       |       |       |   |   |
| Overnight investments                                                                  |       | $                                    | 10,370     |                |       | $                  | —     |                |       | $                   | —     |       | $          | — |   | $ | — |   | $ | 10,370 |   |
| Investment securities                                                                  |       | 7,005                                |       |                | 1,000      |               |       | 19,005              |       | 123,004             |       | 945        |       | 150,959 |   |
| Mortgage-backed securities                                                             |       | 13,911                               |       |                | 12,181     |               |       | 24,207              |       | 126,736             |       | 57,823     |       | 234,858 |   |
| FHLB Stock                                                                             |       | 16,062                               |       |                | —     |               |       | —              |       | —              |       | —     |       | 16,062 |   |
| Commercial loans and  leases                                                           |       | 126,349                              |       |                | 28,062     |               |       | 46,607              |       | 198,248             |       | 39,043     |       | 438,309 |   |
| Residential mortgage loans                                                             |       | 17,631                               |       |                | 17,328     |               |       | 32,618              |       | 180,872             |       | 57,567     |       | 306,016 |   |
| Consumer and other loans                                                               |       | 78,964                               |       |                | 8,881      |               |       | 16,099              |       | 74,025              |       | 28,512     |       | 206,481 |   |
| Total interest-earning assets                                                          |       | 270,292                              |       |                | 67,452     |               |       | 138,536             |       | 702,885             |       | 183,890    |       | 1,363,055 |   |
| Interest-bearing  liabilities:                                                         |       |                                 |       |                |       |               |       |                |       |                |       |       |       |   |   |
| NOW accounts                                                                           |       | 7,466                                |       |                | 7,466      |               |       | 14,933              |       | 59,729              |       | —     |       | 89,594 |   |
| Money market accounts                                                                  |       | 1,010                                |       |                | 1,010      |               |       | 2,020               |       | 8,082               |       | —     |       | 12,122 |   |
| Savings accounts                                                                       |       | 28,530                               |       |                | 28,530     |               |       | 57,060              |       | 226,995             |       | —     |       | 341,115 |   |
| Certificate of deposit accounts                                                        |       | 98,943                               |       |                | 74,878     |               |       | 120,476             |       | 58,710              |       | 42         |       | 353,049 |   |
| Overnight & short-term borrowings                                             |       | 26,238                               |       |                | —     |               |       | —              |       | —              |       | —     |       | 26,238 |   |
| FHLB and other borrowings                                                              |       | 76,134                               |       |                | 17,400     |               |       | 44,370              |       | 124,891             |       | 37,178     |       | 299,973 |   |
| Subordinated deferrable interest debentures                                            |       | 10,310                               |       |                | —     |               |       | —              |       | 5,155               |       | 3,093      |       | 18,558 |   |
| Total interest-bearing liabilities                                                     |       | 248,631                              |       |                | 129,284    |               |       | 238,859             |       | 483,562             |       | 40,313     |       | 1,140,649 |   |
| Net interest sensitivity gap during the period                                         |       | $                                    | 21,661     |                |       | $                  | (61,832    | )                   |       | $                   | (100,323   | )          | $          | 219,323 |   | $ | 143,577 |   | $ | 222,406 |   |
| Cumulative  gap—12/31/05                                                          |       | $                                    | 21,661     |                |       | $                  | (40,171    | )                   |       | $                   | (140,494   | )          | $          | 78,829 |   | $ | 222,406 |   |   |   |
| Cumulative  gap—12/31/04                                                          |       | $                                    | 121,134    |                |       | $                  | 50,888     |                |       | $                   | 2,996      |       | $          | 40,909 |   | $ | 193,792 |   |   |   |
| Interest-sensitive  assets as a percent of Interest-sensitive liabilities (cumulative) |       | 108.71                               | %          |                | 89.37      | %                  |       | 77.22               | %          | 107.16              | %          | 119.50     | %          |   |   |
| Cumulative gap as a  percent of total assets                                           |       | 1.50                                 | %          |                | -2.79%     |               |       | -9.74%              |       | 5.47                | %          | 15.42      | %          |   |   |

 

The preceding table doesnot necessarily indicate the impact of general interest rate movements on theCompany’s net interest income because the repricing of various assets andliabilities is discretionary 

52

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and issubject to competitive and other factors. As a result, assets and liabilitiesindicated as repricing within the same period may, in fact, reprice atdifferent times and at different rate levels.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

The index to financialstatements is included on page 56 of this annual report.

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING OR FINANCIAL DISCLOSURE

There were no changes in,or disagreements with, accountants on accounting or financial disclosure asdefined by Item 304 of Regulation S-K.

**ITEM 9A.**        CONTROLSAND PROCEDURES

As required by Rule 13a-15 under theExchange Act of 1934, the Company carried out an evaluation of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures as of the end of the period covered by this report. Thisevaluation was carried out under the supervision and with the participation ofthe Company’ s management, including the Company’s Chief Executive Officer andthe Company’s Chief Financial Officer. Based upon that evaluation, the ChiefExecutive Officer and the Chief Financial Officer concluded that the Company’sdisclosure controls and procedures are effective as of the end of the periodcovered by this report.

There have been no significantchanges in the Company’s internal control over financial reporting during theCompany’s most recent fiscal quarter that have materially affected, or arereasonably likely to affect, the Company’s internal control over financialreporting.

**ITEM 9B.**       OTHERINFORMATION

There is no other information to report.

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**PART III**

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THECOMPANY**

The information concerning directors required by thisitem, including the Audit Committee and the Audit Committee financial expert,is incorporated herein by reference to the Sections entitled “Election ofDirectors” and “Section 16(a) Beneficial Ownership ReportingCompliance” in the Company’s Definitive Proxy Statement for the 2006 AnnualMeeting of Shareholders to be filed with the SEC.

Thefollowing table sets forth the executive officers of the Company as of the datehereof.

| **Name**            | ** ** | ** ** | ** ** | **Age** | ** ** | **Position**                           | ** ** |
|---------------------|------------|------------|------------|---------|------------|----------------------------------------|------------|
| Merrill W. Sherman  |       |       | 57         |    |       | President and Chief  Executive Officer |       |
| Linda H. Simmons    |       |       | 46         |    |       | Chief Financial Officer  and Treasurer |       |
| Jeffrey W. Angus    |       |       | 50         |    |       | Vice President                         |       |
| James V. DeRentis   |       |       | 44         |    |       | Vice President                         |       |
| Margaret D. Farrell |       |       | 56         |    |       | Secretary                              |       |

 

*MerrillW. Sherman.*   Ms. Sherman has served asPresident and Chief Executive Officer of the Company and Bank since theirformation. Ms. Sherman is also a director of The Providence JournalCompany, a BELO Corp. subsidiary.

*LindaH. Simmons.**  *Ms. Simmonshas served as Chief Financial Officer and Treasurer of the Company and Banksince July 2005 and served as the Bank’s Executive Vice President—Financeand Treasurer since September 2004. From 1995 until joining the Bank, Ms. Simmonswas with Fleet Financial Corp.’s Treasury Group where she held variouspositions with responsibilities in the asset/liability management area.

*JeffreyW. Angus.**  *Mr. Angushas served as Vice President of the Company and Executive Vice President andChief Operating Officer of the Bank since December 2005. From 1998 until2004, Mr. Angus served as senior vice president of information systems andas a corporate officer at New England Business Service, Inc.

*JamesV. DeRentis.*   Mr. DeRentis has served asVice President of the Company since December 2005 and the Bank’s ChiefBusiness Officer since October 2005. Mr. DeRentis previously servedas the Bank’s Executive Vice President—Retail Banking from October 2001through September 2005. Immediately prior, Mr. DeRentis served as theBank’s Senior Vice President—Retail Banking from December 1998 through October 2001.

*Margaret D. Farrell.*   Ms. Farrellhas served as Secretary of the Company and Bank since their formation.Ms. Farrell has been a partner of the law firm of Hinckley, Allen &Snyder LLP since 1981. Ms. Farrell is also a director of the Company andthe Bank.

**Code of Ethics**

The Company has adopted aCode of Ethics which applies to all directors, officers and employees of theCompany and the Bank, including the Chief Executive Officer (“CEO”), ChiefFinancial Officer (“CFO”), Controller and Chief Auditor, as supplemented by aCode of Ethical Conduct for Executive Officers and Senior Financial Officers,which meets the requirements of a “code of ethics” as defined in Item 406 ofRegulation S-K. The Company will provide a copy of the Codes to shareholders,without charge, upon request directed to the Investor Relations Contact listedon the Company’s website, http://www.bankri.com,under “Investor Relations”. The Company has posted the Codes on the Company’swebsite under “Investor Relations” and intends to disclose any amendment to, orwaiver of, a provision of the Codes for the CEO, CFO, Controller or personsperforming similar functions by posting such information on its website andfiling a Form 8-K as required by the rules of the Nasdaq StockMarket.

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**ITEM 11. EXECUTIVE COMPENSATION**

The information requiredby this item is incorporated herein by reference to the Section entitled “ExecutiveCompensation” in the Company’s Definitive Proxy Statement for the 2006 AnnualMeeting of Shareholders to be filed with the SEC.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The information requiredby this item is incorporated herein by reference to the Sections entitled “CommonStock Ownership of Certain Beneficial Owners and Management” in the Company’sDefinitive Proxy Statement for the 2006 Annual Meeting of Shareholders to befiled with the SEC.

**EquityCompensation Plan Information**

Thefollowing table sets forth information about the Company’s equity compensationplans as of December 31, 2005:

| **Plan category**                                      | ** ** | ** ** | ** ** | **Number of Securities to  be Issued Upon Exercise  of Outstanding Options,  Warrants and Rights** | ** ** | **Weighted-Average  Exercise Price of  Outstanding Options,  Warrants and Rights** | ** ** | **Number of Securities  Remaining Available for  Future Issuance Under  Equity Compensation  Plans** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity Compensation  Plans Approved by Security Holders     |       |       | 478,480    | (1)                                                                                                                                                  |       |                                                                                                        | $          | 21.42                                                                                                                                   |       |   |   | 121,163 | (2) |   |
| Equity Compensation  Plans Not Approved by Security Holders |       |       | 0          |                                                                                                                                                 |       |                                                                                                        | N/A        |                                                                                                                                    |       |   | 0 |   |   |
| Total                                                       |       |       | 478,480    |                                                                                                                                                 |       |                                                                                                        | $          | 21.42                                                                                                                                   |       |   |   | 121,163 |   |   |

 

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(1)          Includes 428,980 sharesissuable upon exercise of outstanding awards granted under the Bancorp RhodeIsland, Inc. 2002 Equity Incentive Plan and predecessor plan (Amended andRestated Bancorp Rhode Island, Inc. 1996 Incentive and Nonqualified StockOption Plan) and 49,500 shares issuable upon exercise of outstanding awardsgranted under the Amended and Restated Bancorp Rhode Island, Inc.Non-Employee Directors Stock Plan.

(2)          Includes 119,663 sharesreserved for awards under the Bancorp Rhode Island, Inc. 2002 EquityIncentive Plan and predecessor plan and 1,500 shares reserved for awards underthe Amended and Restated Bancorp Rhode Island, Inc. Non-Employee DirectorsStock Plan.

Additional informationregarding these equity compensation plans is contained in Note 15 to theCompany’s Consolidated Financial Statements included in this annual report.

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

The information requiredby this item is incorporated herein by reference to the Section entitled “Transactionswith Management” in the Company’s Definitive Proxy Statement for the 2006Annual Meeting of Shareholders to be filed with the SEC.

**ITEM14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

The information required by this item is incorporatedherein by reference to the Section entitled “Independent Accountant Feesand Services” in the Company’s Definitive Proxy Statement for the 2006 AnnualMeeting of Shareholders to be filed with the SEC.

55

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**PART IV**

**ITEM 15. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES**

**(a)****          (1)   Financial Statements**

Thefollowing consolidated financial statements appear in response to Item 8 ofthis report commencing on the page numbers specified below:

| Management’s Report on  Internal Control Over Financial Reporting                                                                                          |   | F-1 |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----|--------|
| Report of Independent Registered Public Accounting  Firm on Management’s Assessment of and the Effectiveness of Internal Control  Over Financial Reporting |   | F-2 |   |
| Report of Independent Registered Public Accounting  Firm                                                                                                        |   | F-3 |   |
| Consolidated  Balance Sheets as of December 31, 2005 and 2004                                                                                              |   | F-4 |   |
| Consolidated Statements of Operations for the Years  Ended December 31, 2005, 2004  and 2003                                                               |   | F-5 |   |
| Consolidated Statements of Changes in Shareholders’  Equity for the Years Ended December 31, 2005, 2004 and 2003                                      |   | F-6 |   |
| Consolidated Statements of Cash Flows for the Years  Ended December 31, 2005, 2004  and 2003                                                               |   | F-7 |   |
| Notes to  Consolidated Financial Statements                                                                                                                     |   | F-8 |   |

 

**(2)   FinancialStatement Schedules**

All schedules for which provision is made in theapplicable accounting regulations of the Securities and Exchange Commission arenot required under the related instructions or are inapplicable, and thereforehave been omitted.

**(3)   Exhibits**
| Exhibit No. | ** ** | ** **                                                                                                              | ** ** | **Description** | ** ** |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|
| 3.1         |       | Articles of  Incorporation of the Company, as amended(1)                                                                |
| 3.2         |       | By-laws of the Company, as amended                                                                                      |
| 10.1        |       | Employment Agreement of Merrill W. Sherman dated  December 18, 2000(2)†                                       |
| 10.2        |       | Employment Agreement of Linda H. Simmons dated  September 8, 2004(3)†                                         |
| 10.3        |       | Employment Agreement of Jeffrey W. Angus dated  February 24, 2006†                                            |
| 10.4        |       | Employment Agreement of James V. DeRentis dated  December 18, 2000(2)†                                        |
| 10.4(a)     |       | Amendment to Employment Agreement of James V.  DeRentis dated February 24, 2006†                              |
| 10.5        |       | Amended and Restated 1996 Incentive and Nonqualified  Stock Option Plan(2)†                                        |
| 10.6        |       | Amended and Restated Non-Employee Director Stock  Plan(4)†                                                         |
| 10.6(a)     |       | Amendment to Amended and Restated Non-Employee  Director Stock Plan(5)†                                            |
| 10.7(a)     |       | Bank  Rhode Island Supplemental Executive Retirement Plan, as amended by Amendments  No. 1 and No. 2(1)† |
|             |            |                                                                                                                         |            |                 |            |  |

56

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| 10.7(b)  |   | Amendment No. 3 to Bank Rhode Island  Supplemental Executive Retirement Plan(2)†                                                                         |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7(c)  |   | Amendment No. 4 to Bank Rhode Island Supplemental  Executive Retirement Plan†                                                                            |
| 10.7(d)  |   | Amendment No. 5 to Bank Rhode Island  Supplemental Executive Retirement Plan(6)†                                                                         |
| 10.7(e)  |   | Amendment No. 6 to Bank Rhode Island  Supplemental Executive Retirement Plan(7)†                                                                         |
| 10.8     |   | Bank  Rhode Island Nonqualified Deferred Compensation Plan, as amended by Amendment  No. 1(1)†                                                           |
| 10.8(a)  |   | Amendment No. 2 to Bank Rhode Island  Nonqualified Deferred Compensation Plan (8)†                                                                       |
| 10.9     |   | Executive Incentive Bonus Plan(9)†                                                                                                                            |
| 10.10    |   | Bank Rhode Island 2002 Supplemental Executive  Retirement Plan(8)†                                                                                            |
| 10.10(a) |   | Amendment No. 1 to Bank Rhode Island 2002  Supplemental Executive Retirement Plan(10)†                                                                   |
| 10.10(b) |   | Amendment No. 2 to Bank Rhode Island 2002  Supplemental Executive Retirement Plan(11)†                                                                   |
| 10.10(c) |   | Amendment No. 4 to Bank Rhode Island 2002 Supplemental  Executive Retirement Plan(11)†                                                                   |
| 10.11    |   | Restricted  Stock Agreement by and among Bancorp Rhode Island, Inc., Bank Rhode  Island and Merrill W. Sherman(12)†                                      |
| 10.12    |   | Form of Bank Rhode Island Split Dollar  Agreement(6)†                                                                                                    |
| 10.13    |   | 2002 Equity Incentive Plan(13)†                                                                                                                               |
| 11       |   | Computation of earnings per share(14)                                                                                                                              |
| 21       |   | List of Subsidiaries                                                                                                                                               |
| 23       |   | Consent of KPMG LLP, as independent registered  public accountants for the Company                                                                                 |
| 31.1     |   | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes—Oxley  Act of 2002                                                |
| 31.2     |   | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes—Oxley  Act of 2002                                                |
| 32.1     |   | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes—Oxley Act of 2002. |
| 32.2     |   | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes—Oxley Act of 2002. |

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(1)          Incorporatedby reference from the Company’s Registration Statement on Form S-4,SEC File No. 333-33182

(2)          Incorporatedby reference from the Company’s Annual Report on Form 10-K for theyear ended December 31, 2000.

(3)          Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q forthe period ended September 30, 2004.

(4)          Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q forthe period ended September 30, 2000.

57

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(5)          Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q forthe period ended June 30, 2002.

(6)          Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q forthe period ended March 31, 2002.

(7)          Incorporatedby reference from the Company’s Annual Report on Form 10-K for theyear ened December 31, 2004.

(8)          Incorporatedby reference from the Company’s Annual Report on Form 10-K for theyear ended December 31, 2002.

(9)          Incorporatedby reference from the Company’s Current Report on Form 8-K dated February 9,2005.

(10)   Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q forthe period ended June 30, 2003.

(11)   Incorporatedby reference from the Company’s Current Report on Form 8-K dated January 21,2005.

(12)   Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q forthe period ended March 31, 2001.

(13)   Incorporatedby reference to Appendix B to the Company’s Definitive Proxy Statement onSchedule 14A filed on April 15, 2005.

(14)   Thecalculation of earnings per share is set forth as Note 20 to the Company’saudited consolidated financial statements.

†                    Managementcontract or compensatory plan or arrangement.

