**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

** **

**FORANNUAL AND TRANSITION REPORTS**

**PURSUANTTO SECTIONS 13 OR 15(d) OF THE**

**SECURITIESEXCHANGE ACT OF 1934**

 

| **ý** | **ANNUAL REPORT PURSUANT TO SECTIONS  13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|---------------------------------------------------------------------------------------------|

 

|   | **For the fiscal year ended December  31, 2001** |
|--------|--------------------------------------------------|

**OR**

 

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

 

**COMMISSIONFILE NUMBER: 000-25077**

 

**SEACOAST FINANCIAL SERVICES CORPORATION**

(Exact name of Registrantas Specified in its Charter)

 

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

 

SECURITIES REGISTERED PURSUANT TO SECTION 12 (b) OFTHE ACT:  None

 

SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OFTHE ACT:  Common Stock, $.01 par value

 

Indicate by check mark whether the registrant: (1) has filed all reportsrequired to be filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý    No o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of  registrant’s knowledge,in definitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment of this Form 10-K. ý

 

The aggregate market value of the voting stock held by non-affiliatesof the registrant, based on the closing price on March 15, 2002 on the NasdaqNational Market, was $452,099,586. Although directors and executive officers of the registrant were assumedto be “affiliates” of the registrant for the purposes of this calculation, thisclassification is not to be interpreted as an admission of such status.

 

As of March 15, 2002, 24,238,886 shares of the registrant’s commonstock were outstanding.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of the Proxy Statement for the annual meeting of stockholdersto be held on May 16, 2002 are incorporated by reference into the annual reportas portions of Part III of Form 10-K.

 

 

**PART I**

**Item 1.  Business**

 

**General**

 

Until thecompletion of a mutual to stock conversion and initial public offering of stock on November 20, 1998, SeacoastFinancial Services Corporation (the “Company” or “Seacoast Financial”) was amutual holding company created in connection with the reorganization of CompassBank for Savings ( “Compass”) into a mutual holding company form oforganization in 1994.  The Company isregistered with the Board of Governors of the Federal Reserve System (the“FRB”) as a bank holding company under the Bank Holding Company Act of 1956, asamended (the “BHCA”).  Since itsformation, the Company has owned 100% of Compass’s outstanding capital stock.

 

On December 4,1998, the Company acquired by merger all of the issued and outstanding capitalstock of Sandwich Bancorp, Inc. (“Sandwich”) in a stock-for-stock exchange andmerged Sandwich’s wholly-owned subsidiary, The Sandwich Co-operative Bank(“Sandwich Bank”), into Compass.  Thisacquisition was accounted for as a pooling of interests and, accordingly, allfinancial data is presented herein as if the Company and Sandwich had alwaysbeen combined.

 

On December 31,2000,  the Company completed itsacquisition of Home Port Bancorp, Inc., holding company for Nantucket Bank, athree branch savings bank located on Nantucket Island, Massachusetts.  This transaction was accounted for under thepurchase method of accounting.  As theclosing of this acquisition coincided with the Company’s year-end, the assetsand liabilities of Nantucket Bank are included in the consolidated balancesheet, as well as the various tables presented herein, as of December 31,2000.  The results of operations ofNantucket Bank are included herein beginning January 1, 2001.  The narrative in this Item I. does notinclude Nantucket Bank’s financial operating data, such as the amount of loanoriginations, for any period prior to 2001.    See Note 2 to the consolidated financial statements for disclosure ofcertain pro forma information.  Compassand Nantucket Bank are collectively referred to herein as “the Banks.”

 

Compass wasorganized in 1855 as a Massachusetts-chartered mutual savings bank, andreorganized into mutual holding company form in 1994.  Nantucket Bank was organized in 1834 as a Massachusetts-charteredmutual savings bank and reorganized to a stock savings bank in 1988.  The Banks’ principal business has been, andcontinues to be, gathering deposits from customers within its market areas andinvesting those funds in residential and commercial real estate loans, indirectautomobile loans (Compass only), commercial loans, construction loans, homeequity loans and other consumer loans and investment securities.  The Banks’ investment portfolios consistprimarily of  U.S. Government and agencysecurities, corporate bonds, mortgage-backed securities, collateralizedmortgage obligations and, to a lesser extent, marketable equity securities.  Individual and business customers have avariety of deposit accounts with the Banks, including NOW (checking) and otherdemand deposit accounts, passbook savings accounts, money market depositaccounts, Individual Retirement Accounts (“IRAs”) and various certificates ofdeposit.  In 2001, Compass began toprovide private banking services to both individuals and businesses.