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**BANCORP RHODE ISLAND, INC.**

SIGNATURES

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

|                          | ** ** | BANCORP RHODE ISLAND, INC. |
|--------------------------|------------|----------------------------|
| Date: March 6, 2006 |       | By:                        |   | /s/ Merrill W. Sherman |
|                     |       |                       |   | Merrill W. Sherman |
|                     |       |                       |   | President and Chief Executive Officer |

 

Each person whose signature appears below constitutesand appoints each of Merrill W. Sherman or Linda H. Simmons, or either of them,each acting alone, his or her true and lawful attorneys-in-fact and agents,with full power of substitution and resubstitution, for such person and in hisor her name, place and stead, in any and all capacities in connection with theannual report on Form 10-K of Bancorp Rhode Island, Inc. forthe year ended December 31, 2005, to sign any and all amendments to the Form 10-K,and to file the same, with all exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange Commission, grantingunto said attorneys-in-fact and agents, each acting alone, full power andauthority to do and perform each and every act and thing requisite andnecessary to be done in and about the premises, as fully to all intents andpurposes as he or she might or could do in person, hereby ratifying andconfirming all that said attorneys-in-fact and agents, or their substitutes orsubstitute, may lawfully do or cause to be done by virtue hereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

| /s/ Merrill W. Sherman                                                         |   | /s/  Linda H. Simmons                                                |   | /s/  Michael J. Hebert                     |
|--------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|--------------------------------------------|
| Merrill  W. Sherman,                                                           |   | Linda  H. Simmons,                                                   |   | Michael  J. Hebert,                        |
| President,  Chief Executive Officer and Director (Principal Executive Officer) |   | Chief  Financial Officer and Treasurer (Principal Financial Officer) |   | Controller  (Principal Accounting Officer) |
| Date:  March 6, 2006                                                      |   | Date:  March 6, 2006                                            |   | Date:  March 6, 2006                  |
| /s/ Karen Adams                                                                |   | /s/ Meredith A. Curren                                               |   | /s/ Bogdan Nowak                           |
| Karen  Adams, Director                                                         |   | Meredith  A. Curren, Director                                        |   | Bogdan  Nowak, Director                    |
| Date:  March 6, 2006                                                      |   | Date:  March 6, 2006                                            |   | Date:  March 6, 2006                  |
| /s/ Anthony F. Andrade                                                         |   | /s/ Karl F. Ericson                                                  |   | /s/ Cheryl W. Snead                        |
| Anthony  F. Andrade, Director                                                  |   | Karl  F. Ericson, Director                                           |   | Cheryl  W. Snead, Director                 |
| Date:  March 6, 2006                                                      |   | Date:  March 6, 2006                                            |   | Date:  March 6, 2006                  |
| /s/ John R. Berger                                                             |   | /s/ Margaret D. Farrell                                              |   | /s/ Pablo Rodriguez                        |
| John  R. Berger, Director                                                      |   | Margaret  D. Farrell, Director                                       |   | Pablo  Rodriguez, Director                 |
| Date:  March 6, 2006                                                      |   | Date:  March 6, 2006                                            |   | Date:  March 6, 2006                  |
| /s/ Malcolm G. Chace                                                           |   | /s/ Mark R. Feinstein                                                |   | /s/ John A. Yena                           |
| Malcolm G. Chace, Director and                                                 |   | Mark  R. Feinstein, Director                                         |   | John  A. Yena, Director                    |
| Chairman of the Board                                                          |   | Date:  March 6, 2006                                            |   | Date:  March 6, 2006                  |
| Date:  March 6, 2006                                                      |   |                                                                 |   |                                       |
| /s/ Ernest J. Chornyei, Jr.                                               |   | /s/ Edward J. Mack                                                   |   |                                       |
| Ernest  J. Chornyei, Jr., Director                                        |   | Edward  J. Mack, Director                                            |   |                                       |
| Date:  March 6, 2006                                                      |   | Date:  March 6, 2006                                            |   |                                       |

 

59

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**BANCORP RHODE ISLAND, INC.**

**Management’s Report on Internal ControlOver Financial Reporting**

The management of Bancorp Rhode Island, Inc. (the“Company”) is responsible for establishing and maintaining adequate internalcontrol over financial reporting. Bancorp Rhode Island Inc.’s internal controlsystem was designed to provide reasonable assurance to the Company’s managementand board of directors regarding the preparation and fair presentation ofpublished financial statements.

All internal control systems, no matter how welldesigned, have inherent limitations. Therefore, even those systems determinedto be effective can provide only reasonable assurance with respect to financialstatement preparation and presentation.

Bancorp Rhode Island, Inc.’s management assessedthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2005. In making this assessment, it used the criteria setforth by the Committee of Sponsoring Organizations of the Treadway Commission(COSO) in Internal Control—Integrated Framework. Based on our assessment webelieve that, as of December 31, 2005, the Company’s internal control overfinancial reporting is effective based on those criteria.

BancorpRhode Island, Inc.’s Independent Registered Public Accounting Firm haveissued an audit report on our assessment of the Company’s internal control overfinancial reporting. This report appears on page F-2 of this annualreport.

| Merrill W. Sherman      |   | Linda H. Simmons            |
|-------------------------|--------|-----------------------------|
| President and           |   | Chief Financial Officer and |
| Chief Executive Officer |   | Treasurer                   |

 

F-1

----

**BANCORPRHODE ISLAND, INC.**

**Report of Independent Registered Public AccountingFirm on Management’sAssessment of and the Effectiveness of Internal Control Over FinancialReporting**

TheBoard of Directors and ShareholdersBancorp Rhode Island, Inc.:

Wehave audited management’s assessment, included in the accompanying Management’sReport on Internal Control Over Financial Reporting, that Bancorp Rhode Island, Inc.(the “Company”) maintained effective internal control over financial reportingas of December 31, 2005, based on criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommissions (COSO). The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

A company’s internal control over financial reporting isa process designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition,use, or disposition of the company’s assets that could have a material effecton the financial statements.

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Inour opinion, management’s assessment that the Company maintained effectiveinternal control over financial reporting as of December 31, 2005, isfairly stated, in all material respects, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commissions (COSO). Also, in our opinion, the Companymaintained, in all material respects, effective internal control over financialreporting as of December 31, 2005, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commissions (COSO).

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balancesheets of the Company and subsidiaries as of December 31, 2005 and2004, and the related consolidated statements of operations, changes inshareholders’ equity, and cash flows for each of the years in the three-yearperiod ended December 31, 2005, and our report dated March 6, 2006expressed an unqualified opinion on those consolidated financial statements.

/s/KPMG LLPProvidence, Rhode Island

March 6,2006

F-2

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**BANCORP RHODE ISLAND, INC.**

**Report of Independent Registered Public AccountingFirm**

The Board of Directors and ShareholdersBancorp Rhode Island, Inc.:

We have audited the accompanying consolidated balancesheets of Bancorp Rhode Island, Inc. and subsidiaries as of December 31,2005 and 2004, and the related consolidated statements of operations, changesin shareholders’ equity, and cash flows for each of the years in the three-yearperiod ended December 31, 2005. These consolidated financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

We conducted our audits in accordance with generallyaccepted auditing standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Bancorp Rhode Island, Inc. and subsidiaries as of December 31,2005 and 2004, and the results of their operations and their cash flows foreach of the years in the three-year period ended December 31, 2005, inconformity with U.S. generally accepted accounting principles.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of Bancorp Rhode Island, Inc. andsubsidiaries’ internal control over financial reporting as of December 31,2005, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated March 6,2006 expressed an unqualified opinion on management’s assessment of, and theeffective operation of, internal control over financial reporting.

/s/ KPMG LLPProvidence, Rhode Island

March 6, 2006

F-3

----

**BANCORP RHODE ISLAND, INC.**

**ConsolidatedBalance Sheets**

| ** **                                                                                                                                   | ** ** | **December 31,**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                                                                                                                   | ** ** | **(In thousands)** | ** ** |
| **Assets**                                                                                                                                   |       |                    |       |   |   |
| Assets:                                                                                                                                      |       |                    |       |   |   |
| Cash and due from banks (Note 4)                                                                                                             |       | $                       | 30,177     |   | $ | 21,585 |   |
| Overnight investments                                                                                                                        |       | 10,370                  |       | 14,094 |   |
| Total cash and cash equivalents                                                                                                              |       | 40,547                  |       | 35,679 |   |
| Investment securities available for sale (amortized  cost of $153,328 and $103,953, respectively) (Notes 5, 11 and 12)                       |       | 150,959                 |       | 104,600 |   |
| Mortgage-backed securities available for sale  (amortized cost of $237,449 and $159,581, respectively) (Notes 6 and 12)                      |       | 234,858                 |       | 159,946 |   |
| Stock in the Federal Home Loan Bank of Boston (Note  12)                                                                                     |       | 16,062                  |       | 13,229 |   |
| Loans  and leases receivable (Notes 7, 11 and 12):                                                                                           |       |                    |       |   |   |
| Commercial loans and leases                                                                                                                  |       | 438,309                 |       | 402,770 |   |
| Residential mortgage loans                                                                                                                   |       | 306,016                 |       | 316,135 |   |
| Consumer and other loans                                                                                                                     |       | 206,481                 |       | 167,396 |   |
| Total loans and leases receivable                                                                                                            |       | 950,806                 |       | 886,301 |   |
| Allowance for loan and lease losses (Note 8)                                                                                                 |       | (12,168                 | )          | (11,906 | ) |
| Net loans and leases receivable                                                                                                              |       | 938,638                 |       | 874,395 |   |
| Premises and equipment, net (Note 9)                                                                                                         |       | 14,858                  |       | 11,857 |   |
| Goodwill, net (Notes 2 and 3)                                                                                                                |       | 11,234                  |       | 10,766 |   |
| Accrued interest receivable                                                                                                                  |       | 6,965                   |       | 5,666 |   |
| Investment in bank-owned life insurance (Note 2)                                                                                             |       | 18,824                  |       | 18,132 |   |
| Prepaid expenses and other assets (Note 13)                                                                                                  |       | 9,334                   |       | 4,799 |   |
| Total assets                                                                                                                                 |       | $                       | 1,442,279  |   | $ | 1,239,069 |   |
| **Liabilities  and Shareholders’ Equity**                                                                                               |       |                    |       |   |   |
| Liabilities:                                                                                                                                 |       |                    |       |   |   |
| Deposits  (Note 10):                                                                                                                         |       |                    |       |   |   |
| Demand deposit accounts                                                                                                                      |       | $                       | 185,089    |   | $ | 167,682 |   |
| NOW accounts                                                                                                                                 |       | 89,594                  |       | 108,159 |   |
| Money market accounts                                                                                                                        |       | 12,122                  |       | 16,489 |   |
| Savings accounts                                                                                                                             |       | 341,115                 |       | 339,836 |   |
| Certificate of deposit accounts                                                                                                              |       | 353,049                 |       | 248,508 |   |
| Total deposits                                                                                                                               |       | 980,969                 |       | 880,674 |   |
| Overnight and short-term borrowings (Note 11)                                                                                                |       | 26,238                  |       | 18,050 |   |
| Wholesale repurchase agreements (Note 11)                                                                                                    |       | 20,000                  |       | — |   |
| Federal Home Loan Bank of Boston borrowings (Note 12)                                                                                        |       | 279,973                 |       | 234,778 |   |
| Subordinated deferrable interest debentures (Note 13)                                                                                        |       | 18,558                  |       | 18,558 |   |
| Other liabilities                                                                                                                            |       | 11,709                  |       | 8,086 |   |
| Total liabilities                                                                                                                            |       | 1,337,447               |       | 1,160,146 |   |
| Commitments  and contingencies (Notes 3, 9, 17 and 21)                                                                                       |       |                    |       |   |   |
| Shareholders’ equity  (Notes 1, 3 and 19):                                                                                              |       |                    |       |   |   |
| Preferred stock, par value $0.01 per share,  authorized 1,000,000 shares: Issued and outstanding: none                                       |       | —                  |       | — |   |
| Common stock, par value $0.01 per share, authorized 11,000,000  shares: Issued and outstanding: 4,719,126 and 4,010,554 shares, respectively |       | 47                      |       | 40 |   |
| Additional paid-in capital                                                                                                                   |       | 65,768                  |       | 42,852 |   |
| Retained earnings                                                                                                                            |       | 42,241                  |       | 35,373 |   |
| Accumulated other comprehensive income (loss), net  (Notes 5 and 6)                                                                          |       | (3,224                  | )          | 658 |   |
| Total shareholders’ equity                                                                                                              |       | 104,832                 |       | 78,923 |   |
| Total liabilities  and shareholders’ equity                                                                                             |       | $                       | 1,442,279  |   | $ | 1,239,069 |   |

 

See accompanying notes to consolidated financial statements.

F-4

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**BANCORP RHODEISLAND, INC.Consolidated Statements of Operations**

| ** **                                                     | ** ** | **Year Ended December 31,**                         | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                     | ** ** | **(In thousands, except per share data)** | ** ** |
| Interest and dividend income:                                  |       |                                                               |       |   |   |   |   |
| Commercial loans  and leases                                   |       | $                                                                  | 28,015     |   | $ | 23,092 |   | $ | 19,494 |   |
| Residential  mortgage loans                                    |       | 15,670                                                             |       | 17,087 |   | 17,677 |   |
| Consumer and other  loans                                      |       | 10,137                                                             |       | 6,933 |   | 5,285 |   |
| Mortgage-backed  securities                                    |       | 9,313                                                              |       | 5,709 |   | 4,886 |   |
| Investment  securities                                         |       | 5,537                                                              |       | 4,452 |   | 3,999 |   |
| Overnight  investments                                         |       | 201                                                                |       | 138 |   | 170 |   |
| Federal Home Loan  Bank of Boston stock dividends              |       | 647                                                                |       | 308 |   | 262 |   |
| Total interest and  dividend income                            |       | 69,520                                                             |       | 57,719 |   | 51,773 |   |
| Interest expense:                                              |       |                                                               |       |   |   |   |   |
| NOW accounts                                                   |       | 590                                                                |       | 1,172 |   | 1,363 |   |
| Money market  accounts                                         |       | 235                                                                |       | 213 |   | 121 |   |
| Savings accounts                                               |       | 4,734                                                              |       | 3,899 |   | 4,043 |   |
| Certificate of  deposit accounts                               |       | 8,962                                                              |       | 5,638 |   | 5,916 |   |
| Overnight and  short-term borrowings                           |       | 652                                                                |       | 157 |   | 140 |   |
| Wholesale  repurchase agreements                               |       | 276                                                                |       | — |   | — |   |
| Federal Home Loan  Bank of Boston borrowings                   |       | 9,898                                                              |       | 7,505 |   | 7,185 |   |
| Subordinated  deferrable interest debentures                   |       | 1,272                                                              |       | 1,041 |   | — |   |
| Company-obligated  mandatorily redeemable capital securities   |       | —                                                             |       | — |   | 685 |   |
| Total interest expense                                         |       | 26,619                                                             |       | 19,625 |   | 19,453 |   |
| Net interest income                                            |       | 42,901                                                             |       | 38,094 |   | 32,320 |   |
| Provision for loan  and lease losses (Note 8)                  |       | 1,474                                                              |       | 900 |   | 1,600 |   |
| Net interest  income after provision for loan and lease losses |       | 41,427                                                             |       | 37,194 |   | 30,720 |   |
| Noninterest income:                                            |       |                                                               |       |   |   |   |   |
| Service charges on  deposit accounts                           |       | 4,561                                                              |       | 4,514 |   | 3,915 |   |
| Loan related fees                                              |       | 1,024                                                              |       | 541 |   | 915 |   |
| Commissions on  nondeposit investment products                 |       | 849                                                                |       | 973 |   | 875 |   |
| Income from  bank-owned life insurance                         |       | 691                                                                |       | 641 |   | 723 |   |
| Commissions on  loans originated for others                    |       | 184                                                                |       | 71 |   | 355 |   |
| Gain/(loss) on  sales of mortgage-backed securities            |       | 181                                                                |       | (260 | ) | 104 |   |
| Gain on sales of  investment securities                        |       | —                                                             |       | 350 |   | 984 |   |
| Gain on sales of  premises and equipment                       |       | —                                                             |       | 535 |   | — |   |
| Other income                                                   |       | 1,784                                                              |       | 1,216 |   | 959 |   |
| Total noninterest  income                                      |       | 9,274                                                              |       | 8,581 |   | 8,830 |   |
| Noninterest expense:                                           |       |                                                               |       |   |   |   |   |
| Salaries and  employee benefits (Note 15)                      |       | 19,476                                                             |       | 17,072 |   | 14,496 |   |
| Occupancy (Note 9)                                             |       | 3,126                                                              |       | 2,669 |   | 2,390 |   |
| Equipment                                                      |       | 1,569                                                              |       | 1,591 |   | 1,496 |   |
| Data processing                                                |       | 2,759                                                              |       | 2,832 |   | 2,777 |   |
| Marketing                                                      |       | 1,584                                                              |       | 1,429 |   | 1,250 |   |
| Professional  services                                         |       | 2,017                                                              |       | 1,965 |   | 1,374 |   |
| Loan servicing                                                 |       | 968                                                                |       | 1,092 |   | 1,034 |   |
| Loan workout and  other real estate owned                      |       | 217                                                                |       | 110 |   | 73 |   |
| Other expenses  (Note 16)                                      |       | 4,576                                                              |       | 4,105 |   | 3,900 |   |
| Total noninterest  expense                                     |       | 36,292                                                             |       | 32,865 |   | 28,790 |   |
| Income before  income taxes                                    |       | 14,409                                                             |       | 12,910 |   | 10,760 |   |
| Income tax expense  (Note 14)                                  |       | 4,840                                                              |       | 4,296 |   | 3,546 |   |
| Net income                                                     |       | $                                                                  | 9,569      |   | $ | 8,614 |   | $ | 7,214 |   |
| Per share data (Notes 2 and 20):                               |       |                                                               |       |   |   |   |   |
| Basic earnings per  common share                               |       | $                                                                  | 2.14       |   | $ | 2.17 |   | $ | 1.89 |   |
| Diluted earnings  per common share                             |       | $                                                                  | 2.04       |   | $ | 2.04 |   | $ | 1.77 |   |
| Average common  shares outstanding—basic                  |       | 4,478,081                                                          |       | 3,975,413 |   | 3,819,232 |   |
| Average common  shares outstanding—diluted                |       | 4,697,134                                                          |       | 4,222,856 |   | 4,085,878 |   |

 

See accompanying notes to consolidated financial statements.

F-5

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**BANCORP RHODE ISLAND, INC.**

**Consolidated Statements of Changes in Shareholders’Equity**

**For Years Ended December 31, 2005, 2004 and 2003**

| ** **                                                                          | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |   |
|-------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|------------|------------|--------|
| ** **                                                                          | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Other**         | ** ** | ** ** | ** ** |   |
| ** **                                                                          | ** ** | ** **                                                         | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |   |
| ** **                                                                          | ** ** | **Preferred**                                                      | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Income/**       | ** ** | ** ** | ** ** |   |
| ** **                                                                          | ** ** | **Stock**                                                          | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **(Loss)**        | ** ** | **Total**  | ** ** |   |
| ** **                                                                          | ** ** | **(In thousands, except per share info)** | ** ** |       |
| Balance at December 31, 2002                                                   |       |                                                               | $          | —     |       |           |       | $            | 38         |              |       |       | $          | 40,134 |   |   |   | $ | 24,002 |   |   |   | $ | 2,253 |   |   | $ | 66,427 |   |
| Net income                                                                          |       |                                                               | —     |       |       |           | —     |         |       |              | —     |       |       |   | 7,214 |   |   |   | — |   |   | 7,214 |   |
| Other  comprehensive income:                                                        |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding gains on securities available for  sale, net of taxes of $(15)   |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   | 31 |   |   | 31 |   |
| Reclassification adjustment, net of taxes of $359                                   |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   | (729 | ) |   | (729 | ) |
| Comprehensive income                                                                |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   |   |   |   | 6,516 |   |
| Exercise of stock options                                                           |       |                                                               | —     |       |       |           | —     |         |       |              | 513        |       |       |   | — |   |   |   | — |   |   | 513 |   |
| Exercise of stock warrants                                                          |       |                                                               | —     |       |       |           | 1          |         |       |              | 662        |       |       |   | — |   |   |   | — |   |   | 663 |   |
| Tax effect of disqualifying disposition of stock  option exercises                  |       |                                                               | —     |       |       |           | —     |         |       |              | 95         |       |       |   | — |   |   |   | — |   |   | 95 |   |
| Common stock issued for incentive stock award,  net                                 |       |                                                               | —     |       |       |           | —     |         |       |              | 35         |       |       |   | — |   |   |   | — |   |   | 35 |   |
| Dividends on common stock ($0.56 per common share)                                  |       |                                                               | —     |       |       |           | —     |         |       |              | —     |       |       |   | (2,142 | ) |   |   | — |   |   | (2,142 | ) |
| Balance at December 31, 2003                                                   |       |                                                               | —     |       |       |           | 39         |         |       |              | 41,439     |       |       |   | 29,074 |   |   |   | 1,555 |   |   | 72,107 |   |
| Net income                                                                          |       |                                                               | —     |       |       |           | —     |         |       |              | —     |       |       |   | 8,614 |   |   |   | — |   |   | 8,614 |   |
| Other  comprehensive income:                                                        |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding losses on securities available for  sale, net of taxes of $432   |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   | (838 | ) |   | (838 | ) |
| Reclassification adjustment, net of taxes of $31                               |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   | (59  | ) |   | (59  | ) |
| Comprehensive income                                                                |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   |   |   |   | 7,717 |   |
| Exercise of stock options                                                           |       |                                                               | —     |       |       |           | —     |         |       |              | 566        |       |       |   | — |   |   |   | — |   |   | 566 |   |
| Exercise of stock warrants                                                          |       |                                                               | —     |       |       |           | 1          |         |       |              | 699        |       |       |   | — |   |   |   | — |   |   | 700 |   |
| Tax effect of disqualifying disposition of stock  option exercises                  |       |                                                               | —     |       |       |           | —     |         |       |              | 113        |       |       |   | — |   |   |   | — |   |   | 113 |   |
| Common stock issued for incentive stock award,  net                                 |       |                                                               | —     |       |       |           | —     |         |       |              | 35         |       |       |   | — |   |   |   | — |   |   | 35 |   |
| Dividends on common stock ($0.58 per common share)                                  |       |                                                               | —     |       |       |           | —     |         |       |              | —     |       |       |   | (2,315 | ) |   |   | — |   |   | (2,315 | ) |
| Balance at December 31, 2004                                                   |       |                                                               | —     |       |       |           | 40         |         |       |              | 42,852     |       |       |   | 35,373 |   |   |   | 658 |   |   | 78,923 |   |
| Net income                                                                          |       |                                                               | —     |       |       |           | —     |         |       |              | —     |       |       |   | 9,569 |   |   |   | — |   |   | 9,569 |   |
| Other  comprehensive income:                                                        |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding losses on securities available for  sale, net of taxes of $2,027 |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   | (3,764  | ) |   | (3,764  | ) |
| Reclassification adjustment, net of taxes of $63                               |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   | (118 | ) |   | (118  | ) |
| Comprehensive income                                                                |       |                                                               |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   |   |   |   | 5,687 |   |
| Proceeds from stock offering                                                        |       |                                                               | —     |       |       |           | 7          |         |       |              | 21,450     |       |       |   |   |   |   |   |   |   |   | 21,457 |   |
| Acquisition of Macrolease                                                           |       |                                                               | —     |       |       |           | —     |         |       |              | 250        |       |       |   |   |   |   |   |   |   |   | 250 |   |
| Exercise of stock options                                                           |       |                                                               | —     |       |       |           | —     |         |       |              | 825        |       |       |   | — |   |   |   | — |   |   | 825 |   |
| Share-based compensation                                                            |       |                                                               | —     |       |       |           | —     |         |       |              | 49         |       |       |   | — |   |   |   | — |   |   | 49 |   |
| Tax effect of disqualifying disposition of stock  option exercises                  |       |                                                               | —     |       |       |           | —     |         |       |              | 309        |       |       |   | — |   |   |   | — |   |   | 309 |   |
| Common stock issued for incentive stock award,  net                                 |       |                                                               | —     |       |       |           | —     |         |       |              | 33         |       |       |   | — |   |   |   | — |   |   | 33 |   |
| Dividends on common stock ($0.60 per common share)                                  |       |                                                               | —     |       |       |           | —     |         |       |              | —     |       |       |   | (2,701 | ) |   |   | — |   |   | (2,701 | ) |
| Balance at  December 31, 2005                                                  |       |                                                               | $          | —     |       |           |       | $            | 47         |              |       |       | $          | 65,768 |   |   |   | $ | 42,241 |   |   |   | $ | (3,224 | ) |   | $ | 104,832 |   |

 

See accompanying notes to consolidated financial statements.

F-6

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**BANCORP RHODEISLAND, INC.**

**ConsolidatedStatements of Cash Flows**

| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                        | ** ** | **(In thousands)**                    | ** ** |
| Cash flows from operating activities:                                             |       |                                       |       |   |   |   |   |
| Net income                                                                        |       | $                                          | 9,569      |   | $ | 8,614 |   | $ | 7,214 |   |
| Adjustment to reconcile net income to net cash  provided by operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and  amortization                                                    |       | 2,680                                      |       | 3,656 |   | 4,604 |   |
| Provision for loan and  lease losses                                              |       | 1,474                                      |       | 900 |   | 1,600 |   |
| Gain on sales of  investment securities                                           |       | —                                     |       | (350 | ) | (984 | ) |
| Loss/(gain) on sales of mortgage-backed  securities                               |       | (181                                       | )          | 260 |   | (104 | ) |
| Gain on sales of premises  and equipment                                          |       | —                                     |       | (535 | ) | — |   |
| Gain on other real estate  owned                                                  |       | (14                                        | )          | (2 | ) | (15 | ) |
| Income from bank-owned  life insurance                                            |       | (691                                       | )          | (641 | ) | (723 | ) |
| Share-based compensation  expense                                                 |       | 82                                         |       | 35 |   | 35 |   |
| (Increase) decrease in  accrued interest receivable                               |       | (1,299                                     | )          | (69 | ) | 586 |   |
| (Increase) in prepaid  expenses and other assets                                  |       | (2,445                                     | )          | (479 | ) | (760 | ) |
| Increase in other  liabilities                                                    |       | 3,623                                      |       | 1,127 |   | 1,725 |   |
| Other, net                                                                        |       | (406                                       | )          | (165 | ) | 83 |   |
| Net cash provided by  operating activities                                        |       | 12,392                                     |       | 12,351 |   | 13,261 |   |
| Cash flows from investing activities:                                             |       |                                       |       |   |   |   |   |
| Origination of:                                                                   |       |                                       |       |   |   |   |   |
| Residential mortgage  loans                                                       |       | (5,009                                     | )          | (9,617 | ) | (28,331 | ) |
| Commercial loans and  leases                                                      |       | (99,490                                    | )          | (109,448 | ) | (106,103 | ) |
| Consumer loans                                                                    |       | (82,426                                    | )          | (91,382 | ) | (66,195 | ) |
| Purchase of:                                                                      |       |                                       |       |   |   |   |   |
| Investment securities  available for sale                                         |       | (63,520                                    | )          | (63,982 | ) | (82,738 | ) |
| Mortgage-backed  securities available for sale                                    |       | (142,287                                   | )          | (107,486 | ) | (82,484 | ) |
| Residential mortgage  loans                                                       |       | (56,512                                    | )          | (55,716 | ) | (251,496 | ) |
| Commercial loans and  leases                                                      |       | (9,243                                     | )          | (3,004 | ) | — |   |
| Federal Home Loan Bank of  Boston stock                                           |       | (2,833                                     | )          | (3,675 | ) | (1,871 | ) |
| Principal payments on:                                                            |       |                                       |       |   |   |   |   |
| Investment securities  available for sale                                         |       | 13,999                                     |       | 46,000 |   | 56,832 |   |
| Mortgage-backed  securities available for sale                                    |       | 50,654                                     |       | 47,759 |   | 104,453 |   |
| Residential mortgage  loans                                                       |       | 71,218                                     |       | 114,813 |   | 210,316 |   |
| Commercial loans and  leases                                                      |       | 72,736                                     |       | 42,052 |   | 54,402 |   |
| Consumer loans                                                                    |       | 42,978                                     |       | 39,417 |   | 41,970 |   |
| Proceeds from sale of  investment securities available for sale                   |       | —                                     |       | 10,946 |   | 29,407 |   |
| Proceeds from sale of  mortgage-backed securities available for sale              |       | 13,754                                     |       | 5,572 |   | 25,164 |   |
| Capital expenditures for  premises and equipment                                  |       | (5,372                                     | )          | (2,165 | ) | (4,603 | ) |
| Proceeds from sale of  premises and equipment                                     |       | —                                     |       | 1,206 |   | — |   |
| Proceeds from disposition  of other real estate owned                             |       | 261                                        |       | 2 |   | 56 |   |
| Purchase of bank-owned  life insurance                                            |       | —                                     |       | (2,000 | ) | — |   |
| Net cash used in  investing activities                                            |       | (201,092                                   | )          | (140,708 | ) | (101,221 | ) |
| Cash flows from financing activities:                                             |       |                                       |       |   |   |   |   |
| Net increase in deposits                                                          |       | 100,295                                    |       | 69,391 |   | 49,372 |   |
| Net increase (decrease)  in overnight and short-term borrowings                   |       | 8,188                                      |       | 4,590 |   | (13,904 | ) |
| Proceeds from long-term  borrowings                                               |       | 333,908                                    |       | 204,155 |   | 111,153 |   |
| Repayment of long-term  borrowings                                                |       | (268,713                                   | )          | (140,981 | ) | (72,932 | ) |
| Proceeds from issuance of  common stock                                           |       | 22,282                                     |       | 1,266 |   | 1,176 |   |
| Tax effect of  disqualifying disposition of stock options                         |       | 309                                        |       | 113 |   | 95 |   |
| Dividends on common stock                                                         |       | (2,701                                     | )          | (2,315 | ) | (2,142 | ) |
| Net cash provided by  financing activities                                        |       | 193,568                                    |       | 136,219 |   | 72,818 |   |
| Net increase  (decrease) in cash and cash equivalents                             |       | 4,868                                      |       | 7,862 |   | (15,142 | ) |
| Cash and cash  equivalents at beginning of year                                   |       | 35,679                                     |       | 27,817 |   | 42,959 |   |
| Cash and cash  equivalents at end of year                                         |       | $                                          | 40,547     |   | $ | 35,679 |   | $ | 27,817 |   |
| Supplementary disclosures:                                                        |       |                                       |       |   |   |   |   |
| Cash paid for interest                                                            |       | $                                          | 25,137     |   | $ | 19,305 |   | $ | 19,604 |   |
| Cash paid for income  taxes                                                       |       | 5,592                                      |       | 4,729 |   | 2,867 |   |
| Non-cash transactions:                                                            |       |                                       |       |   |   |   |   |
| Acquisition of Macrolease                                                         |       | 250                                        |       | — |   | — |   |
| Change in other  comprehensive income, net of taxes                               |       | (3,882                                     | )          | (897 | ) | (698 | ) |
| Change in borrowings resulting from adoption of FIN  46-R                         |       | —                                     |       | — |   | (403 | ) |

 

See accompanying notes to consolidated financial statements.

F-7

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements**

**(1)**          Organization

Bancorp Rhode Island, Inc. (the “Company”), aRhode Island corporation, is the holding company for Bank Rhode Island (the “Bank”).The Company has no significant assets other than the common stock of the Bank. Forthis reason, substantially all of the discussion in these ConsolidatedFinancial Statements and accompanying Notes relates to the operations of theBank and its subsidiaries.

TheBank is a commercial bank chartered as a financial institution in the State ofRhode Island. The Bank pursues a community banking mission and is principallyengaged in providing banking products and services to businesses andindividuals in Rhode Island and nearby areas of Massachusetts. The Bank issubject to competition from a variety of traditional and nontraditionalfinancial service providers both within and outside of Rhode Island. The Bankoffers a wide variety of commercial real estate, business, residential andconsumer loans and leases, deposit products, nondeposit investment products,cash management and other banking products and services designed to meet thefinancial needs of individuals and small- to mid-sized businesses. The Bankalso offers both commercial and consumer on-line banking products and maintainsa web site at http://www.bankri.com.The Company and Bank are subject to the regulations of certain federal andstate agencies and undergo periodic examinations by those regulatoryauthorities. The Bank’s deposits are insured by the Federal Deposit InsuranceCorporation (“FDIC”), subject to regulatory limits. The Bank is also a memberof the Federal Home Loan Bank of Boston (“FHLB”).

**(2)**          Summaryof Significant Accounting Policies

*Basisof Presentation—**The***accountingand reporting policies of the Company conform to U.S. generally accepted accountingprinciples and to prevailing practices within the banking industry. The Companyhas one reportable operating segment. The following is a summary of thesignificant accounting and reporting policies used by management in preparingand presenting the consolidated financial statements.

*Useof Estimates—**In* preparing the consolidatedfinancial statements, management is required to make estimates and assumptionsthat affect the reported amounts of assets and liabilities as of the date ofthe balance sheet and revenues and expenses for the period. Actual resultscould differ from those estimates. Material estimates that are particularlysusceptible to change relate to the determination of the allowance for loan andlease losses and review of goodwill for impairment.

*Principlesof Consolidation—**At* December 31, 2005 and 2004,the consolidated financial statements include the accounts of Bancorp RhodeIsland, Inc., and its wholly-owned subsidiary, Bank Rhode Island, alongwith the Bank’s wholly-owned subsidiaries, BRI Investment Corp. (a Rhode Islandpassive investment company), BRI Realty Corp. (a Rhode Island real estateholding company), Acorn Insurance Agency, Inc. (a licensed insuranceagency) and Macrolease Corporation (an equipment leasing company). The Companyadopted Financial Accounting Standards Board (“FASB”) Interpretation 46-R,“*Consolidationof Variable Interest Entities—Revised*” on December 31,2003, and therefore deconsolidated its statutory trust subsidiaries as of thatdate. All significant intercompany accounts and transactions have beeneliminated in consolidation.

*Cashand Cash Equivalents—**For* purposes of the consolidatedstatements of cash flows, the Company considers cash, due from banks, andovernight investments to be cash equivalents. Cash flows relating to depositsare presented net in the statements of cash flows.

F-8

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

*Investmentand Mortgage-Backed Securities—**Debt* securities areclassified as held to maturity, available for sale, or trading. As of December 31,2005 and 2004, all of the Company’s securities were classified as available forsale. Securities are classified as held to maturity and carried at amortizedcost only if the Company has a positive intent and the ability to hold thesesecurities to maturity. Securities are classified as trading and carried atfair value, with unrealized gains and losses included in earnings, if they arebought and held principally for the purpose of selling in the near term. Securitiesnot classified as either held to maturity or trading are classified asavailable for sale and reported at fair value, with unrealized gains and lossesexcluded from earnings and reported as a separate component of shareholders’equity, net of estimated income taxes.

Premiums and discounts on securities are amortized oraccreted into income by the level-yield method. Declines in the fair values ofsecurities below their cost that are deemed to be other-than-temporary arereflected in earnings in the period that management concludes thatother-than-temporary impairment occurs. The Company uses various indicators indetermining whether a security is other-than-temporarily impaired, includingfor debt securities, when it is probable that the contractual interest andprincipal will not be collected.

Gains and losses on the sale of securities arerecognized at the time of sale on a specific identification basis.

*Loansand Leases Receivable—**Loans* are stated at the principalamount outstanding, net of unamortized premiums, discounts, or deferred feesand costs. Interest income is accrued on a level-yield basis over the life ofthe loan.

Leases which meet the appropriate criteria specifiedin Statement of Financial Accounting Standard (“SFAS”) 13, “*Accounting for Leases*”, are classified as direct financeleases. Direct finance leases are recorded upon acceptance of the equipment bythe customer. Unearned lease income represents the excess of the gross leaseinvestment over the cost of the leased equipment, which is recognized over thelease term at a constant rate of return on the net investment in the lease.

Premiums, discounts, and deferred loan originationfees and costs and lease origination costs are amortized as an adjustment toyield over the life of the related loans. When loans and leases are paid-off,the unamortized portion of premiums, discounts or net fees is recognized intoincome.

Loans on which the accrual of interest has beendiscontinued are designated nonaccrual loans. Accrual of interest income isdiscontinued when concern exists as to the collectibility of principal orinterest, or when a loan becomes over 90 days delinquent. Additionally, when aloan is placed on nonaccrual status, all interest previously accrued but notcollected is reversed against current period income. Loans are removed fromnonaccrual when they become less than 90 days past due and when concern nolonger exists as to the collectibility of principal or interest. Interestcollected on nonaccruing loans is either applied against principal or reportedas income according to management’s judgment as to the collectibility ofprincipal.

Impaired loans are loans for which it is probable thatthe Bank will not be able to collect all amounts due according to thecontractual terms of the loan agreements. Impairment is measured on adiscounted cash flow method, or at the loan’s observable market price, or atthe fair value of the collateral if the loan is collateral dependent. Whenforeclosure is probable, impairment is measured based on the fair value of thecollateral. In addition, the Bank classifies a loan as an in-substanceforeclosure when the Bank is in possession of the collateral prior to actuallyforeclosing.

F-9

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

*Allowancefor Loan and Lease Losses—**The* allowance forloan and lease losses is established for credit losses inherent in the loanportfolio through a charge to earnings. When management believes that thecollectibility of a loan’s principal balance or portions thereof, is unlikely,the principal amount is charged against the allowance. Recoveries on loans thathave been previously charged off are credited to the allowance as received.

Management’s methodology to estimate loss exposureinherent in the portfolio includes an analysis of individual loans  deemed to be impaired, reserve allocationsfor various loan types based on payment status or loss experience and anunallocated allowance that is maintained based on management’s assessment ofmany factors including the growth, composition and quality of the loanportfolio, historical loss experience, industry loss experience, generaleconomic conditions and other pertinent factors. While management evaluatescurrently available information in establishing the allowance for loan losses,future adjustments to the allowance may be necessary if economic conditionsdiffer substantially from the assumptions used in making the evaluations. Inaddition, various regulatory agencies, as an integral part of their examinationprocess, periodically review a financial institution’s allowance for loanlosses. Such agencies may require the financial institution to recognizeadditions to the allowance based on their judgments about information availableto them at the time of their examination.

*OtherReal Estate Owned—**Other* Real Estate Owned (“OREO”)consists of property acquired through foreclosure, real estate acquired throughacceptance of a deed in lieu of foreclosure and loans determined to besubstantively repossessed. Real estate loans that are substantively repossessedinclude only those loans for which the Company has taken possession of thecollateral, but has not completed legal foreclosure proceedings.

OREO, including real estate substantively repossessed,is stated at the lower of cost or fair value, minus estimated costs to sell, atthe date of acquisition or classification to OREO status. Fair value of such assetsis determined based on independent appraisals and other relevant factors. Anywrite-down to fair value at the time of foreclosure is charged to the allowancefor loan losses. A valuation allowance is maintained for known specific andpotential market declines and for estimated selling expenses. Increases to thevaluation allowance, expenses associated with ownership of these properties,and gains and losses from their sale, are reflected in operations as incurred. Realizedgains upon disposal are recognized as income.

Management believes that the net carrying value ofOREO reflects the lower of its cost basis or net fair value. Factors similar tothose considered in the evaluation of the allowance for loan losses, includingregulatory agency requirements, are considered in the evaluation of the netfair value of OREO.

*Premisesand Equipment—**Land* is carried at cost. Premisesand equipment are carried at cost, less accumulated depreciation andamortization. Depreciation and amortization are computed primarily by thestraight-line method over the estimated useful lives of the assets, or theterms of the leases if shorter.

*Impairmentof Long-Lived Assets except Goodwill—**The*Company reviewslong-lived assets, including premises and equipment and other intangible assetsfor impairment at least annually or whenever events or changes in businesscircumstances indicate that the remaining useful life may warrant revision orthat the carrying amount of the long-lived asset may not be fully recoverable. TheCompany performs undiscounted cash flow analyses to determine if impairmentexists. If impairment is determined to exist, any related impairment loss iscalculated based on fair value. Impairment losses on assets to be disposed of,if any, are based on the estimated proceeds to be received, less any costs ofdisposal.

F-10

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

*Goodwill—**Goodwill* representsthe excess of the cost of an acquisition over the fair value of the tangibleand identifiable intangible assets acquired. As a result of the adoption ofSFAS 142, “*Goodwill and Other IntangibleAssets*”, business acquisition goodwill is not amortized over anestimated life, but rather is tested at least annually for impairment usingmarket value comparisons. In the event that the Company was to determine thatits goodwill was impaired, an impairment writedown would be charged againstearnings.