 

The Banks’deposits are insured by the Bank Insurance Fund (the “BIF”), as administered bythe Federal Deposit Insurance Corporation (the “FDIC”), up to the maximumamount permitted by law, except that certain deposits that Compass acquiredfrom a savings association are insured by the Savings Association InsuranceFund (the “SAIF”), also administered by the FDIC.  Deposit amounts in excess of FDIC insurance limits are insured bythe Depositors Insurance Fund (the “DIF”), a deposit insuring entity forMassachusetts savings banks. The Banks are voluntary members of the FederalHome Loan Bank of Boston (FHLB), which serves principally as a credit source inproviding funds for residential mortgage lending.

 

At December 31,2001, the Company was the largest publicly traded stock holding companyheadquartered in Massachusetts.

 

**Market Area and Competition**

 

At December 31,2001, the Company and Compass conducted business from their corporate headquartersin New Bedford, Massachusetts and the Banks conducted business from 42full-service branches, seven of which are located in New Bedford and theremaining 35 of which are located in the Massachusetts communities of FallRiver (two branches), Plymouth (four branches), Fairhaven, Mattapoisett, NorthDartmouth, Seekonk, Somerset, Swansea, Westport, Assonet and Carver, Cape Cod(twelve branches) and the islands of Martha’s Vineyard (five branches) andNantucket (three branches).  Compassalso has two limited service high school branches and seven remote ATMs. 

 

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In addition, Compass’s indirect auto lending business extends into allof Eastern Massachusetts and the State of Rhode Island.

 

The Banks facesignificant competition both in generating loans and in attractingdeposits.  Compass’s primary market areais highly competitive and it  facesdirect competition from a significant number of financial institutions, manywith either a state-wide, a regional or, in some cases, a national presence.Several of these financial institutions are significantly larger and havegreater financial resources than Compass. Compass’s competition for loans comes principally from commercial banks,savings banks, credit unions, mortgage brokers, mortgage banking companies andinsurance companies.  Its most directcompetition for deposits has historically come from savings, cooperative andcommercial banks and credit unions.  Inaddition, the Banks face competition for depositors’ funds from non-bankinstitutions, such as brokerage firms and insurance companies which offerfinancial alternatives such as short-term money-market funds, corporate andgovernment securities funds, mutual funds and annuities.

 

Nantucket Bank is theonly bank headquartered on Nantucket Island; however, it faces competition fromother banks, mortgage banking companies and other financial service providers,many of which have significantly greater resources.  Its most direct competition for deposits primarily comes fromother banks located on Nantucket Island and in southeastern Massachusetts,credit unions and brokerage firms. Nantucket Bank competes for deposits principally by offering depositorsconvenient branch hours and locations, personalized customer service, telephoneand computer access to accounts, a wide variety of deposit programs, automatedteller machines and competitive interest rates.

 

Competition forreal estate loans on Nantucket comes primarily from other banks, mortgagebrokers, mortgage banking companies and other institutional lenders.  The competition for loans varies dependingon factors which include, among others, the general availability of lendablefunds and credit, general and local economic conditions, current interest rate levels, conditions in themortgage market and other factors which are not readily predictable.

 

**Lending Activities**

 

*General.*The loan portfolio, excluding loans held-for-sale, totaled $2,575.0 million asof December 31, 2001, representing 77.0% of total assets on that date.  TheBanks primarily make residential real estate loans secured by one- tofour-family residences, indirect auto loans (Compass only)  and commercial real estate loans.   The Banks also make home equity line ofcredit loans, residential and commercial construction loans, commercial loans,fixed rate home equity loans, personal installment loans and passbookloans.  The majority of loans, includingsome loans classified as commercial loans, are collateralized by real estate.

 

Interest ratescharged on loans are affected primarily by the demand for such loans, thesupply of money available for lending purposes, secondary market mortgage ratesand the rates offered by competitors. These factors are, in turn, affected by national, regional and localeconomic conditions, the levels of federal government spending and revenue,monetary policies of the FRB and tax policies.