*Bank-OwnedLife Insurance—**Bank-owned* life insurance (“BOLI”)represents life insurance on the lives of certain employees who have providedpositive consent allowing the Bank to be the beneficiary of such policies. TheBank utilizes BOLI as tax-efficient financing for the Bank’s benefitobligations to its employees, including the Bank’s obligations under itsSupplemental Executive Retirement Plans. Since the Bank is the primarybeneficiary of the insurance policies, increases in the cash value of thepolicies, as well as insurance proceeds received, are recorded in othernoninterest income, and are not subject to income taxes. The cash value of thepolicies, less any applicable cash surrender charges, is included in otherassets. The Bank reviews the financial strength of the insurance carriers priorto the purchase of BOLI to ensure minimum credit ratings of at least investmentgrade. The financial strength of the carriers are reviewed at least annuallyand BOLI with any individual carrier is limited to 10% of capital plusreserves.

*SecuritiesSold Under Agreements to Repurchase—**The* Bank enters intosales of securities under agreements to repurchase, with both the Bank’scommercial customers (“retail repurchase agreements”) and financialinstitutions (“wholesale repurchase agreements”). These agreements are treatedas financings, and the obligations to repurchase securities sold are reflectedas a liability in the consolidated balance sheets. Securities pledged ascollateral under agreements to repurchase are reflected as assets in theaccompanying consolidated balance sheets.

*EmployeeBenefits—**The* Bank maintains a Section 401(k) savingsplan for employees of the Bank and its subsidiaries. Under the plan, the Bankmakes a matching contribution of the amount contributed by each participatingemployee, up to 4% of the employee’s yearly salary, subject to Internal RevenueService (“IRS”) limits. The Bank’s contributions are charged against currentoperations in the year made.

The Company has adopted SFAS 123, “*Accountingfor Stock-Based Compensation*”*.*ThisStatement establishes a fair value based method of accounting for stock-basedcompensation plans under which compensation cost is measured at the grant datebased on the value of the award and is recognized over the service period. However,the Statement allows a company to continue to measure compensation cost forsuch plans using the intrinsic value method under Accounting Principles BoardOpinion (“APB”) 25, “*Accounting for Stock Issued to Employees*”*.*Under APB 25, no compensationcost is recorded if, at the grant date, the exercise price of the options isequal to the fair market value of the Company’s common stock. The Company haselected to continue to follow the accounting in APB 25. SFAS 123 requirescompanies that elect to continue to follow the accounting in APB 25 to disclosein the notes to their financial statements various information as if the fairvalue based method of accounting had been applied.

F-11

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Thefollowing table summarizes the differences between the fair value and intrinsicvalue methods of accounting for stock-based compensation:

| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (in  thousands):     |       |                                       |       |   |   |   |   |
| As reported                     |       | $                                          | 9,569      |   | $ | 8,614 |   | $ | 7,214 |   |
| Compensation cost, net of taxes |       | (855                                       | )          | (530 | ) | (189 | ) |
| Pro forma                       |       | $                                          | 8,714      |   | $ | 8,084 |   | $ | 7,025 |   |
| Earnings per common  share:     |       |                                       |       |   |   |   |   |
| Basic:                          |       |                                       |       |   |   |   |   |
| As reported                     |       | $                                          | 2.14       |   | $ | 2.17 |   | $ | 1.89 |   |
| Compensation cost, net of taxes |       | (0.19                                      | )          | (0.14 | ) | (0.05 | ) |
| Pro forma                       |       | $                                          | 1.95       |   | $ | 2.03 |   | $ | 1.84 |   |
| Diluted:                        |       |                                       |       |   |   |   |   |
| As reported                     |       | $                                          | 2.04       |   | $ | 2.04 |   | $ | 1.77 |   |
| Compensation cost, net of taxes |       | (0.18                                      | )          | (0.13 | ) | (0.05 | ) |
| Pro forma                       |       | $                                          | 1.86       |   | $ | 1.91 |   | $ | 1.72 |   |

 

The compensation cost, net of taxes, for year ended2005 reflects the Company’s acceleration of the vesting of all outstandingoptions as of December 30, 2005.

The fair value of each option granted was estimated asof the date of the grant using the Black-Scholes option-pricing model with thefollowing weighted average assumptions: expected life of 7 years; expected volatility of 25% in 2005, 2004 and2003; average risk-free interest rates of 3.90% in 2005, 3.81% in 2004 and3.05% in 2003; and a dividend rate of 1.70% in 2005, 1.66% in 2004 and 2.33% in2003.

*IncomeTaxes—**The* Company recognizes income taxesunder the asset and liability method. Under this method, deferred tax assetsand liabilities are established for the future tax consequences attributable totemporary differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and operatingloss and tax credit carryforwards. Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply to taxable income in the yearsin which those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income during the period that includes the enactment date.

*RevenueRecognition—**Noninterest* income is recognized onthe accrual basis of accounting.

*EarningsPer Share—**Basic* earnings per share (“EPS”)excludes dilution and is computed by dividing income available to commonshareholders by the weighted average number of common shares outstanding forthe period. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock or resulted in the issuance of common stock that then sharein the earnings of the entity.

*ComprehensiveIncome—**Comprehensive* income is defined asall changes to equity except investments by and distributions to shareholders. Netincome is a component of comprehensive income, with all other componentsreferred to in the aggregate as ‘other comprehensive income.’

F-12

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

*SegmentReporting—**An* operating segment is defined asa component of a business for which separate financial information is availablethat is evaluated regularly by the chief operating decision-maker in decidinghow to allocate resources and evaluate performance. The Company’s primarybusiness is banking, which provided substantially all of its total revenues andpre-tax income in 2005 and 2004. Accordingly, disaggregated segment informationis not presented in the notes to the financial statements.

*Guarantees—**FASB* Interpretation (“FIN”)45, “*Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers*”, considers standby letters of credit, excluding commercialletters of credit and other lines of credit, a guarantee of the Bank. The Bankenters into a standby letter of credit to guarantee performance of a customerto a third party. The credit risk involved is represented by the contractualamounts of those instruments. Under the standby letters of credit, the Bank isrequired to make payments to the beneficiary of the standby letters of creditupon request by the beneficiary so long as all performance criteria have beenmet. Most guarantees extend up to one year.

Pledged collateral including cash, accountsreceivable, inventory, property, plant, equipment and real estate supported allstandby letters of credit outstanding at December 31, 2005 and 2004. Thecollateral obtained is determined based on management’s credit evaluation ofthe customer. Should the Bank be required to make payments to the beneficiaryof a letter of credit, repayment to the Bank is required. When cash collateralis present the recourse provisions of the agreements allow the Bank to collectthe cash used to collateralize the agreement. If any other business assets areused as collateral and cash is not available, the Bank creates a loan for thecustomer with the same criteria as its other lending activities. The standbyletters of credit and the fair value of customer guarantees and cash collateralsupporting the standby letters of credit are not reflected on the balancesheet.

*Reclassifications—**Certain* amounts inthe prior years’ financial statements may have been reclassified to conform withthe current year’s presentation.

*RecentAccounting Developments—**In* December 2005,the FASB issued Staff Position (“FSP”) Statement of Position (“SOP”) 94-6-1,“*Terms of Loan Products That May GiveRise to a Concentration of Credit Risk*”. The FSP addresses thecircumstances under which the terms of loan products give rise to aconcentration of credit risk and related disclosures and accountingconsiderations. The FSP is intended to emphasize the requirement to assess theadequacy of disclosures for all lending products and the effect of changes inmarket or economic conditions on the adequacy of those disclosures. FSP SOP 94-6-1is effective for all periods after December 19, 2005. The adoption of thisFSP on December 31, 2005 did not materially impact the Company’s financialstatements.

In November 2005, the FASB issued FSP 115-1,“*The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments*”, whichsuperseded Emerging Issues Task Force Issue (“EITF”) 03-1 andrelated amendments to EITF 03-1. The guidance in FSP 115-1 outlinesa three-step model for identifying investment impairments regarding impairmentmeasurement, other-than-temporary impairment evaluation and recognition ofother-than-temporary impairment losses and subsequent accounting. The FSP alsocarries forward the disclosure requirements of EITF 03-1. FSP 115-1is effective for periods beginning after December 15, 2005. The Companydoes not anticipate FSP 115-1 will materially impact its financialstatements upon adoption on January 1, 2006.

In May 2005, the FASB issued SFAS 154, “*Accounting Changes and Error Corrections*”. This statement replaces APB 20, “*Accounting Changes*”, and SFAS 3, “*Reporting Accounting Changes in Interim Financial*

F-13

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

*Statements*”,and changes the requirements for the accounting for and reporting of a changein accounting principle. SFAS 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15,2005. The Company does not anticipate SFAS 154 will materially impact itsfinancial statements upon adoption on January 1, 2006.

In December 2004, the FASB issued SFAS 123-R,“*Share-BasedPayment*”, which was subsequently revised in April 2005by delaying the implementation date. SFAS 123-R addresses the accountingfor share-based payments to employees and non-employees, including grants ofemployee stock options. Under the new standard, companies will no longer beable to account for share-based compensation transactions using the intrinsicmethod in accordance with APB 25. Instead, companies will be required toaccount for such transactions using a fair-value method and recognize theexpense in the consolidated statements of operations. The Company adopted SFAS123-R on January 1, 2006.

The calculation of compensation cost for share-basedpayment transactions after the effective date of SFAS 123-R may differfrom the calculation of compensation cost presented in the pro formainformation above, but management has not yet quantified such differences. TheCompany expects that the adoption of SFAS 123-R will not have a materialimpact on its overall financial position. However, the Company will be requiredto recognize expense on new stock options granted, which may have a materialimpact on the Company’s statement of operations. The Company had fully vestedall previously granted options as of December 30, 2005.

In December 2003, the American Institute ofCertified Public Accountants (“AICPA”) issued SOP 03-3, “*Accountingfor Certain Loans or Debt Securities Acquired in a Transfer*”. SOP03-3 requires loans acquired through a transfer, such as a businesscombination, where there are differences in expected cash flows and contractualcash flows due in part to credit quality be recognized at their fair value. Theyield that may be accreted is limited to the excess of the investor’s estimateof undiscounted expected principal, interest and other cash flows over theinvestor’s initial investment in the loan. The excess of contractual cash flowsover expected cash flows is not to be recognized as an adjustment of yield,loss accrual or valuation allowance. Valuation allowances cannot be created nor“carried over” in the initial accounting for loans acquired in a transfer ofloans with evidence of deterioration of credit quality since origination. However,valuation allowances for non-impaired loans acquired in a business combinationcan be carried over. This SOP is effective for loans acquired in fiscal yearsbeginning after December 15, 2004. The adoption of SOP 03-3 did nothave a material impact on the Company’s financial statements.

In December 2003, the FASB issued FASBInterpretation (“FIN”) 46-R, “*Consolidationof Variable Interest Entities—Revised*”. FIN 46-R revises FIN46, “*Consolidation of Variable Interest Entities*”which is an interpretation of Accounting Research Bulletin 51, “*ConsolidatedFinancial Statements*”. FIN 46-R provides guidanceregarding the consolidation of special purpose entities, and removeduncertainty over whether FIN 46 required consolidation or deconsolidation ofspecial purpose entities that issue trust preferred securities. FIN 46-Rclarified that even those entities that issue trust preferred securities withcall options must be deconsolidated. FIN 46-R is effective for financialstatements for periods ending after December 15, 2003, with no requirementfor restatement of previous periods. The Company adopted FIN 46-R onDecember 31, 2003, and therefore has deconsolidated its statutory trustsubsidiaries as of that date. Adoption of this Interpretation did not have amaterial impact on the Company’s financial statements.

F-14

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

**(3)**          BusinessCombinations

On March 1, 1996, the Bank acquired certainassets and assumed certain liabilities from Fleet Financial Group, Inc.and other related entities. This acquisition was accounted for utilizing thepurchase method of accounting and generated $17.5 million of goodwill. Thisgoodwill was amortized in the years prior to 2002, resulting in a net balanceof $10.8 million.

On May 1,2005, the Bank acquired certain operating assets from Macrolease InternationalCorporation. This acquisition was accounted for utilizing the purchase methodof accounting and generated $468,000 of goodwill. In connection with thecompletion of the acquisition, the Company issued 6,781 shares of itscommon stock. In addition, 20,342 shares of the Company’s common stock maybe issued over the next four years contingent upon Macrolease reachingspecified performance criteria. Based on the closing price of the Company’scommon stock on May 5, 2005, the 6,781 shares of common stock werevalued at $250,000.

**(4)**          Restrictionson Cash and Due from Banks

The Bank is required tomaintain average reserve balances in a noninterest bearing account with theFederal Reserve Bank based upon a percentage of certain deposits. As of December 31,2005 and 2004, the average daily amount required to be held was $774,000 and$3.3 million, respectively.

**(5)**          InvestmentSecurities Available for Sale

Asummary of investment securities available for sale follows:

| ** **                  | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
|-----------------------------|------------|-------------------------|------------|----------------|------------|------------|------------|
| ** **                  | ** ** | **Cost**                | ** ** | **Gains**      | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                  | ** ** | **(In thousands)** | ** ** |
| At December 31,  2005: |       |                    |       |           |       |       |       |   |   |
| U.S. Agency obligations     |       | $                       | 125,915    |           | $          | —     |       | $ | (1,921 | ) | $ | 123,994 |   |
| Corporate debt securities   |       | 21,214                  |       | 57             |       | (608       | )          | 20,663 |   |
| Trust preferred securities  |       | 6,199                   |       | 108            |       | (5         | )          | 6,302 |   |
| Total                       |       | $                       | 153,328    |           | $          | 165        |       | $ | (2,534 | ) | $ | 150,959 |   |
| At  December 31, 2004: |       |                    |       |           |       |       |       |   |   |
| U.S. Agency obligations     |       | $                       | 74,330     |           | $          | 219        |       | $ | (358 | ) | $ | 74,191 |   |
| Corporate debt securities   |       | 25,388                  |       | 528            |       | (43        | )          | 25,873 |   |
| Trust preferred securities  |       | 4,235                   |       | 301            |       | —     |       | 4,536 |   |
| Total                       |       | $                       | 103,953    |           | $          | 1,048      |       | $ | (401 | ) | $ | 104,600 |   |

 

F-15

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Thefollowing table sets forth certain information regarding temporarily impairedinvestment securities:

| ** **                  | ** ** | **Less than One Year** | ** ** | **One Year or Longer** | ** ** | **Total** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|-----------|------------|
| ** **                  | ** ** | **Fair**                              | ** ** | **Unrealized**                        | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                  | ** ** | **Value**                             | ** ** | **Losses**                            | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| ** **                  | ** ** | **(In thousands)**               | ** ** |
| At December 31,  2005: |       |                                  |       |                                  |       |      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| US Agency obligations       |       | $                                     | 71,938     |                                  |       | $         | (1,077     | ) |   | $ | 52,056 |   |   | $ | (844 | ) |   | $ | 123,994 |   |   | $ | (1,921 | ) |   |
| Corporate debt securities   |       | 10,724                                |       |                                  | (352       | )         |       | 1,799 |   |   | (256 | ) |   | 12,523 |   |   | (608 | ) |   |
| Trust preferred securities  |       | —                                |       |                                  | —     |      |       | 1,995 |   |   | (5 | ) |   | 1,995 |   |   | (5 | ) |   |
| Total                       |       | $                                     | 82,662     |                                  |       | $         | (1,429     | ) |   | $ | 55,850 |   |   | $ | (1,105 | ) |   | $ | 138,512 |   |   | $ | (2,534 | ) |   |
| At  December 31, 2004: |       |                                  |       |                                  |       |      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| US Agency obligations       |       | $                                     | 29,271     |                                  |       | $         | (145       | ) |   | $ | 9,782 |   |   | $ | (213 | ) |   | $ | 39,053 |   |   | $ | (358 | ) |   |
| Corporate debt securities   |       | 2,028                                 |       |                                  | (43        | )         |       | — |   |   | — |   |   | 2,028 |   |   | (43 | ) |   |
| Trust preferred securities  |       | —                                |       |                                  | —     |      |       | — |   |   | — |   |   | — |   |   | — |   |   |
| Total                       |       | $                                     | 31,299     |                                  |       | $         | (188       | ) |   | $ | 9,782 |   |   | $ | (213 | ) |   | $ | 41,081 |   |   | $ | (401 | ) |   |

 

The above securities were deemed to be notother-than-temporarily impaired after considering that substantially all of theabove securities were rated “investment grade” with unrealized losses primarilycaused by market interest rate changes. In addition, the Company is able andintends to fully recover principal and interest for all of the securities.

F-16

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Thefollowing table sets forth the maturities of investment securities availablefor sale and the weighted average yields of such securities*:*

| ** ** | ** ** | ** **                 | ** ** | **After One, But**    | ** ** | **After Five, But**  | ** ** | ** **          | ** ** |
|------------|------------|----------------------------|------------|-----------------------|------------|----------------------|------------|---------------------|------------|
| ** ** | ** ** | **Within One Year**        | ** ** | **Within Five Years** | ** ** | **Within Ten Years** | ** ** | **After Ten Years** | ** ** |
| ** ** | ** ** | ** **                 | ** ** | ** **            | ** ** | **Weighted**         | ** ** | ** **          | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** ** | ** ** | **Amortized**              | ** ** | **Fair**              | ** ** | **Average**          | ** ** | **Amortized**       | ** ** | **Fair** | ** ** | **Average** | ** ** | **Amortized** | ** ** | **Fair** | ** ** | **Average** | ** ** | **Amortized** | ** ** | **Fair** | ** ** | **Average** | ** ** |
| ** ** | ** ** | **Cost**                   | ** ** | **Value**             | ** ** | **Yield**            | ** ** | **Cost**            | ** ** | **Value** | ** ** | **Yield** | ** ** | **Cost** | ** ** | **Value** | ** ** | **Yield** | ** ** | **Cost** | ** ** | **Value** | ** ** | **Yield** | ** ** |
| ** ** | ** ** | **(Dollars in thousands)** | ** ** |

| At December 31, 2005: |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|-----------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

| U.S. Agency obligations    |   |   | $      | 14,992 |   |   | $      | 14,815 |   |   | 2.81   | %      |   |   | $      | 110,923 |   |   | $      | 109,179 |   |   | 4.11   | %      |   |   | $      | — |   |   |   | $      | — |   |   |   | 0.00   | %      |   |   | $      | — |   |   | $ | — |   |   | 0.00 | % |   |
|----------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---|--------|--------|--------|------|---|--------|
| Corporate debt securities  |   |   | 5,047  |   |   | 5,045  |   |   | 4.94   | %      |   |   | 16,167 |   |   | 15,618  |   |   | 4.86   | %       |   |   | — |   |   |   | — |   |   |   | 0.00   | %      |   |   | — |   |   | — |   |   | 0.00   | %      |   |
| Trust preferred securities |   |   | — |   |   | — |   |   | 0.00   | %      |   |   | — |   |   | —  |   |   | 0.00   | %       |   |   | — |   |   |   | — |   |   |   | 0.00   | %      |   |   | 6,199  |   |   | 6,302  |   |   | 7.34   | %      |   |
| Total                      |   |   | $      | 20,039 |   |   | $      | 19,860 |   |   | 3.35   | %      |   |   | $      | 127,090 |   |   | $      | 124,797 |   |   | 4.21   | %      |   |   | $      | — |   |   |   | $      | — |   |   |   | 0.00   | %      |   |   | $      | 6,199  |   |   | $ | 6,302  |   |   | 7.34 | % |   |
| At December 31, 2004:      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Agency obligations    |   |   | $      | — |   |   | $      | — |   |   | 0.00   | %      |   |   | $      | 74,330  |   |   | $      | 74,190  |   |   | 3.66   | %      |   |   | $      | — |   |   |   | $      | — |   |   |   | 0.00   | %      |   |   | $      | — |   |   | $ | — |   |   | 0.00 | % |   |
| Corporate debt securities  |   |   | 4,027  |   |   | 4,073  |   |   | 5.68   | %      |   |   | 21,361 |   |   | 21,801  |   |   | 4.88   | %       |   |   | — |   |   |   | — |   |   |   | 0.00   | %      |   |   | — |   |   | — |   |   | 0.00   | %      |   |
| Trust preferred securities |   |   | — |   |   | — |   |   | 0.00   | %      |   |   | — |   |   | —  |   |   | 0.00   | %       |   |   | — |   |   |   | — |   |   |   | 0.00   | %      |   |   | 4,235  |   |   | 4,536  |   |   | 8.40   | %      |   |
| Total                      |   |   | $      | 4,027  |   |   | $      | 4,073  |   |   | 5.68   | %      |   |   | $      | 95,691  |   |   | $      | 95,991  |   |   | 3.94   | %      |   |   | $      | — |   |   |   | $      | — |   |   |   | 0.00   | %      |   |   | $      | 4,235  |   |   | $ | 4,536  |   |   | 8.40 | % |   |

 

F-17

 

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

The weighted average remaining life of investmentsecurities available for sale at December 31, 2005 and 2004 was 2.5 yearsand 3.8 years, respectively. Included in the weighted average remaining lifecalculation at December 31, 2005 and 2004, were $84.2 million and $53.4million, respectively, of securities that are callable at the discretion of theissuer. These call dates were not utilized in computing the weighted averageremaining life.

Thefollowing table presents the sale of investment securities available for saleand the resulting gains from such sales*:*

| ** **                                        | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                        | ** ** | **(In thousands)**                    | ** ** |
| Amortized cost of  investment securities sold     |       |                                       | $          | — |   |   | $ | 10,596 |   | $ | 28,423 |   |
| Gains realized on  sales of investment securities |       |                                       | —     |   |   | 350 |   | 984 |   |
| Net proceeds from  sales of investment securities |       |                                       | $          | — |   |   | $ | 10,946 |   | $ | 29,407 |   |

 

**(6)**          Mortgage-BackedSecurities Available for Sale

Asummary of mortgage-backed securities available for sale by issuer follows:

| ** **                               | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
|------------------------------------------|------------|-------------------------|------------|----------------|------------|------------|------------|
| ** **                               | ** ** | **Cost**                | ** ** | **Gains**      | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                               | ** ** | **(In thousands)** | ** ** |
| At December 31,  2005:              |       |                    |       |           |       |       |       |   |   |
| Government National Mortgage Association |       | $                       | 23,762     |           | $          | 160        |       | $ | (103 | ) | $ | 23,819 |   |
| Federal National Mortgage Association    |       | 113,252                 |       | 191            |       | (1,062     | )          | 112,381 |   |
| Federal Home Loan Mortgage Corporation   |       | 37,528                  |       | 53             |       | (321       | )          | 37,260 |   |
| Collateralized Mortgage Obligations      |       | 62,907                  |       | —         |       | (1,509     | )          | 61,398 |   |
| Total                                    |       | $                       | 237,449    |           | $          | 404        |       | $ | (2,995 | ) | $ | 234,858 |   |
| At  December 31, 2004:              |       |                    |       |           |       |       |       |   |   |
| Government National Mortgage Association |       | $                       | 31,891     |           | $          | 389        |       | $ | (94 | ) | $ | 32,186 |   |
| Federal National Mortgage Association    |       | 50,394                  |       | 393            |       | (236       | )          | 50,551 |   |
| Federal Home Loan Mortgage Corporation   |       | 14,925                  |       | 300            |       | (3         | )          | 15,222 |   |
| Collateralized Mortgage Obligations      |       | 62,371                  |       | 52             |       | (436       | )          | 61,987 |   |
| Total                                    |       | $                       | 159,581    |           | $          | 1,134      |       | $ | (769 | ) | $ | 159,946 |   |

 

F-18

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Thefollowing table sets forth certain information regarding temporarily impairedinvestment securities:

| ** **                               | ** ** | **Less than One Year** | ** ** | **One Year or Longer** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|-----------|------------|
| ** **                               | ** ** | **Fair**                              | ** ** | **Unrealized**                        | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                               | ** ** | **Value**                             | ** ** | **Losses**                            | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| ** **                               | ** ** | **(In thousands)**               | ** ** |
| At December 31,  2005:              |       |                                  |       |                                  |       |      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Government National Mortgage Association |       | $                                     | 3,913      |                                  |       | $         | (52        | ) |   | $ | 6,953 |   |   | $ | (51 | ) |   | $ | 10,866 |   |   | $ | (103 | ) |   |
| Federal National Mortgage Association    |       | 55,008                                |       |                                  | (676       | )         |       | 16,225 |   |   | (386 | ) |   | 71,233 |   |   | (1,062 | ) |   |
| Federal Home Loan Mortgage Corporation   |       | 32,901                                |       |                                  | (317       | )         |       | 412 |   |   | (4 | ) |   | 33,313 |   |   | (321 | ) |   |
| Collateralized Mortgage Obligations      |       | 29,623                                |       |                                  | (555       | )         |       | 31,775 |   |   | (954 | ) |   | 61,398 |   |   | (1,509 | ) |   |
| Total                                    |       | $                                     | 121,445    |                                  |       | $         | (1,600     | ) |   | $ | 55,365 |   |   | $ | (1,395 | ) |   | $ | 176,810 |   |   | $ | (2,995 | ) |   |
| At December 31,  2004:              |       |                                  |       |                                  |       |      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Government National Mortgage Association |       | $                                     | 4,756      |                                  |       | $         | (94        | ) |   | $ | — |   |   | $ | — |   |   | $ | 4,756 |   |   | $ | (94 | ) |   |
| Federal National Mortgage Association    |       | 14,993                                |       |                                  | (225       | )         |       | 2,052 |   |   | (11 | ) |   | 17,045 |   |   | (236 | ) |   |
| Federal Home Loan Mortgage Corporation   |       | —                                |       |                                  | —     |      |       | 582 |   |   | (3 | ) |   | 582 |   |   | (3 | ) |   |
| Collateralized Mortgage Obligations      |       | 49,529                                |       |                                  | (431       | )         |       | 1,048 |   |   | (5 | ) |   | 50,577 |   |   | (436 | ) |   |
| Total                                    |       | $                                     | 69,278     |                                  |       | $         | (750       | ) |   | $ | 3,682 |   |   | $ | (19 | ) |   | $ | 72,960 |   |   | $ | (769 | ) |   |

 

The above securities were deemed to be notother-than-temporarily impaired after considering that all of the abovesecurities were rated “investment grade” with unrealized losses caused bymarket interest rate changes. In addition, the Company is able and intends to fullyrecover principal and interest for all of the securities.

F-19

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Thefollowing table sets forth the maturities of mortgage-backed securitiesavailable for sale and the weighted average yields of such securities*:*

| ** **                                  | ** ** | **After Five, But Within Ten Years** | ** ** | **After Ten Years** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                  | ** ** | ** **                                                    | ** ** | ** **                    | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                  | ** ** | **Amortized**                                                 | ** ** | **Fair**                      | ** ** | **Average** | ** ** | **Amortized** | ** ** | **Fair** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | **Cost**                                                      | ** ** | **Value**                     | ** ** | **Yield** | ** ** | **Cost** | ** ** | **Value** | ** ** | **Yield** | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)**                          | ** ** |
| At December 31,  2005:                 |       |                                                          |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Government National Mortgage Association    |       |                                                          | $          | —                        |       |   | $ | — |   |   | 0.00 | % |   |   | $ | 23,762 |   |   | $ | 23,819 |   |   | 4.32 | % |   |
| Federal National Mortgage Association  |       |                                                          | 18,939     |                          |       | 18,613 |   |   | 4.55 | % |   |   | 94,313 |   |   | 93,767 |   |   | 4.69 | % |   |
| Federal Home Loan Mortgage Corporation      |       |                                                          | —     |                          |       | — |   |   | 0.00 | % |   |   | 37,528 |   |   | 37,261 |   |   | 4.65 | % |   |
| Collateralized Mortgage Obligations         |       |                                                          | —     |                          |       | — |   |   | 0.00 | % |   |   | 62,907 |   |   | 61,398 |   |   | 4.52 | % |   |
| Total                                       |       |                                                          | $          | 18,939                        |       |   | $ | 18,613 |   |   | 4.55 | % |   |   | $ | 218,510 |   |   | $ | 216,245 |   |   | 4.59 | % |   |
| At December 31,  2004:                 |       |                                                          |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Government National Mortgage Association    |       |                                                          | $          | —                        |       |   | $ | — |   |   | 0.00 | % |   |   | $ | 31,891 |   |   | $ | 32,186 |   |   | 4.26 | % |   |
| Federal National Mortgage Association  |       |                                                          | —     |                          |       | — |   |   | 0.00 | % |   |   | 50,394 |   |   | 50,551 |   |   | 4.41 | % |   |
| Federal Home Loan Mortgage Corporation      |       |                                                          | —     |                          |       | — |   |   | 0.00 | % |   |   | 14,925 |   |   | 15,222 |   |   | 5.05 | % |   |
| Collateralized Mortgage Obligations         |       |                                                          | —     |                          |       | — |   |   | 0.00 | % |   |   | 62,371 |   |   | 61,987 |   |   | 4.41 | % |   |
| Total                                       |       |                                                          | $          | —                        |       |   | $ | — |   |   | 0.00 | % |   |   | $ | 159,581 |   |   | $ | 159,946 |   |   | 4.44 | % |   |

 

Maturities on mortgage-backed securities are based oncontractual maturities and do not take into consideration scheduledamortization or prepayments. Actual maturities will differ from contractualmaturities due to scheduled amortization and prepayments. The weighted averageremaining contractual term of mortgage-backed securities available for sale atDecember 31, 2005 and 2004 was 20.2 years and 20.9 years, respectively.

Thefollowing table presents the sale of mortgage-backed securities available forsale and the resulting gains from such sales*:*

| ** **                                                   | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**                    | ** ** |
| Amortized cost of  mortgage-backed securities sold           |       | $                                          | 13,573     |   | $ | 5,832 |   | $ | 25,060 |   |
| Gain/(Loss)  realized on sales of mortgage-backed securities |       | 181                                        |       | (260 | ) | 104 |   |
| Net proceeds from sales of mortgage-backed  securities       |       | $                                          | 13,754     |   | $ | 5,572 |   | $ | 25,164 |   |

 

F-20

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

**(7)**          Loansand Leases Receivable

Thefollowing is a summary of loans and leases receivable:

| ** **                                    | ** ** | **December 31,**   | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|
| ** **                                    | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | **(In thousands)** | ** ** |
| Commercial loans and  leases:                 |       |                    |       |   |   |
| Commercial real estate—owner occupied    |       | $                       | 112,987    |   | $ | 93,027 |   |
| Commercial real estate—nonowner occupied |       | 95,779                  |       | 90,716 |   |
| Commercial and industrial                     |       | 73,620                  |       | 78,918 |   |
| Small business                                |       | 38,641                  |       | 37,820 |   |
| Multi-family                                  |       | 33,725                  |       | 32,415 |   |
| Construction                                  |       | 37,772                  |       | 32,319 |   |
| Leases and other                              |       | 49,342                  |       | 38,116 |   |
| Subtotal                                      |       | 441,866                 |       | 403,331 |   |
| Discount on leases acquired                   |       | (3,366                  | )          | (226 | ) |
| Net deferred loan origination fees            |       | (191                    | )          | (335 | ) |
| Total commercial loans and leases             |       | 438,309                 |       | 402,770 |   |
| Residential mortgage  loans:                  |       |                    |       |   |   |
| One- to four-family adjustable rate           |       | 202,223                 |       | 199,031 |   |
| One- to four-family fixed rate                |       | 101,598                 |       | 115,350 |   |
| Subtotal                                      |       | 303,821                 |       | 314,381 |   |
| Premium on loans  acquired                    |       | 2,257                   |       | 1,826 |   |
| Net deferred loan  origination fees           |       | (62                     | )          | (72 | ) |
| Total residential mortgage loans              |       | 306,016                 |       | 316,135 |   |
| Consumer and other  loans:                    |       |                    |       |   |   |
| Home equity—term loans                   |       | 134,932                 |       | 110,542 |   |
| Home equity—lines of credit              |       | 67,959                  |       | 53,551 |   |
| Automobile                                    |       | 157                     |       | 488 |   |
| Installment                                   |       | 365                     |       | 491 |   |
| Savings secured                               |       | 358                     |       | 439 |   |
| Unsecured and other                           |       | 1,271                   |       | 801 |   |
| Subtotal                                      |       | 205,042                 |       | 166,312 |   |
| Premium on loans acquired                     |       | 2                       |       | 15 |   |
| Net deferred loan origination costs           |       | 1,437                   |       | 1,069 |   |
| Total consumer and other loans                |       | 206,481                 |       | 167,396 |   |
| Total loans and  leases receivable            |       | $                       | 950,806    |   | $ | 886,301 |   |

 

The Bank’s commercial and consumer lending activitiesare conducted principally in the State of Rhode Island and, to a lesser extent,in nearby areas of Massachusetts. The Bank’s recently acquired subsidiary,Macrolease, is based in Long Island, NY, with borrowers located throughout theUnited States. The Bank originates commercial real estate loans, commercial andindustrial loans, multi-family residential loans, equipment leases, residentialmortgage loans and consumer loans (principally home equity loans and lines ofcredit) for its portfolio.

F-21

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

The Bank purchases one- to four-family residentialmortgage loans and commercial leases from third party originators. These loansand leases may have been originated from areas outside of New England. Mostloans made by the Bank are secured by borrowers’ personal or business assets. TheBank considers a concentration of credit to a particular industry to exist whenthe aggregate credit exposure to a borrower or group of borrowers in thatindustry exceeds 25% of the Bank’s capital plus reserves. At December 31,2005, no concentrations of credit to a particular industry existed as definedby these parameters. The ability of the Bank’s residential and consumerborrowers to honor their repayment commitments is generally dependent on thelevel of overall economic activity within the area they reside.

Commercial borrowers’ ability to repay is generallydependent upon the general health of the economy and in cases of real estateloans, the real estate sector in particular. Accordingly, the ultimatecollectibility of a substantial portion of the Bank’s loan portfolio issusceptible to changing conditions in the Rhode Island economy in particular,and the New England and Northeast and national economies, in general.

The Bank’s lending limit to any single borrowingrelationship is limited by law to approximately $17.0 million. At December 31,2005, the Bank had no outstanding commitments to any single borrowingrelationship that were in excess of $7.0 million.

At December 31, 2005, the risk elements containedwithin the loan portfolio were centered in $415,000 of nonaccrual loans. Therewere $300,000 of loans past due 60 to 89 days at December 31, 2005. At December 31,2005, the Bank had no commitments to lend additional funds to borrowers whoseloans were on nonaccrual. This compares to $733,000 of nonaccrual loans andless than $1,000 of loans past due 60 to 89 days as of December 31, 2004. Includedin nonaccrual loans as of December 31, 2005, 2004 and 2003, were $141,000,$671,000 and $2.1 million of impaired loans, respectively. At December 31,2005, specific reserves of $71,000 were maintained against impaired loans comparedto $170,000 at December 31, 2004. At December 31, 2003, no specificreserves were necessary in conjunction with impaired loans. The average balanceof impaired loans was $741,000 during 2005, $1.2 million during 2004 and$2.9 million during 2003.

Thereduction in interest income associated with nonaccrual loans was as follows:

| ** **                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                | ** ** | **(In thousands)**                    | ** ** |
| Income in  accordance with original terms |       | $                                          | 36         |   | $ | 63 |   | $ | 343 |   |
| Income recognized                         |       | (13                                        | )          | (34 | ) | (45 | ) |
| Foregone interest  income                 |       | $                                          | 23         |   | $ | 29 |   | $ | 298 |   |

 

F-22

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Loansoutstanding to executive officers and directors of the Company, including theirimmediate families and affiliated companies (“related parties”), are made inthe ordinary course of business under normal credit terms, including interestrates and collateral, prevailing at the time of origination for comparabletransactions with other persons, and do not represent more than normal creditrisk. These loans comply with the provisions of Regulation O under the FederalReserve Act and, accordingly, are permissible under Section 402 of theSarbanes-Oxley Act of 2002. An analysis of the activity of these loans is asfollows:

| ** **                    | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|
| ** **                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                    | ** ** | **(In thousands)**                    | ** ** |
| Balance at  beginning of year |       | $                                          | 5,019      |   | $ | 10,188 |   |
| Additions                     |       | 10,854                                     |       | 2,950 |   |
| Repayments                    |       | (10,312                                    | )          | (8,119 | ) |
| Balance at end of year        |       | $                                          | 5,561      |   | $ | 5,019 |   |

 

**(8) Allowance forLoan and Lease Losses**

Ananalysis of the activity in the allowance for loan and lease losses is asfollows:

| ** **                                                  | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                  | ** ** | **(In thousands)**                    | ** ** |
| Balance at  beginning of year                               |       | $                                          | 11,906     |   | $ | 11,078 |   | $ | 10,096 |   |
| Provision for loan and lease losses charged against  income |       | 1,474                                      |       | 900 |   | 1,600 |   |
| Loans charged-off                                           |       | (1,274                                     | )          | (150 | ) | (646 | ) |
| Recoveries of loans previously charged-off                  |       | 62                                         |       | 78 |   | 28 |   |
| Balance at end of year                                      |       | $                                          | 12,168     |   | $ | 11,906 |   | $ | 11,078 |   |

 

Thefollowing table represents the allocation of the allowance for loan and leaselosses as of the dates indicated:

| ** **                  | ** ** | **December 31,**   | ** ** |
|-----------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                  | ** ** | **(In thousands)** | ** ** |
| Loan category:              |       |                    |       |   |   |
| Commercial loans and leases |       | $                       | 7,240      |   | $ | 6,503 |   |
| Residential mortgage loans  |       | 1,653                   |       | 1,644 |   |
| Consumer and other loans    |       | 2,159                   |       | 1,745 |   |
| Unallocated                 |       | 1,116                   |       | 2,014 |   |
| Total                       |       | $                       | 12,168     |   | $ | 11,906 |   |

 

F-23

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

 

**(9) Premises and Equipment**

Premisesand equipment consisted of the following:

| ** **                                      | ** ** | **December 31,**   | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(In thousands)** | ** ** |
| Land                                            |       | $                       | 2,620      |   | $ | 890 |   |
| Office buildings  and improvements              |       | 2,631                   |       | 2,266 |   |
| Leasehold  improvements                         |       | 8,692                   |       | 6,446 |   |
| Data processing  equipment and software         |       | 6,429                   |       | 5,662 |   |
| Furniture,  fixtures and other equipment        |       | 5,463                   |       | 5,276 |   |
| Subtotal                                        |       | 25,835                  |       | 20,540 |   |
| Less accumulated  depreciation and amortization |       | (10,977                 | )          | (8,683 | ) |
| Total premises  and equipment                   |       | $                       | 14,858     |   | $ | 11,857 |   |

 

The Company utilizes a useful life of 40 years forbuildings and 15 years for building improvements. Leasehold improvements areamortized over their respective lease terms. Data processing equipment andsoftware’s useful life varies but is primarily three years. Furniture, fixturesand other equipment’s useful life varies but is primarily five years. Depreciationexpense totaled $2.4 million, $2.3 million and $1.8 million for the years endedDecember 31, 2005, 2004 and 2003, respectively.