 

 

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The following table summarizes the composition of theloan portfolio as of the dates indicated:

 
| ** **                       | ** ** | **At December  31,**        | ** ** | **At October  31,** | ** ** |
|----------------------------------|------------|-----------------------------|------------|---------------------|------------|
| ** **                       | ** ** | **2001**                    | ** ** | **2000**            | ** ** | **1999** | ** ** | **1998** | ** ** | **1998** | ** ** | **1997** | ** ** |
| ** **                       | ** ** | ** **                  | ** ** | **Percent**         | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                       | ** ** | **Amount**                  | ** ** | **of total**        | ** ** | **Amount** | ** ** | **of total** | ** ** | **Amount** | ** ** | **of total** | ** ** | **Amount** | ** ** | **of total** | ** ** | **Amount** | ** ** | **of total** | ** ** | **Amount** | ** ** | **of total** | ** ** |
| ** **                       | ** ** | **(Dollars in  thousands)** |       | ** **          |
| Real estate loans:               |       |                        |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Residential (one-to four-family) |       | $                           | 1,311,606  |                | 50.9       | % | $ | 1,212,595 |   | 51.3 | % | $ | 896,479 |   | 51.3 | % | $ | 697,031 |   | 49.6 | % | $ | 629,779 |   | 47.7 | % | $ | 618,084 |   | 51.9 | % |
| Commercial                       |       | 337,277                     |       | 13.1                |       | 322,724 |   | 13.7 |   | 223,500 |   | 12.8 |   | 201,636 |   | 14.4 |   | 209,366 |   | 15.8 |   | 202,781 |   | 17.0 |   |
| Construction, net                |       | 108,556                     |       | 4.2                 |       | 109,360 |   | 4.6 |   | 71,735 |   | 4.1 |   | 66,373 |   | 4.7 |   | 63,189 |   | 4.8 |   | 59,178 |   | 5.0 |   |
| Home equity                      |       | 45,709                      |       | 1.8                 |       | 39,932 |   | 1.7 |   | 26,076 |   | 1.5 |   | 25,984 |   | 1.9 |   | 27,471 |   | 2.1 |   | 27,835 |   | 2.3 |   |
| Total real estate loans          |       | 1,803,148                   |       | 70.0                |       | 1,684,611 |   | 71.3 |   | 1,217,790 |   | 69.7 |   | 991,024 |   | 70.6 |   | 929,805 |   | 70.4 |   | 907,878 |   | 76.2 |   |
|                             |       |                        |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial loans                 |       | 115,562                     |       | 4.5                 |       | 100,789 |   | 4.3 |   | 66,360 |   | 3.8 |   | 58,829 |   | 4.2 |   | 50,344 |   | 3.8 |   | 43,496 |   | 3.7 |   |
|                             |       |                        |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer loans:                  |       |                        |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Indirect auto loans              |       | 601,884                     |       |                |       | 528,653 |   |   |   | 439,753 |   |   |   | 358,101 |   |   |   | 343,910 |   |   |   | 238,114 |   |   |   |
| Less: unearned discount (1)      |       | 1,651                       |       |                |       | 6,781 |   |   |   | 17,370 |   |   |   | 37,394 |   |   |   | 37,201 |   |   |   | 30,066 |   |   |   |
| Indirect auto loans, net         |       | 600,233                     |       | 23.3                |       | 521,872 |   | 22.1 |   | 422,383 |   | 24.2 |   | 320,707 |   | 22.8 |   | 306,709 |   | 23.2 |   | 208,048 |   | 17.5 |   |
| Other                            |       | 56,039                      |       | 2.2                 |       | 56,060 |   | 2.3 |   | 40,673 |   | 2.3 |   | 33,494 |   | 2.4 |   | 33,822 |   | 2.6 |   | 31,517 |   | 2.6 |   |
| Total consumer loans, net        |       | 656,272                     |       | 25.5                |       | 577,932 |   | 24.4 |   | 463,056 |   | 26.5 |   | 354,201 |   | 25.2 |   | 340,531 |   | 25.8 |   | 239,565 |   | 20.1 |   |
| Total loans                      |       | $                           | 2,574,982  |                | 100.0      | % | $ | 2,363,332 |   | 100.0 | % | $ | 1,747,206 |   | 100.0 | % | $ | 1,404,054 |   | 100.0 | % | $ | 1,320,680 |   | 100.0 | % | $ | 1,190,939 |   | 100.0 | % |

 

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(1)     Since January 1999, allindirect auto loans have been originated on a simple interest basis.  Accordingly, the balance of unearneddiscount will continue to decline as pre-1999 indirect auto loans are repaid.