During November 2004, the Bank sold its SouthBroadway, East Providence, RI office building, leasing back its branch officespace, for a gross selling price of $1.2 million. This transaction generated atotal gain of $755,000 from the sale of the premises, $511,000 of which wasrecognized in 2004’s earnings and $244,000 was deferred, to be recognized overthe term of the branch office space lease.

Rentexpense for the years ended December 31, 2005, 2004 and 2003 was $1.3million, $1.0 million and $1.0 million, respectively. In connection with theacquisition of branches from Fleet Financial Group, Inc. and relatedentities, the Bank assumed the liability for lease payments on seven bankingoffices previously occupied by Shawmut Bank Connecticut, N.A. The Bank hasrenegotiated some of these leases and has also entered into agreements to leaseadditional space. Under the terms of these noncancellable operating leases, theBank is currently obligated to minimum annual rents as follows:

| ** ** | ** ** | **Minimum**             | ** ** |
|------------|------------|-------------------------|------------|
| ** ** | ** ** | **Lease**               | ** ** |
| ** ** | ** ** | **Payments**            | ** ** |
| ** ** | ** ** | **(In thousands)** | ** ** |
| 2006       |       |                    | $          | 1,314 |   |   |
| 2007       |       |                    | 1,471      |   |   |
| 2008       |       |                    | 1,356      |   |   |
| 2009       |       |                    | 995        |   |   |
| 2010       |       |                    | 692        |   |   |
| Thereafter |       |                    | 7,640      |   |   |
|       |       |                    | $          | 13,468 |   |   |

 

F-24

----

**BANCORP RHODE ISLAND, INC.  Notes to Consolidated Financial Statements (Continued)**

**(10) Deposits**

Certificateof deposit accounts had the following schedule of maturities:

| ** **                              | ** ** | **December 31,**   | ** ** |
|-----------------------------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                              | ** ** | **(In thousands)** | ** ** |
| 1 year or less  remaining               |       | $                       | 293,053    |   | $ | 135,469 |   |
| More than 1 year  to 2 years remaining  |       | 36,378                  |       | 78,152 |   |
| More than 2 years  to 3 years remaining |       | 6,071                   |       | 16,930 |   |
| More than 3 years  to 4 years remaining |       | 9,020                   |       | 6,897 |   |
| More than 4 years  remaining            |       | 8,527                   |       | 11,060 |   |
| Total                                   |       | $                       | 353,049    |   | $ | 248,508 |   |

 

At December 31, 2005, 2004 and 2003, certificateof deposit accounts with balances $100,000 or more aggregated $98.0 million,$52.4 million and $31.0 million, respectively.

**(11)**   Short-TermBorrowings and Repurchase Agreements

Informationconcerning short-term borrowings and repurchase agreements are as follows:

| ** **                       | ** ** | **December 31,**   | ** ** |
|----------------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                       | ** ** | **(In thousands)** | ** ** |
| Treasury tax and  loan notes     |       | $                       | 2,387      |   | $ | 1,759 |   |
| FHLB Ideal Way  advances         |       | —                  |       | — |   |
| Retail repurchase  agreements    |       | 23,851                  |       | 16,291 |   |
| Wholesale  repurchase agreements |       | 20,000                  |       | — |   |
| Total                            |       | $                       | 46,238     |   | $ | 18,050 |   |

 

TheBank utilizes the Note Option for remitting Treasury Tax and Loan payments tothe Federal Reserve Bank. Under this option the U.S. Treasury invests inobligations of the Bank, as evidenced by open-ended interest-bearing notes. Thesenotes are collateralized by U.S. Agency securities owned by the Bank. Informationconcerning these treasury tax and loan notes is as follows:

| ** **                                      | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                      | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(Dollars in thousands)**   | ** ** |
| Outstanding at  end of year                     |       | $                                      | 2,387      |   | $ | 1,759 |   |
| Outstanding  collateralized by securities with: |       |                                   |       |   |   |
| Par value                                       |       | 5,000                                  |       | 5,000 |   |
| Market value                                    |       | 4,897                                  |       | 4,907 |   |
| Average  outstanding for the year               |       | 739                                    |       | 697 |   |
| Maximum  outstanding at any month end           |       | 2,387                                  |       | 1,759 |   |
| Weighted average  rate at end of year           |       | 3.95                                   | %          | 1.87 | % |
| Weighted average rate  paid for the year        |       | 2.98                                   | %          | 1.17 | % |
|                                                 |            |                                        |            |  |  |  |  |

 

The Bank has a short-term line of credit with the FHLB.All borrowings from the FHLB are secured by the Bank’s stock in the FHLB and ablanket lien on “qualified collateral” defined principally as 90% of 

F-25

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**BANCORP RHODE ISLAND, INC.  Notes to Consolidated Financial Statements (Continued)**

the market value of U.S.Government and Agency obligations and 75% of the carrying value of certainresidential mortgage loans. Unused borrowing capacity under this line at December 31,2005, 2004 and 2003 was $25.0 million, $15.0 million and $14.7 million,respectively.

Informationconcerning this short-term line of credit is as follows:

| ** **                               | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|
| ** **                               | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(Dollars in thousands)**   | ** ** |
| Outstanding at  end of year              |       | $                                      | —     |   | $ | — |   |
| Maturity date                            |       | NA                                     |       | NA |   |
| Average  outstanding for the year        |       | $                                      | 295        |   | $ | 947 |   |
| Maximum  outstanding at any month end    |       | 773                                    |       | — |   |
| Weighted average  rate at end of year    |       | NA                                     |       | NA |   |
| Weighted average rate  paid for the year |       | 3.36                                   | %          | 1.92 | % |

 

The Bank utilizes retail repurchase agreements inconnection with a cash management product that the Bank offers its commercialcustomers and wholesale repurchase agreements with financial institutions. Salesof repurchase agreements are treated as financings. The obligations torepurchase the identical securities that were sold are reflected as liabilitiesand the securities remain in the asset accounts. All of these agreements arecollateralized by U.S. Agency securities owned by the Bank. The securitiesunderlying the agreements were held by the Bank in a special custody accountand remained under the Bank’s control.

Informationconcerning retail repurchase agreements is as follows:

| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(Dollars in thousands)**       | ** ** |
| Outstanding at  end of year                     |       | $                                          | 23,851     |   | $ | 16,291 |   |
| Maturity date                                   |       | 1/3/06                                     |       | 1/3/05 |   |
| Outstanding  collateralized by securities with: |       |                                       |       |   |   |
| Par value                                       |       | $                                          | 55,769     |   | $ | 21,168 |   |
| Market value                                    |       | 55,609                                     |       | 21,198 |   |
| Average  outstanding for the year               |       | 22,280                                     |       | 15,084 |   |
| Maximum  outstanding at any month end           |       | 23,851                                     |       | 21,480 |   |
| Weighted average  rate at end of year           |       | 3.69                                       | %          | 1.70 | % |
| Weighted average rate  paid for the year        |       | 2.80                                       | %          | 0.87 | % |

 

F-26

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**BANCORP RHODE ISLAND, INC.  Notes to Consolidated Financial Statements (Continued)**

Informationconcerning wholesale repurchase agreements is as follows:

| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                   | ** ** | **   2004   ** | ** ** |
| ** **                                      | ** ** | **(Dollars in thousands)**       | ** ** |
| Outstanding at  end of year                     |       | $                                          | 20,000     |   |   | $ | — |   |   |
| Maturity date                                   |       | 3/2010 and  11/2010                        |       |   | NA |   |   |
| Outstanding  collateralized by securities with: |       |                                       |       |   |   |   |   |
| Par value                                       |       | $                                          | 22,076     |   |   | $ | NA |   |   |
| Market value                                    |       | 21,946                                     |       |   | NA |   |   |
| Average  outstanding for the year               |       | 9,417                                      |       |   | — |   |   |
| Maximum  outstanding at any month end           |       | 20,000                                     |       |   | — |   |   |
| Weighted average  rate at end of year           |       | 3.45                                       | %          |   | NA |   |   |
| Weighted average rate  paid for the year        |       | 2.93                                       | %          |   | NA |   |   |

 

Additionally,at December 31, 2005, the Bank had a $3.0 million line of credit with acorrespondent bank to facilitate the issuance of letters of credit by the Bankand the conducting of foreign exchange transactions for the Bank’s customers. Sinceinception, there have been no outstanding balances under this line of credit.

**(12)**   FederalHome Loan Bank of Boston Borrowings

FHLBborrowings are comprised of the following:

| ** **               | ** ** | **December 31, 2005**      | ** ** | **December 31, 2004** | ** ** |
|--------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **Scheduled**                        | ** ** | **First**                       | ** ** | **Weighted** | ** ** | **Scheduled** | ** ** | **First** | ** ** | **Weighted** | ** ** |
| ** **               | ** ** | **Final**                            | ** ** | **Call**                        | ** ** | **Average** | ** ** | **Final** | ** ** | **Call** | ** ** | **Average** | ** ** |
| ** **               | ** ** | **Maturity**                         | ** ** | **Date(1)**                     | ** ** | **Rate(2)** | ** ** | **Maturity** | ** ** | **Date(1)** | ** ** | **Rate(2)** | ** ** |
| ** **               | ** ** | **(Dollars in thousands)** | ** ** |
| Within 1 year            |       | $                                    | 79,250     |                            | $          | 196,250 |   |   | 3.79 | % |   | $ | 97,000 |   | $ | 124,000 |   |   | 2.58 | % |   |
| Over 1 year to 2  years  |       | 38,880                               |       | 38,880                          |       |   | 3.60 | % |   | 29,250 |   | 59,250 |   |   | 3.50 | % |   |
| Over 2 years to 3  years |       | 30,917                               |       | 30,917                          |       |   | 4.16 | % |   | 41,003 |   | 41,003 |   |   | 3.59 | % |   |
| Over 3 years to 5  years |       | 63,702                               |       | 13,702                          |       |   | 3.87 | % |   | 30,293 |   | 10,293 |   |   | 3.59 | % |   |
| Over 5 years             |       | 67,224                               |       | 224                             |       |   | 4.46 | % |   | 37,232 |   | 232 |   |   | 4.98 | % |   |
| Total                    |       | $                                    | 279,973    |                            | $          | 279,973 |   |   | 3.98 | % |   | $ | 234,778 |   | $ | 234,778 |   |   | 3.38 | % |   |

----

(1)          Callable FHLB advancesof $117 million are shown in the respective periods assuming that the callabledebt is redeemed at the next call date while all other advances are shown inthe periods corresponding to their scheduled maturity date.

(2)          Weighted average ratebased on scheduled maturity dates.

Allborrowings from the FHLB are secured by the Bank’s stock in the FHLB and ablanket lien on “qualified collateral” defined principally as 90% of the marketvalue of U.S. Government and Agency obligations and 75% of the carrying valueof certain residential mortgage loans. Unused term borrowing capacity with theFHLB at December 31, 2005, 2004 and 2003 was $26.9 million, $106.8 millionand $133.8 million, respectively. As one requirement of its borrowings, theBank is required to invest in the common stock of the FHLB in an amount atleast equal to five percent of its outstanding borrowings from the 

F-27

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**BANCORP RHODE ISLAND, INC.  Notes to Consolidated Financial Statements (Continued)**

FHLB. As and when such stock is redeemed, the Bankwould receive from the FHLB an amount equal to the par value of the stock. Asof December 31, 2005, the Bank’s FHLB stock holdings, recorded at cost,were $16.1 million.

**(13)**   Company-ObligatedMandatorily Redeemable Capital Securities and Subordinated Deferrable InterestDebentures

On January 23, 2001, the Company sponsored thecreation of BRI Statutory Trust I (the “Trust I”), a Connecticut statutorytrust. The Company is the owner of all of the common securities of Trust I. On February 22,2001, Trust I issued $3.0 million of its 10.20% Company-Obligated MandatorilyRedeemable Capital Securities (“Capital Securities”) through a pooled trustpreferred securities offering. The proceeds from this issuance, along with theCompany’s $93,000 capital contribution for Trust I’s common securities (whichis included in Prepaid expenses and other assets), were used to acquire $3.1million of the Company’s 10.20% Subordinated Deferrable Interest Debentures (“JuniorSubordinated Notes”) due February 22, 2031, and constitute the primaryasset of Trust I. The Company has, through the Declaration of Trust, theGuarantee Agreement, the Notes and the related Indenture, taken together, fullyirrevocably and unconditionally guaranteed all of Trust I’s obligations underthe Capital Securities, to the extent Trust I has funds availabletherefor.

On June 4, 2002, the Company sponsored thecreation of BRI Statutory Trust II (the “Trust II”), a Connecticut statutorytrust. The Company is the owner of all of the common securities of Trust II. OnJune 26, 2002, Trust II issued $5.0 million of its floating rate(quarterly reset to 3 month LIBOR plus 3.45%) Capital Securities through apooled trust preferred securities offering. At December 31, 2005, the rateof the Capital Securities was 7.97%. The proceeds from this issuance, alongwith the Company’s $155,000 capital contribution for Trust II’s commonsecurities (which is included in Prepaid expenses and other assets), were usedto acquire $5.2 million of the Company’s floating rate (quarterly reset to 3month LIBOR plus 3.45%) Junior Subordinated Notes due June 26, 2032, andconstitute the primary asset of Trust II. The Company has, through theDeclaration of Trust, the Guarantee Agreement, the Notes and the relatedIndenture, taken together, fully irrevocably and unconditionally guaranteed allof Trust II’s obligations under the Capital Securities, to the extent Trust IIhas funds available therefor.

On June 5, 2003, the Company sponsored thecreation of BRI Statutory Trust III (the “Trust III”), a Connecticut statutorytrust. The Company is the owner of all of the common securities of Trust III. OnJune 26, 2003, Trust III issued $5.0 million of its 5.55% (quarterly resetto 3 month LIBOR plus 3.10% beginning June 26, 2008) Capital Securitiesthrough a pooled trust preferred securities offering. The proceeds from thisissuance, along with the Company’s $155,000 capital contribution for Trust III’scommon securities (which is included in Prepaid expenses and other assets),were used to acquire $5.2 million of the Company’s 5.55% (quarterly reset to 3month LIBOR plus 3.10% beginning June 26, 2008) Junior Subordinated Notesdue June 26, 2033, and constitute the primary asset of Trust III. TheCompany has, through the Declaration of Trust, the Guarantee Agreement, theNotes and the related Indenture, taken together, fully irrevocably andunconditionally guaranteed all of Trust III’s obligations under the CapitalSecurities, to the extent Trust III has funds available therefor.

On February 24, 2004, the Company sponsored thecreation of BRI Statutory Trust IV (the “Trust IV”), a Connecticutstatutory trust. The Company is the owner of all of the common securities ofTrust IV. On March 17, 2004, Trust IV issued $5.0 million of itsfloating rate (quarterly reset to 3 month LIBOR plus 2.79%) Capital Securitiesthrough a pooled trust preferred securities offering. At December 31,2005, the rate of the Capital Securities was 7.29%. The proceeds from thisissuance, along 

F-28

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**BANCORP RHODE ISLAND, INC.  Notes to Consolidated Financial Statements (Continued)**

with the Company’s$155,000 capital contribution for Trust IV’s common securities (which isincluded in Prepaid expenses and other assets), were used to acquire $5.2million of the Company’s floating rate (quarterly reset to 3 month LIBOR plus2.79%) Junior Subordinated Notes due March 17, 2034, and constitute theprimary asset of Trust IV. The Company has, through the Declaration of Trust,the Guarantee Agreement, the Notes and the related Indenture, taken together,fully irrevocably and unconditionally guaranteed all of Trust IV’s obligationsunder the Capital Securities, to the extent Trust IV has funds availabletherefor.

The Company adopted FASBInterpretation 46-R, “*Consolidation of Variable Interest Entities—Revised*”on December 31, 2003, and therefore has deconsolidated its statutory trustsubsidiaries as of that date. As of December 31, 2005, the Company’sinvestments in its statutory trust subsidiaries aggregated $623,000 and areincluded in other assets.

**(14) Income Taxes**

Thecomponents of income tax expense are as follows:

| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|
| ** **                | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                | ** ** | **(In thousands)**                    | ** ** |
| Current expense:          |       |                                       |       |   |   |   |   |
| Federal                   |       | $                                          | 4,763      |   | $ | 4,873 |   | $ | 3,346 |   |
| State                     |       | 92                                         |       | 66 |   | 200 |   |
| Total current expense     |       | 4,855                                      |       | 4,939 |   | 3,546 |   |
| Deferred benefit:         |       |                                       |       |   |   |   |   |
| Federal                   |       | (15                                        | )          | (643 | ) | — |   |
| State                     |       | —                                     |       | — |   | — |   |
| Total deferred benefit    |       | (15                                        | )          | (643 | ) | — |   |
| Total income tax  expense |       | $                                          | 4,840      |   | $ | 4,296 |   | $ | 3,546 |   |

 

Thedifference between the statutory federal income tax rate and the effectivefederal income tax rate is as follows:

| ** **                                            | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Statutory federal  income tax rate                    |       | 35.0                                       | %          | 35.0 | % | 35.0 | % |
| Increase resulting from:                              |       |                                       |       |   |   |   |   |
| State income tax, net of federal tax benefit          |       | 0.4                                        |       | 0.3 |   | 0.5 |   |
| Bank-owned life insurance                             |       | (1.7                                       | )          | (1.7 | ) | (2.4 | ) |
| Other, net                                            |       | (0.1                                       | )          | (0.3 | ) | (0.1 | ) |
| Effective combined  federal and state income tax rate |       | 33.6                                       | %          | 33.3 | % | 33.0 | % |

 

F-29

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Thecomponents of gross deferred tax assets and gross deferred tax liabilities areas follows:

| ** **                                       | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(In thousands)** | ** ** |
| Gross deferred tax  assets:                      |       |                    |       |   |   |
| Allowance for loan and lease losses              |       | $                       | 4,279      |   | $ | 4,167 |   |
| Unrealized loss on securities available for sale |       | 1,736                   |       | — |   |
| Accrued retirement                               |       | 632                     |       | 428 |   |
| Stock issuance costs                             |       | 103                     |       | 103 |   |
| Nonaccrual interest                              |       | 13                      |       | 95 |   |
| Incentive stock award                            |       | 90                      |       | — |   |
| Other                                            |       | 290                     |       | 276 |   |
| Total gross deferred tax assets                  |       | 7,143                   |       | 5,069 |   |
| Gross deferred tax  liabilities:                 |       |                    |       |   |   |
| Goodwill                                         |       | (2,210                  | )          | (1,887 | ) |
| Unrealized gain on securities available for sale |       | —                  |       | (354 | ) |
| Total gross deferred tax liabilities             |       | (2,210                  | )          | (2,241 | ) |
| Net deferred tax  asset                          |       | $                       | 4,933      |   | $ | 2,828 |   |

 

It ismanagement’s belief, that it is more likely than not, that the reversal ofdeferred tax liabilities and results of future operations will generatesufficient taxable income to realize the deferred tax assets. In addition, theCompany’s net deferred tax asset is supported by recoverable income taxes. Therefore,no valuation allowance was necessary at December 31, 2005 or 2004 for thedeferred tax assets. It should be noted, however, that factors beyondmanagement’s control, such as the general state of the economy and real estatevalues, can affect future levels of taxable income and that no assurance can begiven that sufficient taxable income will be generated to fully absorb grossdeductible temporary differences.