 

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*LoanOrigination and Underwriting — Compass*.  Loan officers based in each of Compass’sfive regions — Plymouth, Fall River, New Bedford, Cape Cod and Martha’sVineyard — originate and underwrite mortgage and commercial loans. Compass alsoemploys external loan originators, based in each of the regions, who originateresidential mortgage loans.  Compassunderwrites consumer loans at its main office, although it originates suchloans at its branches and, in the case of indirect auto loans, through anetwork of car dealers located throughout its current market area, EasternMassachusetts and Rhode Island.

 

Compass’s loanunderwriting varies depending on the type of loan.  It generally includes the use of credit applications, propertyappraisals and verification of an applicant’s credit history, employment andbanking relationships to the extent management deems appropriate in eachcase.  With respect to indirect autoloans, car dealers originate the loans and transmit loan applications toCompass for underwriting.  Additionalinformation concerning the underwriting of specific types of loans is set forthin sections that discuss those loans.

 

Four senior loanofficers oversee loan origination and underwriting.  Individual loan officers may originate loans within certainapproved lending limits.  A creditcommittee, consisting of senior loan and credit officers, and Compass’s Boardof Directors, or the executive committee thereof, must approve all unsecuredcommercial loans over $1.25 million and all secured commercial loans, includingcommercial real estate loans, over $2.5 million.  Pursuant to its loan policy, Compass generally will not makeloans aggregating more than $12.5 million to any one borrower.  Exceptions to this “house” lending limitmust be approved by the Board.  AtDecember 31, 2001, no customers had aggregate borrowing capacity with Compassexceeding the $12.5 million house limit. Compass’s legal lending limit, which is set at 20% of its capital, wasapproximately $44 million at December 31, 2001.

 

*LoanOrigination and Underwriting — Nantucket Bank. *Loan originations come from a number of sources.  Most real estate loan originations areattributable to referrals from existing customers, real estate brokers,attorneys and builders as well as walk-in customers and officer calls.  Officer calls and referrals are importantsources of commercial and commercial mortgage loan originations.  Consumer loans generally are written withexisting depositors.

 

Each loanoriginated by Nantucket Bank is underwritten by its personnel with individuallending officers having the authority to approve loans up to specifiedlimits.  A credit committee, consistingof senior loan and other officers, must approve all loans that exceed $700,000and Nantucket Bank’s Board of Directors, or the executive committee thereof,must approve all loans over $1.2 million. Nantucket Bank will generally notmake loans to any one borrower with an aggregate balance in excess of its houselending limit of $2.5 million. At December 31, 2001, one customer had anaggregate loan balance in excess of such limit.  Nantucket Bank’s legal lending limit was approximately $6.5million at December 31, 2001.

 

Independentlicensed appraisers are used to appraise the property intended to secure realestate loans.  Nantucket Bank’sunderwriting criteria are designed to minimize the risks of each loan.  There are detailed guidelines concerning thetypes  of loans that may be made, thenature of the collateral required, the information that must be obtainedconcerning the loan applicant and follow-up inspections of collateral after theloan is made.

 

 

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The followingtable sets forth activity within the loan portfolio for the periods indicated:

 
|                                    |   | **Years  ended December 31,** |      |
|-----------------------------------------|--------|-------------------------------|-----------|
|                                    |   | **2001**                      |      | **2000  (1)** |   | **1999  (1)** |   |
|                                    |   | **(In thousands)**            |      |
| Loans  outstanding at beginning of year |   | $                             | 2,363,332 |   | $ | 1,747,206 |   | $ | 1,404,054 |   |
| Loans  originated:                      |   |                          |      |   |   |   |   |
| Real estate  loans:                     |   |                          |      |   |   |   |   |
| Residential                             |   | 479,061                       |      | 219,868 |   | 323,913 |   |
| Commercial                              |   | 78,042                        |      | 61,541 |   | 46,549 |   |
| Construction                            |   | 146,949                       |      | 116,067 |   | 100,725 |   |
| Home equity                             |   | 31,905                        |      | 20,973 |   | 16,592 |   |
| Total real estate loans                 |   | 735,957                       |      | 418,449 |   | 487,779 |   |
| Commercial loans                        |   | 82,072                        |      | 72,705 |   | 42,846 |   |
| Indirect auto  loans                    |   | 364,684                       |      | 307,645 |   | 260,043 |   |
| Other consumer  loans                   |   | 36,604                        |      | 34,460 |   | 27,550 |   |
| Total loans originated                  |   | 1,219,317                     |      | 833,259 |   | 818,218 |   |
| Purchases of  real estate loans         |   | —                        |      | 19,501 |   | 13,343 |   |
| Acquisition of  Nantucket Bank          |   | —                        |      | 275,918 |   | — |   |
| Less:                                   |   |                          |      |   |   |   |   |
| Principal  repayments                   |   | 930,091                       |      | 509,048 |   | 479,117 |   |
| Loans sold                              |   | 68,472                        |      | 1,505 |   | 6,899 |   |
| Increase in  loans held-for-sale        |   | 6,009                         |      | — |   | — |   |
| Transfers to  other real estate owned   |   | 832                           |      | 366 |   | 755 |   |
| Principal  charged-off                  |   | 2,263                         |      | 1,633 |   | 1,638 |   |
| Loans  outstanding at end of year       |   | $                             | 2,574,982 |   | $ | 2,363,332 |   | $ | 1,747,206 |   |

 

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(1)     Loan activity for these years do notinclude Nantucket Bank which was acquired on December 31, 2000.

 

The Banks chargeorigination fees, or points, and collect fees to cover the costs of appraisalsand credit reports on most new residential mortgage loans and on manycommercial real estate loans.  The Banksalso collect late charges on real estate and consumer loans.  For information regarding the recognition ofloan fees and costs, see Note 1 of the Notes to the Consolidated FinancialStatements.

 

*Loan Maturity and Repricing.*  The following table presents the contractualmaturity and repricing dates of the Banks’ loan portfolio at December 31, 2001.

 
|                                |   | **Real  estate loans** |      |           |   |             |   | **Other**        |    |           |   |
|-------------------------------------|--------|------------------------|-----------|----------------|--------|------------------|--------|------------------|---------|----------------|--------|
|                                |   | **Residential**        |      | **Commercial** |   | **Construction** |   | **Home  equity** |    | **Commercial** |   | **Indirect  auto loans** |   | **consumer  loans** |   | **Total   loans** |   |
|                                |   | **(In  thousands)**    |      |
| Within one year                     |   | $                      | 154,006   |           | $      | 85,030           |   | $                | 42,231  |           | $      | 45,221 |   | $ | 87,890 |   | $ | 168,922 |   | $ | 8,650 |   | $ | 591,950 |   |
| After one year:                     |   |                   |      |           |   |             |   |             |    |           |   |   |   |   |   |   |   |
| More than one year to three years   |   | 317,479                |      | 156,893        |   | 25,778           |   | 488              |    | 15,903         |   | 289,002 |   | 16,793 |   | 822,336 |   |
| More than three years to five years |   | 201,084                |      | 70,293         |   | 16,406           |   | —           |    | 8,389          |   | 134,296 |   | 15,457 |   | 445,925 |   |
| More than five years to ten years   |   | 163,785                |      | 11,907         |   | 8,461            |   | —           |    | 3,359          |   | 8,013 |   | 10,984 |   | 206,509 |   |
| More than ten years                 |   | 475,252                |      | 13,154         |   | 15,680           |   | —           |    | 21             |   | — |   | 4,155 |   | 508,262 |   |
| Total due afterDecember  31, 2002   |   | 1,157,600              |      | 252,247        |   | 66,325           |   | 488              |    | 27,672         |   | 431,311 |   | 47,389 |   | 1,983,032 |   |
| Total amount due                    |   | $                      | 1,311,606 |           | $      | 337,277          |   | $                | 108,556 |           | $      | 45,709 |   | $ | 115,562 |   | $ | 600,233 |   | $ | 56,039 |   | 2,574,982 |   |
| Less Allowance for loan losses      |   |                   |      |           |   |             |   |             |    |           |   |   |   |   |   | (29,513 | ) |
| Net loans                           |   |                   |      |           |   |             |   |             |    |           |   |   |   |   |   | $ | 2,545,469 |   |
|                                     |        |                        |           |                |        |                  |        |                  |         |                |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

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The followingtable sets forth the balances of loans at December 31, 2001, which arecontractually due or scheduled to reprice after December 31, 2002, segregatedbetween fixed and adjustable interest rates:

 

|                     |   | **Fixed**          |      | **Adjustable** |   | **Total** |   |
|--------------------------|--------|--------------------|-----------|----------------|--------|-----------|--------|
|                     |   | **(In thousands)** |
| Real estate  loans:      |   |               |      |           |   |      |   |
| Residential              |   | $                  | 724,974   |           | $      | 432,626   |   | $ | 1,157,600 |   |
| Commercial               |   | 36,518             |      | 215,729        |   | 252,247   |   |
| Construction             |   | 31,781             |      | 34,544         |   | 66,325    |   |
| Home equity              |   | —             |      | 488            |   | 488       |   |
| Total real  estate loans |   | 793,273            |      | 683,387        |   | 1,476,660 |   |
| Commercial loans         |   | 20,694             |      | 6,978          |   | 27,672    |   |
| Indirect auto  loans     |   | 431,311            |      | —         |   | 431,311   |   |
| Other consumer  loans    |   | 47,389             |      | —         |   | 47,389    |   |
| Total loans              |   | $                  | 1,292,667 |           | $      | 690,365   |   | $ | 1,983,032 |   |