**(15) Employee Benefits**

*Employee401(k) Plan—**The*Bank maintains a 401(k) Plan(the “Plan”) which qualifies as a tax exempt plan and trust under Sections 401and 501 of the Internal Revenue Code. Generally, Bank employees who are atleast twenty-one (21) years of age are eligible to participate in the Plan. Expensesassociated with the Plan were $388,000, $352,000 and $318,000 for the yearsended December 31, 2005, 2004 and 2003, respectively.

*NonqualifiedDeferred Compensation Plan—**The*Bank alsomaintains a Nonqualified Deferred Compensation Plan (the “Nonqualified Plan”)under which certain participants may contribute the amounts they are precludedfrom contributing to the Bank’s 401(k) Plan because of the qualified planlimitations, and additional compensation deferrals that may be advantageous forpersonal income tax or other planning reasons. Expenses associated with theNonqualified Plan were $43,000, $39,000 and $33,000 for the years ended December 31,2005, 2004 and 2003, respectively. Accrued liabilities associated with theNonqualified Plan were $770,000 and $689,000 for December 31, 2005 and2004, respectively.

*SupplementalExecutive Retirement Plans—**The*Bank maintainsSupplemental Executive Retirement Plans (the “SERPs”) for certain of its seniorexecutives under which participants designated by the Board of Directors areentitled to an annual retirement benefit. Expenses associated with the SERPswere $578,000, $391,000 and $380,000 for the years ended December 31,2005, 2004 and 2003, respectively. 

F-30

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Accrued liabilitiesassociated with the SERPs were $1.8 million and $1.2 million for December 31,2005 and 2004, respectively.

*RestrictedStock Agreement—**During*2001, the Company enteredinto a Restricted Stock Agreement with its CEO, pursuant to which she wasawarded 7,700 shares of restricted stock, subject to achievement of certainperformance goals spanning a three year period, which have been achieved. Therestricted shares vest 50% on January 1, 2005 and 50% on January 1,2006. The restricted shares are subject to forfeiture in the event oftermination of the CEO’s employment prior to the applicable vesting dates forcause by the Company or without good reason by the executive. In addition, theCompany will make a “gross-up” payment sufficient to pay any taxes of the CEO(including those on the “gross-up” payment) arising as a result of the vestingof the restricted stock. Expenses associated with the Restricted StockAgreement were $97,000, $129,000 and $70,000 for the years ended December 31,2005, 2004 and 2003, respectively.

*EmployeeStock Plans—**The*Company maintains a 1996Incentive and Nonqualified Stock Option Plan and a 2002 Equity Incentive Plan(collectively the “Employee Stock Plans”) under which it may grant awards ofits Common Stock to officers and key employees. The total number of sharesavailable for awards under the Employee Stock Plans is 760,000. The 2002 EquityIncentive Plan also provides for automatic incremental increases each year inthe number of shares authorized for issuance under such plan on the date of theannual shareholders meeting equal to the least of (i) 2% of totalissued and outstanding common stock on the date of the shareholders meeting, (ii) 75,000shares and (iii) such lesser number as determined by the Board ofDirectors of the Company. The Employee Stock Plans allow grants of options,restricted stock, stock appreciation rights (“SARs”), performance shares orunits and other stock-based awards. To date, the Company has only awardedoptions under the Employee Stock Plans, which have been granted at an exerciseprice equal to the market value of the stock on the date of the grant withoriginal vesting terms of three to five year periods. Unless exercised, optionsgranted under the Employee Stock Plans expire ten years from the grant date.

F-31

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Thefollowing table summarizes changes in options outstanding under the EmployeeStock Plans during 2003, 2004 and 2005 and options exercisable at December 31,2005:

| ** **                                     | ** ** | **Number of** | ** ** | **Weighted**          | ** ** |
|------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **Unexercised**    | ** ** | **Average**           | ** ** |
| ** **                                     | ** ** | **Options**        | ** ** | **Option Price** | ** ** |
| Options  outstanding at December 31, 2002 |       |               | 395,750    |                  |       |   | $ | 13.09 |   |   |
| Granted                                        |       |               | 52,600     |                  |       |   | 23.05 |   |   |
| Exercised                                      |       |               | (43,925    | )                     |       |   | 10.12 |   |   |
| Forfeited/Canceled                             |       |               | (4,887     | )                     |       |   | 19.32 |   |   |
| Options outstanding at December 31, 2003  |       |               | 399,538    |                  |       |   | 14.65 |   |   |
| Granted                                        |       |               | 106,650    |                  |       |   | 33.79 |   |   |
| Exercised                                      |       |               | (53,308    | )                     |       |   | 13.70 |   |   |
| Forfeited/Canceled                             |       |               | (7,575     | )                     |       |   | 23.21 |   |   |
| Options outstanding at December 31, 2004  |       |               | 445,305    |                  |       |   | 19.21 |   |   |
| Granted                                        |       |               | 68,000     |                  |       |   | 37.05 |   |   |
| Exercised                                      |       |               | (73,374    | )                     |       |   | 18.29 |   |   |
| Forfeited/Canceled                             |       |               | (10,951    | )                     |       |   | 33.18 |   |   |
| Options outstanding at December 31, 2005  |       |               | 428,980    |                  |       |   | $ | 21.27 |   |   |
| Options  exercisable at December 31, 2005 |       |               | 428,980    |                  |       |   | $ | 21.27 |   |   |

 

In connection with the pending adoption of SFAS 123-R,in December 2005, the Executive and Compensation Committees of the Company’sBoard of Directors accelerated the vesting of all 89,586 unvested stock options.No other changes were made to the terms and conditions of the options. TheCompany recorded expenses of $49,000 in connection with the acceleratedvesting.

Under SFAS 123-R, the Company would be requiredto record compensation expense for the fair value of unvested stock optionsover the remaining service period. At the time of the vesting acceleration,approximately 79% of the expenses anticipated to be recorded over the nextthree years related to stock options that had no intrinsic value, as the stockoptions were “out-of-the-money”. Additionally, 73% of the unvested options witha positive intrinsic value, or “in-the-money”, were scheduled to fully vestwithin four months after December 31, 2005. As a result of this acceleratedvesting, the Company estimates that it will not be required to recognizeanticipated non-cash compensation expense relating to stock options ofapproximately $370,000 in 2006, $260,000 in 2007 and $70,000 in 2008.

*DirectorStock Plan—**The*Company established aNon-Employee Director Stock Plan (the “Director Stock Plan”) under which it maygrant up to 65,000 options to acquire its Common Stock to non-employeedirectors. Each non-employee director elected at the 1998 shareholders meetingreceived an option for 1,500 shares and each new non-employee director electedsubsequently receives an option for 1,000 shares. Non-employee directors alsoreceive an annual option grant for 500 shares as of the date of each annualmeeting of shareholders. Options are granted at an exercise price equal to themarket value of the stock on the date of the grant and vest six months afterthe grant date. Unless exercised, options granted under the Director Stock Planexpire ten years from the date granted.

F-32

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Thefollowing table summarizes changes in options outstanding under the DirectorStock Plan during 2003, 2004 and 2005 and options exercisable at December 31,2005:

| ** **                                     | ** ** | **Number of** | ** ** | **Weighted**          | ** ** |
|------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **Unexercised**    | ** ** | **Average**           | ** ** |
| ** **                                     | ** ** | **Options**        | ** ** | **Option Price** | ** ** |
| Options  outstanding at December 31, 2002 |       |               | 33,500     |                  |       |   | $ | 16.48 |   |   |
| Granted                                        |       |               | 7,000      |                  |       |   | 25.12 |   |   |
| Exercised                                      |       |               | (3,500     | )                     |       |   | 19.57 |   |   |
| Forfeited/Canceled                             |       |               | —     |                  |       |   | — |   |   |
| Options outstanding at December 31, 2003  |       |               | 37,000     |                  |       |   | 17.82 |   |   |
| Granted                                        |       |               | 7,000      |                  |       |   | 33.43 |   |   |
| Exercised                                      |       |               | (1,500     | )                     |       |   | 22.60 |   |   |
| Forfeited/Canceled                             |       |               | —     |                  |       |   | — |   |   |
| Options outstanding at December 31, 2004  |       |               | 42,500     |                  |       |   | 20.22 |   |   |
| Granted                                        |       |               | 7,000      |                  |       |   | 38.07 |   |   |
| Exercised                                      |       |               | —     |                  |       |   | — |   |   |
| Forfeited/Canceled                             |       |               | —     |                  |       |   | — |   |   |
| Options outstanding at December 31, 2005  |       |               | 49,500     |                  |       |   | $ | 22.75 |   |   |
| Options exercisable  at December 31, 2005 |       |               | 49,500     |                  |       |   | $ | 22.75 |   |   |

 

F-33

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

*Change of ControlAgreements—**The*Bank has entered intoEmployment Agreements with its President and Chief Executive Officer, ChiefFinancial Officer, Chief Operating Officer and Chief Business Officer. Theseagreements generally provide for the continued payment of specifiedcompensation and benefits for the remainder of the term of the agreement upontermination without cause.  Theagreements also provide that if the executive is terminated (or in the case ofthe Chief Executive Officer, resigns) in conjunction with a Change in Control,they are entitled to a severance payment, which is equal to 2.99 times basesalary plus bonus for the President and Chief Executive Officer and 2.00 timesbase salary plus bonus for the Chief Financial Officer, Chief OperatingOfficer, and Chief Business Officer. Except in the case of the Chief OperatingOfficer, payments under the employment agreements following a Change in Controlare subject to the “golden parachute” excise tax, the Company will make a “gross-up”payment sufficient to ensure that the net after-tax amount retained by theexecutive (taking into account all taxes, including those on the “gross-up”payment) is the same as if such excise tax had not applied.

**(16) Other Operating Expenses**

Majorcomponents of other operating expenses are as follows:

| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|
| ** **                | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                | ** ** | **(In thousands)**                    | ** ** |
| Telephone                 |       | $                                          | 584        |   | $ | 507 |   | $ | 566 |   |
| Forms and  supplies       |       | 583                                        |       | 578 |   | 564 |   |
| Postage and  mailing      |       | 566                                        |       | 582 |   | 506 |   |
| Director fees             |       | 346                                        |       | 241 |   | 243 |   |
| Charitable  contributions |       | 246                                        |       | 268 |   | 204 |   |
| Insurance                 |       | 207                                        |       | 221 |   | 218 |   |
| Correspondent  bank fees  |       | 154                                        |       | 202 |   | 180 |   |
| Recruiting                |       | 130                                        |       | 176 |   | 278 |   |
| Interchange fees          |       | 124                                        |       | 182 |   | 119 |   |
| Other                     |       | 1,636                                      |       | 1,148 |   | 1,022 |   |
| Total                     |       | $                                          | 4,576      |   | $ | 4,105 |   | $ | 3,900 |   |

 

**(17) Commitmentsand Contingent Liabilities**

The Bank is party to financial instruments withoff-balance sheet risk in the normal course of business to meet the financingneeds of its customers. These financial instruments include commitments tooriginate loans and letters of credit. The instruments involve, to varyingdegrees, elements of credit and interest rate risk in excess of the amountrecognized in the balance sheet. The contract or notional amounts of thoseinstruments reflect the extent of involvement the Bank has in particularclasses of financial instruments.

The Bank’s exposure to credit loss in the event ofnonperformance by the other party to the financial instrument for loancommitments and letters of credit is represented by the contractual amount ofthose instruments. The Bank uses the same credit policies in making commitmentsand conditional obligations as it does for on-balance sheet instruments.

F-34

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Financialinstruments with off-balance sheet risk are summarized as follows:

| ** **                                             | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **(In thousands)** | ** ** |
| Commitments to  originate or purchase loans and leases |       | $                       | 37,623     |   | $ | 17,445 |   |
| Unused lines of  credit and other commitments          |       | 177,317                 |       | 162,284 |   |
| Letters of credit                                      |       | 1,895                   |       | 4,346 |   |
|                                                        |            |                         |            |  |  |  |  |

 

Commitments to originate loans and unused lines ofcredit are agreements to lend to a customer provided there is no violation ofany condition established in the contract. Commitments generally have fixed expirationdates or other termination clauses and may require payment of a fee. Sincecertain commitments may expire without being drawn upon, the total commitmentamounts do not necessarily represent future cash requirements. The Bankevaluates each customer’s creditworthiness on a case-by-case basis. The amountof collateral obtained, if deemed necessary by the Bank upon extension ofcredit, is based on management’s credit evaluation of the borrower.

Letters of credit are conditional commitments issuedby the Bank to guarantee the performance by a customer to a third party. Thecredit risk involved in issuing letters of credit is essentially the same asthat involved in extending loan facilities to customers. At December 31,2005 and 2004, the maximum potential amount of future payments under letters ofcredit were $1.5 million and $3.5 million, respectively. At December 31,2005 and 2004, cash collateral supported $1.0 million and $1.4 million,respectively, of the outstanding standby letters of credit. The fair value ofthe guarantees was $11,000 and $26,000, respectively, and is not reflected onthe balance sheet.

The Company continues to monitor a receivable recordedin the fourth quarter of 2005 that related to the unauthorized actions of aformer employee, which could result in a future impairment charge. TheCompany’s maximum exposure at December 31, 2005 was $1.3 million. As ofFebruary 28, 2006, the Company’s estimated exposure ranged from $0 to$900,000. The Company has notified its insurance carrier regarding thecircumstances giving rise to the receivable and will seek recovery from itscarrier if it incurs a loss.

**(18) Fair Value of Financial Instruments**

The following disclosureof the estimated fair value of financial instruments is made in accordance withthe requirements of SFAS 107, “*Disclosures About Fair Value of Financial Instruments*”.The estimated fair value amounts have been determined by using availablequoted market information or other appropriate valuation methodologies. Theaggregate fair value amounts presented are in accordance with SFAS 107guidelines but do not represent the underlying value of the Bank taken as awhole.

The fair value estimatesprovided are made at a specific point in time, based on relevant marketinformation and the characteristics of the financial instrument. The estimatesdo not provide for any premiums or discounts that could result fromconcentrations of ownership of a financial instrument. Because no active marketexists for some of the Bank’s financial instruments, certain fair valueestimates are based on subjective judgments regarding current economicconditions, risk characteristics of the financial instruments, future expectedloss experience, prepayment assumptions and other factors. The resulting estimatesinvolve uncertainties and therefore cannot be determined with precision. Changesmade to any of the underlying assumptions could significantly affect theestimates.

F-35

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

Thebook values and estimated fair values for the Company’s financial instrumentsare as follows:

| ** **                                                                | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                                | ** ** | **Book  Value**                 | ** ** | **Estimated  Fair Value**  | ** ** | **Book  Value** | ** ** | **Estimated  Fair Value** | ** ** |
| ** **                                                                | ** ** | **(In thousands)**         | ** ** |
| Assets:                                                                   |       |                            |       |                            |       |   |   |   |   |
| Cash and due from banks                                                   |       | $                               | 30,177     |                            | $          | 30,177 |   | $ | 21,585 |   | $ | 21,585 |   |
| Overnight investments                                                     |       | 10,370                          |       | 10,370                          |       | 14,094 |   | 14,094 |   |
| Investment securities                                                     |       | 150,959                         |       | 150,959                         |       | 104,600 |   | 104,600 |   |
| Mortgage-backed securities                                                |       | 234,858                         |       | 234,858                         |       | 159,946 |   | 159,946 |   |
| Stock in the FHLB                                                         |       | 16,062                          |       | 16,062                          |       | 13,229 |   | 13,229 |   |
| Loans and leases  receivable, net of allowance for loan and lease losses: |       |                            |       |                            |       |   |   |   |   |
| Commercial loans and leases                                               |       | 430,337                         |       | 429,892                         |       | 394,943 |   | 401,587 |   |
| Residential mortgage loans                                                |       | 304,197                         |       | 292,703                         |       | 314,156 |   | 314,736 |   |
| Consumer and other loans                                                  |       | 204,104                         |       | 204,524                         |       | 165,296 |   | 166,241 |   |
| Accrued interest receivable                                               |       | 6,965                           |       | 6,965                           |       | 5,666 |   | 5,666 |   |
| Liabilities:                                                              |       |                            |       |                            |       |   |   |   |   |
| Deposits:                                                                 |       |                            |       |                            |       |   |   |   |   |
| Demand deposit accounts                                                   |       | $                               | 185,089    |                            | $          | 185,089 |   | $ | 167,682 |   | $ | 167,682 |   |
| NOW accounts                                                              |       | 89,594                          |       | 89,594                          |       | 108,159 |   | 108,159 |   |
| Money market accounts                                                     |       | 12,122                          |       | 12,122                          |       | 16,489 |   | 16,489 |   |
| Savings accounts                                                          |       | 341,115                         |       | 341,115                         |       | 339,836 |   | 339,836 |   |
| Certificate of deposit accounts                                           |       | 353,049                         |       | 353,755                         |       | 248,508 |   | 247,900 |   |
| Overnight and short-term borrowings                                       |       | 26,238                          |       | 26,238                          |       | 18,050 |   | 18,050 |   |
| Wholesale repurchase agreements                                           |       | 20,000                          |       | 20,014                          |       | — |   | — |   |
| FHLB borrowings                                                           |       | 279,973                         |       | 280,009                         |       | 234,778 |   | 235,594 |   |
| Subordinated deferrable interest debentures                               |       | 18,558                          |       | 20,564                          |       | 18,558 |   | 18,648 |   |
| Accrued interest  payable                                                 |       | 2,928                           |       | 2,928                           |       | 1,450 |   | 1,450 |   |

 

*Cash and due from banks—**The c*arrying valuesreported in the balance sheet for cash and due from banks approximate the fairvalues because of the short maturity of these instruments.

*Overnight investments—**The*carrying valuesreported in the balance sheet for federal funds sold and overnight investmentsapproximate the fair values because of the short maturity of these instruments.

*Investment andmortgage-backed securities—**The*fair valuespresented for investment and mortgage-backed securities are based on quoted bidprices received from securities dealers.

*Stock in the Federal HomeLoan Bank of Boston—**The*fair value of stock in the FHLBequals the carrying value reported in the balance sheet. This stock isredeemable at full par value only by the FHLB.

*Loans and leasesreceivable—**Fair*value estimates are based onloans and leases with similar financial characteristics. Loans and leases havebeen segregated by homogenous groups into residential mortgage, commercial, andconsumer and other loans. Fair values are estimated by discounting contractualcash flows, adjusted for prepayment estimates, using discount ratesapproximately equal to current market rates on loans with similarcharacteristics and maturities. The incremental credit risk for nonperformingloans has been considered in the determination of the fair value of loans.

F-36

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

*Deposits—**The*fair valuesreported for demand deposit, NOW, money market, and savings accounts are equalto their respective book values reported on the balance sheet. The fair valuesdisclosed are, by definition, equal to the amount payable on demand at thereporting date. The fair values reported for certificate of deposit accountsare based on the discounted value of contractual cash flows. The discount ratesused are representative of approximate rates currently offered on certificateof deposit accounts with similar remaining maturities.

*Overnightand short-term borrowings—*The carrying values reported in thebalance sheet for overnight and short-term borrowings approximate the fairvalues because of the short maturity of these instruments.

*Wholesale repurchaseagreements—**The*fair values reported forwholesale repurchase agreements are based on the discounted value ofcontractual cash flows. The discount rates used are representative ofapproximate rates currently offered on borrowings with similar remainingmaturities.

*Federal Home Loan Bank ofBoston borrowings—**The*fair values reported for FHLBborrowings are based on the discounted value of contractual cash flows. Thediscount rates used are representative of approximate rates currently offeredon borrowings with similar remaining maturities.