 

*ResidentialReal Estate Loans*. As of December 31, 2001, adjustable rate loans represented approximately 44%and fixed rate loans represented approximately 56% of the Banks’ portfolio ofresidential real estate loans secured by one-to four-family residences.   Over 90% of this portfolio is secured bysingle-family, owner-occupied homes.

 

During the pastten years, Compass generally has sold most of the fixed rate residentialmortgage loans originated with terms of 15 years or longer to the Federal HomeLoan Mortgage Corporation (“FHLMC”). Compass continues to service loans that it has sold to FHLMC andreceives a monthly servicing fee equal to .25% per annum of the outstandingbalance.  Compass serviced loans forothers aggregating $287.7 million as of December 31, 2001 and $309.0 million asof December 31, 2000 and earned $506,000 and $689,000 in servicing fees, net ofthe amortization of capitalized mortgage servicing rights, representing 3.10%and 6.90%,  of its noninterest income in2001 and 2000, respectively.

 

From November 1998through September 2001, Compass did not sell fixed rate residential mortgageloans.  In September 2001, managementdetermined that it would sell a portion of its current fixed rate residentialmortgage loan originations with a term of 15 year or less on a servicingretained basis.  During the fourth quarterof 2001, Compass sold $43.9 million of such loans and recognized a gain on saleof $1.0 million.  This decision wasbased on the historically low interest rates which such loans currently yieldas well as general liquidity considerations.

 

It has generallybeen Nantucket Bank’s policy to sell most of its fixed rate residentialmortgage loans originated with terms greater than 10 years and a portion of itsadjustable rate residential mortgage loans on a servicing retained basis.  Loans serviced for others at December 31,2001 and 2000 amounted to $75.4 million and $73.7 million, respectively,excluding loans sold to and serviced for Compass.

 

Adjustable ratemortgage loans generally reprice either annually, or every three, five, orseven years and annually thereafter. The interest rate adjustments on theseloans are indexed to the applicable one-year or three-year U.S. Treasury CMTIndex with corresponding add-on margins of varying amounts generally rangingfrom 2.75% to 3.25%.  Such loans aresubject to certain requirements and limitations set forth in guidelines issuedby the Massachusetts Commissioner of Banks (“the Commissioner”), includinglimitations on the amount and frequency of interest rate changes.  Rates adjust by no more than one or twopercentage points in each adjustment period and by no more than five or sixpercentage points over the life of a loan.

 

Compass’s owneroccupied residential mortgage loans are generally written in amounts up to 95%of the appraised value or selling price, whichever is lower, of the propertysecuring the loan, although the majority of such loans are written with ratiosof 80% or less. Compass generally requires borrowers to obtain private mortgageinsurance with respect to loans with a greater than 80% loan-to-valueratio.  Nantucket Bank’s residentialmortgage loans are generally written with an original loan-to-value ratio of upto 80% of appraised value.

 

 

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The Banks eachmaintain programs to originate residential mortgage loans to low-to-moderateincome borrowers.  At Compass, the loanshave fixed or adjustable interest rates that are typically lower thanprevailing market rates, are closed without points, have substantially lowerclosing costs than other residential loans and have terms of up to 30years.  The loans may have up to a 97%loan-to-value ratio, although borrowers must obtain private mortgage insuranceif the loan-to-value ratio exceeds 80%. At Nantucket Bank, such loans are closed with no points and may haveloan-to-value ratios up to 90% without private mortgage insurance.  The Banks partially fund the loans withborrowings under either the Community Investment Program (“CIP”) or the NewEngland Fund (“NEF”) housing programs of the FHLB.  These programs permit borrowings from the FHLB at below marketrates to finance the loans.  The Bankshad $11.9 million of CIP-funded loans and $23.1 million of NEF-funded loans intheir residential loan portfolios as of December 31, 2001.

 

*CommercialReal Estate Loans*. The Banks make commercial real estate loans throughout their marketareas and  at December 31, 2001, had$337.3 million in commercial real estate loans in the loan portfolio,representing 13.1% of total loans.

 

Properties thatare used for borrowers’ businesses, such as small office buildings, golfcourses, restaurants, inns, retail facilities or multi-family incomeproperties, generally collateralize commercial real estate loans.  The loans typically have terms of up to 20years and interest rates which adjust over periods of one to five years basedon one of various rate indices. Commercial real estate loans with fixed interest rates have termsgenerally ranging from one to five years. The Banks consider the experience of management, cash flows andcollateral values when underwriting commercial real estate loans.  Compass and Nantucket Bank generally makecommercial real estate loans in an amount equal to no more than 75% of theappraised value of the property securing the loan and generally require theowners of businesses seeking commercial real estate loans to personallyguarantee those loans.

 

Commercial realestate lending entails greater credit risks than residential mortgage lendingto owner-occupants.  The repayent ofcommercial real estate loans depends on the business and financial condition ofthe borrower.  Changes in economicconditions or government regulations, which neither the Banks nor theirborrowers control, could have an adverse impact on the cash flows generated byproperties securing commercial real estate loans and on the value of suchproperties.

 

*ConstructionLoans*.  The Banks makeboth residential and commercial construction loans throughout their marketarea.  Compass typically makes the loansto either owner-borrowers who will occupy the properties (residentialconstruction) or licensed and experienced developers for the construction ofsingle-family home developments that generally have no more than 30 housinglots and, to a lesser extent, end users of commercial properties (commercial construction). Commercial constructionloans to end users are generally originated with permanent financing alreadycommitted.

 

The Banksgenerally increase the loan-to-value ratios on such loans as constructionprogresses.  Before any work hascommenced, and while a construction loan’s only collateral is a plot of land,Compass will typically finance only up to 70% of the value of that land.  Once construction has begun, Compass willgenerally make residential construction loans in amounts up to 90% (for primaryhomes) and 80% (for secondary homes) of the lesser of the appraised value ofthe property, as completed, or the property’s cost of construction.  Nantucket Bank generally makes constructionloans on owner-occupied primary or secondary residences up to 80% of appraisedvalue (up to 70% of land value).  TheBanks generally make commercial construction loans in amounts up to 75% of thelesser of the property’s appraised value, as completed, or construction costand generally require developers seeking commercial construction loans topersonally guarantee them.  The proceedsof construction loans are disbursed in stages and require either loan officersor appointed professionals to inspect each project’s progress before the Banksdisburse additional funds and to verify that borrowers have completed projectphases.

 

Residentialconstruction loans to owner-borrowers generally convert to a fully amortizinglong-term mortgage loan upon completion of construction.  Commercial construction loans generally haveterms of six months to a maximum of two years. The Banks had $108.6 million in construction loans in their loanportfolios, representing 4.2% of total loans, as of December 31, 2001.

 

 

7

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Constructionlending, particularly commercial construction lending, entails greater creditrisk than residential mortgage lending to owner-occupants. Economic events andchanges in government regulations, which neither the Banks nor their borrowerscontrol, could have an adverse impact on the value of properties securingconstruction loans and on the borrowers’ ability to complete projects financedand, if not the borrower’s residence, sell them for expected amounts at thetime the projects were commenced.

 

*HomeEquity Loans**.*These loans are revolving lines of credit andare typically secured by second mortgages on one- to four-family owner-occupiedproperties.  Interest rates on homeequity loans normally adjust based on the prime rate of interest.  The lines of credit are available for up toten years at the end of which they become term loans which are amortized forperiods up to 10 years.  The Banks donot originate home equity line of credit loans with loan-to-value ratios inexcess of 80%.  The Banks had $45.7million in home equity loans, representing 1.8% of the loan portfolio, as ofDecember 31, 2001.  The undrawn portionof home equity lines of credit totaled $50.5 million as of December 31, 2001

 

*CommercialLoans**.*The Banks primarily make commercial loans to businessesthat operate in and around their primary market area of SoutheasternMassachusetts including Nantucket, Martha’s Vineyard and Cape Cod.

 

The Banks reviewthe financial resources, debt-to-equity ratios, cash flows and their ownexperience with businesses when underwriting commercial loans and generallyrequire business owners to personally guarantee commercial loans.  Commercial loans are generallycollateralized by equipment, leases, inventory and/or accounts receivable.  Many commercial loans are alsocollateralized by real estate, but are not classified as commercial real estateloans because such loans are not made for the purpose of acquiring, refinancingor constructing the real estate partially securing the loan.  Commercial loans provide, among otherthings, working capital, equipment financing, financing for leaseholdimprovements and financing for acquisitions. The Banks offer both term and revolving commercial loans.  The former have either fixed or adjustablerates of interest and, generally, terms of between four and seven years.  Term loans generally amortize during theirlife, although some loans require a lump sum payment at maturity.  Revolving commercial lines of credittypically have one-year terms, renewable annually, and rates of interest whichare normally indexed to the prime rate of interest.