*Subordinated deferrableinterest debentures—**The*fair values reported forSubordinated deferrable interest debentures are based on the discounted valueof contractual cash flows. The discount rates used are representative ofapproximate rates currently offered on instruments with similar terms andremaining maturities.

*Accrued interestreceivable and payable—**The*carrying valuesfor accrued interest receivable and payable approximate fair values because ofthe short-term nature of these financial instruments.

*Financial instruments withoff-balance sheet risk—**Since*the Bank’scommitments to originate or purchase loans, and for unused lines andoutstanding letters of credit, are primarily at market interest rates, there isno significant fair value adjustment.

**(19) Shareholders’Equity**

Capital guidelines issuedby the Federal Reserve Board (“FRB”) require the Company to maintain minimumcapital levels for capital adequacy purposes. Tier I capital is defined ascommon equity and retained earnings, less certain intangibles. The risk-basedcapital guidelines include both a definition of capital and a framework forcalculating risk-weighted assets by assigning assets and off-balance-sheetitems to one of four risk categories, each with an appropriate weight. Therisk-based capital rules are designed to make regulatory capital moresensitive to differences in risk profiles among banks and bank holdingcompanies, to account for off-balance sheet exposure and to minimize disincentivesfor holding liquid assets. The Bank is also subject to FDIC regulationsregarding capital requirements. These regulations require banks to maintainminimum capital levels for capital adequacy purposes and higher capital levelsto be considered “well capitalized”.

F-37

----

**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

As of December 31,2005, the Company and the Bank met all applicable minimum capital requirementsand were considered “well capitalized” by both the FRB and the FDIC. There havebeen no events or conditions since the end of the year that management believeswould cause a change in either the Company’s or the Bank’s categorization. TheCompany’s and the Bank’s actual and required capital amounts and ratios are asfollows:

| ** **                               | ** ** | **Actual**                           | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Considered  “Well Capitalized”** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Amount**                           | ** ** | **Ratio**                                    | ** ** | **Amount**                                                        | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                               | ** ** | **(Dollars in thousands)** | ** ** |
| At  December 31, 2005:              |       |                                 |       |                                         |       |                                                              |       |   |   |   |   |   |   |   |   |
| Bancorp Rhode Island, Inc.:         |       |                                 |       |                                         |       |                                                              |       |   |   |   |   |   |   |   |   |
| Tier I capital (to average assets)       |       | $                                    | 114,822    |                                         | 8.21       | %                                                                 | $          | 41,933 |   |   | 3.00 | % |   | $ | 69,889 |   | 5.00 | % |
| Tier I capital (to risk-weighted assets) |       | 114,822                              |       | 12.62                                        | %          | 36,394                                                            |       |   | 4.00 | % |   | 54,592 |   | 6.00 | % |
| Total capital (to risk-weighted assets)  |       | 126,200                              |       | 13.87                                        | %          | 72,789                                                            |       |   | 8.00 | % |   | 90,986 |   | 10.00 | % |
| Bank Rhode Island:                       |       |                                 |       |                                         |       |                                                              |       |   |   |   |   |   |   |   |   |
| Tier I capital (to average assets)       |       | $                                    | 93,339     |                                         | 6.67       | %                                                                 | $          | 41,965 |   |   | 3.00 | % |   | $ | 69,941 |   | 5.00 | % |
| Tier I capital (to risk-weighted assets) |       | 93,339                               |       | 10.26                                        | %          | 36,378                                                            |       |   | 4.00 | % |   | 54,566 |   | 6.00 | % |
| Total capital (to risk-weighted assets)  |       | 104,717                              |       | 11.51                                        | %          | 72,755                                                            |       |   | 8.00 | % |   | 90,944 |   | 10.00 | % |
| At December 31, 2004:               |       |                                 |       |                                         |       |                                                              |       |   |   |   |   |   |   |   |   |
| Bancorp Rhode Island, Inc.:         |       |                                 |       |                                         |       |                                                              |       |   |   |   |   |   |   |   |   |
| Tier I capital (to average assets)       |       | $                                    | 85,386     |                                         | 7.06       | %                                                                 | $          | 36,280 |   |   | 3.00 | % |   | $ | 60,466 |   | 5.00 | % |
| Tier I capital (to risk-weighted assets) |       | 85,386                               |       | 10.01                                        | %          | 34,112                                                            |       |   | 4.00 | % |   | 51,168 |   | 6.00 | % |
| Total capital (to risk-weighted assets)  |       | 96,055                               |       | 11.26                                        | %          | 68,225                                                            |       |   | 8.00 | % |   | 85,281 |   | 10.00 | % |
| Bank Rhode Island:                       |       |                                 |       |                                         |       |                                                              |       |   |   |   |   |   |   |   |   |
| Tier I capital (to average assets)       |       | $                                    | 81,928     |                                         | 6.78       | %                                                                 | $          | 36,263 |   |   | 3.00 | % |   | $ | 60,438 |   | 5.00 | % |
| Tier I capital (to risk-weighted assets) |       | 81,928                               |       | 9.61                                         | %          | 34,091                                                            |       |   | 4.00 | % |   | 51,137 |   | 6.00 | % |
| Total capital (to  risk-weighted assets) |       | 92,597                               |       | 10.86                                        | %          | 68,182                                                            |       |   | 8.00 | % |   | 85,228 |   | 10.00 | % |

 

*Warrants—**In*connection withthe formation of the Bank, a warrant to acquire 136,315 shares of Common Stockwas issued. The warrant had a per share exercise price of $10.00 and anexpiration date of March 22, 2006. As of December 31, 2003, warrantsfor 66,315 shares had been exercised and a warrant for 70,000 shares remainedexercisable. The remaining warrant for 70,000 shares was exercised in January 2004.

F-38

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

**(20) Earnings PerShare**

Thefollowing table is a reconciliation of basic EPS and diluted EPS:

| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|
| ** **                | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Basic EPS Computation:    |       |                                       |       |   |   |   |   |
| Numerator:                |       |                                       |       |   |   |   |   |
| Net income (in thousands) |       | $                                          | 9,569      |   | $ | 8,614 |   | $ | 7,214 |   |
| Denominator:              |       |                                       |       |   |   |   |   |
| Common shares outstanding |       | 4,478,081                                  |       | 3,975,413 |   | 3,819,232 |   |
| Basic EPS                 |       | $                                          | 2.14       |   | $ | 2.17 |   | $ | 1.89 |   |
| Diluted EPS  Computation: |       |                                       |       |   |   |   |   |
| Numerator:                |       |                                       |       |   |   |   |   |
| Net income (in thousands) |       | $                                          | 9,569      |   | $ | 8,614 |   | $ | 7,214 |   |
| Denominator:              |       |                                       |       |   |   |   |   |
| Common shares outstanding |       | 4,478,081                                  |       | 3,975,413 |   | 3,819,232 |   |
| Stock options             |       | 214,174                                    |       | 238,281 |   | 193,755 |   |
| Restricted stock          |       | 3,372                                      |       | 6,199 |   | 4,268 |   |
| Contingent shares         |       | 1,507                                      |       | — |   | — |   |
| Warrants                  |       | —                                     |       | 2,963 |   | 68,623 |   |
| Total shares              |       | 4,697,134                                  |       | 4,222,856 |   | 4,085,878 |   |
| Diluted EPS               |       | $                                          | 2.04       |   | $ | 2.04 |   | $ | 1.77 |   |

 

**(21) Regulation and Litigation**

The Company and the Bank are subject to extensiveregulation and examination by the FRB, the Rhode Island Division of Banking andthe FDIC, which insures the Bank’s deposits to the maximum extent permitted bylaw. The federal and state laws and regulations which are applicable to banksregulate, among other things, the scope of their business, their investments,their reserves against deposits, the timing of the availability of depositedfunds and the nature and amount of and collateral for certain loans. The lawsand regulations governing the Bank generally have been promulgated to protectdepositors and not for the purpose of protecting shareholders. Among otherthings, bank regulatory authorities have the right to restrict the payment ofdividends by banks and bank holding companies to shareholders.

The Company is involved inroutine legal proceedings occurring in the ordinary course of business. In theopinion of management, final disposition of these lawsuits will not have amaterial adverse effect on the consolidated financial condition or results ofoperations of the Company.

F-39

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

**(22) Parent Company Statements**

Thefollowing are condensed financial statements for Bancorp Rhode Island, Inc.(the “Parent Company”):

**Balance Sheets**

| ** **                                                                                                                                             | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                             | ** ** | **2005**                | ** ** | **2004** | ** ** |
| **Assets**                                                                                                                                             | ** ** | **(In thousands)** | ** ** |
| Assets:                                                                                                                                                |       |                    |       |   |   |
| Cash and due from banks                                                                                                                                |       | $                       | 20         |   | $ | 19 |   |
| Overnight investments                                                                                                                                  |       | 21,237                  |       | 3,233 |   |
| Investment in subsidiaries                                                                                                                             |       | 101,973                 |       | 93,954 |   |
| Prepaid expenses and other assets                                                                                                                      |       | 381                     |       | 488 |   |
| Total assets                                                                                                                                           |       | $                       | 123,611    |   | $ | 97,694 |   |
| **Liabilities and Shareholders’ Equity**                                                                                                          |       |                    |       |   |   |
| Liabilities:                                                                                                                                           |       |                    |       |   |   |
| Subordinated deferrable interest debentures                                                                                                            |       | $                       | 18,558     |   | $ | 18,558 |   |
| Other liabilities                                                                                                                                      |       | 221                     |       | 213 |   |
| Total liabilities                                                                                                                                      |       | 18,779                  |       | 18,771 |   |
| Shareholders’  equity:                                                                                                                            |       |                    |       |   |   |
| Preferred stock: par value $0.01 per share,  authorized 1,000,000 shares. Issued and outstanding: none                                                 |       | —                  |       | — |   |
| Common stock: par value $0.01 per share, authorized  11,000,000 shares. Issued and outstanding: 4,719,126 shares in 2005 and  4,010,554 shares in 2004 |       | 47                      |       | 40 |   |
| Additional paid-in capital                                                                                                                             |       | 65,768                  |       | 42,852 |   |
| Retained earnings                                                                                                                                      |       | 42,241                  |       | 35,373 |   |
| Accumulated other comprehensive income (loss), net                                                                                                     |       | (3,224                  | )          | 658 |   |
| Total shareholders’ equity                                                                                                                        |       | 104,832                 |       | 78,923 |   |
| Total liabilities  and shareholders’ equity                                                                                                       |       | $                       | 123,611    |   | $ | 97,694 |   |

 

F-40

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

**Statements ofOperations**

| ** **                                                      | ** ** | **Year Ended December 31,**                         | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                      | ** ** | **(In thousands, except per share data)** | ** ** |
| Income:                                                         |       |                                                               |       |   |   |   |   |
| Dividends received from subsidiaries                            |       | $                                                                  | 3,750      |   | $ | 3,500 |   | $ | 3,200 |   |
| Interest on overnight investments                               |       | 486                                                                |       | 30 |   | 16 |   |
| Total income                                                    |       | 4,236                                                              |       | 3,530 |   | 3,216 |   |
| Expenses:                                                       |       |                                                               |       |   |   |   |   |
| Interest on notes payable                                       |       | 1,272                                                              |       | 1,041 |   | 706 |   |
| Compensation expense                                            |       | 97                                                                 |       | 130 |   | 70 |   |
| Directors’ fees                                            |       | 118                                                                |       | 103 |   | 96 |   |
| Professional services                                           |       | 253                                                                |       | 254 |   | 253 |   |
| Other expenses                                                  |       | 1                                                                  |       | 1 |   | 1 |   |
| Total expenses                                                  |       | 1,741                                                              |       | 1,529 |   | 1,126 |   |
| Income before income taxes                                      |       | 2,495                                                              |       | 2,001 |   | 2,090 |   |
| Income tax expense (benefit)                                    |       | (423                                                               | )          | (504 | ) | (372 | ) |
| Income before equity in undistributed earnings of  subsidiaries |       | 2,918                                                              |       | 2,505 |   | 2,462 |   |
| Equity in undistributed earnings of subsidiaries                |       | 6,651                                                              |       | 6,109 |   | 4,752 |   |
| Net income                                                      |       | $                                                                  | 9,569      |   | $ | 8,614 |   | $ | 7,214 |   |
| Basic earnings  per common share:                               |       | $                                                                  | 2.14       |   | $ | 2.17 |   | $ | 1.89 |   |
| Diluted earnings  per common share:                             |       | $                                                                  | 2.04       |   | $ | 2.04 |   | $ | 1.77 |   |
| Average common  shares outstanding—basic                   |       | 4,478,081                                                          |       | 3,975,413 |   | 3,819,232 |   |
| Average common shares  outstanding—diluted                 |       | 4,697,134                                                          |       | 4,222,856 |   | 4,085,878 |   |

 

F-41

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

**Statementsof Cash Flow**

| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                        | ** ** | **(In thousands)**                    | ** ** |
| Cash flows from  operating activities:                                            |       |                                       |       |   |   |   |   |
| Net income                                                                        |       | $                                          | 9,569      |   | $ | 8,614 |   | $ | 7,214 |   |
| Adjustment to reconcile net income to net cash  provided by operating activities: |       |                                       |       |   |   |   |   |
| Equity in undistributed earnings of subsidiaries                                  |       | (6,651                                     | )          | (6,109 | ) | (4,752 | ) |
| Share-based compensation expense                                                  |       | 82                                         |       | 35 |   | 35 |   |
| (Increase) decrease in other assets                                               |       | 107                                        |       | (91 | ) | (127 | ) |
| Increase (decrease) in other liabilities                                          |       | 8                                          |       | 110 |   | (57 | ) |
| Other, net                                                                        |       | —                                     |       | 1 |   | — |   |
| Net cash provided by operating activities                                         |       | 3,115                                      |       | 2,560 |   | 2,313 |   |
| Cash flows from  financing activities:                                            |       |                                       |       |   |   |   |   |
| Proceeds from notes payable                                                       |       | —                                     |       | 5,155 |   | 5,155 |   |
| Investment in subsidiaries                                                        |       | (5,250                                     | )          | (5,155 | ) | (6,155 | ) |
| Proceeds from issuance of common stock                                            |       | 22,532                                     |       | 1,266 |   | 1,176 |   |
| Tax effect of disqualifying disposition of stock  options                         |       | 309                                        |       | 113 |   | 95 |   |
| Dividends on common stock                                                         |       | (2,701                                     | )          | (2,315 | ) | (2,142 | ) |
| Net cash used by financing activities                                             |       | 14,890                                     |       | (936 | ) | (1,871 | ) |
| Net increase  (decrease) in cash and due from banks                               |       | 18,005                                     |       | 1,624 |   | 442 |   |
| Cash and cash  equivalents at beginning of year                                   |       | 3,252                                      |       | 1,628 |   | 1,186 |   |
| Cash and cash  equivalents at end of year                                         |       | $                                          | 21,257     |   | $ | 3,252 |   | $ | 1,628 |   |
| Supplementary  disclosures:                                                       |       |                                       |       |   |   |   |   |
| Cash paid (received) for income taxes                                             |       | $                                          | (542       | ) | $ | (508 | ) | $ | (263 | ) |
| Non-cash transactions:                                                            |       |                                       |       |   |   |   |   |
| Change in other  comprehensive income, net of taxes                               |       | (3,882                                     | )          | (897 | ) | (698 | ) |

 

The Parent Company’s Statements of Changes inShareholders’ Equity is identical to the Consolidated Statements of Changes inShareholders’ Equity and therefore is not presented here.

F-42

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**BANCORP RHODE ISLAND, INC. Notes to Consolidated Financial Statements (Continued)**

**(23) QuarterlyResults of Operations (unaudited)**

| ** **                                          | ** ** | **2005 Quarter Ended**                                   | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **March 31**                                                  | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                                          | ** ** | **(In thousands, except per share data)** | ** ** |
| Interest income                                     |       |                                                               | $          | 15,745 |   |   | $ | 17,068 |   |   | $ | 17,862 |   |   |   | $ | 18,845 |   |   |
| Interest expense                                    |       |                                                               | 5,374      |   |   | 6,298 |   |   | 7,095 |   |   |   | 7,852 |   |   |
| Net interest income                                 |       |                                                               | 10,371     |   |   | 10,770 |   |   | 10,767 |   |   |   | 10,993 |   |   |
| Provision for  loan losses                          |       |                                                               | 300        |   |   | 354 |   |   | 410 |   |   |   | 410 |   |   |
| Net interest income after provision for loan losses |       |                                                               | 10,071     |   |   | 10,416 |   |   | 10,357 |   |   |   | 10,583 |   |   |
| Noninterest  income                                 |       |                                                               | 2,075      |   |   | 2,445 |   |   | 2,581 |   |   |   | 2,173 |   |   |
| Noninterest  expense                                |       |                                                               | 8,512      |   |   | 9,125 |   |   | 9,161 |   |   |   | 9,494 |   |   |
| Income before taxes                                 |       |                                                               | 3,634      |   |   | 3,736 |   |   | 3,777 |   |   |   | 3,262 |   |   |
| Income taxes                                        |       |                                                               | 1,227      |   |   | 1,276 |   |   | 1,310 |   |   |   | 1,027 |   |   |
| Net income                                          |       |                                                               | $          | 2,407 |   |   | $ | 2,460 |   |   | $ | 2,467 |   |   |   | $ | 2,235 |   |   |
| Basic EPS                                           |       |                                                               | $          | 0.60 |   |   | $ | 0.55 |   |   | $ | 0.53 |   |   |   | $ | 0.47 |   |   |
| Diluted EPS                                         |       |                                                               | $          | 0.57 |   |   | $ | 0.52 |   |   | $ | 0.50 |   |   |   | $ | 0.46 |   |   |

 

| ** **                                          | ** ** | **2004 Quarter Ended**                                   | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **March 31**                                                  | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                                          | ** ** | **(In thousands, except per share data)** | ** ** |
| Interest income                                     |       |                                                               | $          | 13,624 |   |   | $ | 13,797 |   |   | $ | 14,910 |   |   |   | $ | 15,388 |   |   |
| Interest expense                                    |       |                                                               | 4,682      |   |   | 4,686 |   |   | 5,064 |   |   |   | 5,193 |   |   |
| Net interest income                                 |       |                                                               | 8,942      |   |   | 9,111 |   |   | 9,846 |   |   |   | 10,195 |   |   |
| Provision for  loan losses                          |       |                                                               | 300        |   |   | 200 |   |   | 200 |   |   |   | 200 |   |   |
| Net interest income after provision for loan losses |       |                                                               | 8,642      |   |   | 8,911 |   |   | 9,646 |   |   |   | 9,995 |   |   |
| Noninterest  income                                 |       |                                                               | 1,998      |   |   | 2,206 |   |   | 2,037 |   |   |   | 2,340 |   |   |
| Noninterest  expense                                |       |                                                               | 7,575      |   |   | 7,980 |   |   | 8,381 |   |   |   | 8,929 |   |   |
| Income before taxes                                 |       |                                                               | 3,065      |   |   | 3,137 |   |   | 3,302 |   |   |   | 3,406 |   |   |
| Income taxes                                        |       |                                                               | 1,001      |   |   | 1,042 |   |   | 1,124 |   |   |   | 1,129 |   |   |
| Net income                                          |       |                                                               | $          | 2,064 |   |   | $ | 2,095 |   |   | $ | 2,178 |   |   |   | $ | 2,277 |   |   |
| Basic EPS                                           |       |                                                               | $          | 0.52 |   |   | $ | 0.53 |   |   | $ | 0.55 |   |   |   | $ | 0.57 |   |   |
| Diluted EPS                                         |       |                                                               | $          | 0.49 |   |   | $ | 0.50 |   |   | $ | 0.52 |   |   |   | $ | 0.54 |   |   |

 

F-43

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