 

Commercialborrowers are not concentrated in any one particular industry.  As of December 31, 2001, the commercial loanportfolio included, among others, floor plan loans to auto dealerships, loansto hotels, inns and other tourism-related businesses, loans to golf courses,loans to building trade companies and loans to retailers.  As of December 31, 2001 the Banks had $115.6million in commercial loans, representing 4.5% of the loan portfolio.

 

Commercial lendingentails greater credit risks than residential mortgage lending toowner-occupants.  Repayment of bothsecured and unsecured commercial loans depends substantially on the borrower’sunderlying business, financial condition and cash flows.  Unsecured loans generally involve a higherdegree of risk of loss than do secured loans because, without collateral,repayment is wholly dependent upon the success of the borrower’s business.  Secured commercial loans are generallycollateralized by equipment, leases, inventory and/or accounts receivable.

 

*IndirectAuto and Other Consumer Loans*.  Compass emphasizes indirect auto lending through a network ofover 200 car dealers.  Compass has beenin the indirect auto lending business since 1985 and has increased itsportfolio of indirect auto loans  to$600.2 million at December 31, 2001, or 23.3% (net of unearned discount) of theloan portfolio.  In developing itsnetwork, Compass has historically focused on dealers in its primary market areasand in Rhode Island.  Because ofincreasing competition for these loans in its market area and management’sintent to continue to increase this portion of the loan portfolio, Compass hasexpanded its network of car dealers to communities throughout EasternMassachusetts.

 

Compass makesindirect auto loans collateralized by both new and used cars.  The loans have terms of up to six years forthose secured by new vehicles and five and a half years for those secured byused vehicles.  As of December 31, 2001,approximately half of Compass’s indirect auto loans were secured by new carloans.  Compass does not engage in autolease financing.

 

 

8

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In connection withthe origination of indirect auto loans, the interest rate charged to theborrower by the dealer is generally one to two percentage points higher thanthe “buy rate” or rate earned by Compass. The difference between the two rates is referred to as the “spread”.  At loan inception, the computed dollar valueof the spread is prepaid by Compass to the car dealer.  Such prepaid amounts are generally subjectto rebate in the event the underlying loan is prepaid or defaults. In recentyears, more dealers have opted to receive either a reduced spread or a flat feein exchange for elimination of their rebate obligation.  The dealer’s ability to refund any portionof the unearned prepaid interest, which amounted to $15.3 million at December31, 2001, is subject to economic conditions generally, and the financial conditionof the dealer.  To mitigate this risk,Compass withholds a portion of the spread at loan origination as a dealerreserve.  The amount withheld, in theaggregate, generally approximates 1% of the outstanding balance of loansoriginated by each dealer.  At December31, 2001, the balance of the dealer reserve was $5.2 million, or 0.9% of thebalance of indirect auto loans.

 

Indirect autolending entails greater risks than residential mortgage lending toowner-occupants.  Although Compass hasnot historically experienced significant delinquencies in this portfolio,borrowers may be more likely to become delinquent on a car loan than on aresidential mortgage loan secured by their primary residence.  Moreover, car values depreciate rapidly and,in the event of default, principal loss as a percentage of the loan balancedepends upon the mileage and condition of the vehicle at the time ofrepossession, factors over which Compass has no control.

 

The Banks  make a variety of other consumer loans,including fixed rate home equity loans, personal installment loans, educationloans, and passbook loans.  The Banks donot offer credit card loans.  Otherconsumer loans totaled $56.0 million, or 2.2% of the loan portfolio, as ofDecember 31, 2001.

 

**Delinquent Loans and Loan Review**

 

*DelinquentLoans.* Compass’s Managed Asset Group performs a monthlyreview of all delinquent loans with a principal balance in excess of $150,000and reviews the status of each account with the appropriate Lending DepartmentManager and/or Account Officer.  Inaddition, Compass’s Board of Directors reviews delinquency statistics, by loantype, on a monthly basis.  NantucketBank’s Loan Review Committee, which includes all of its loan officers and otherofficers and directors , reviews the status of all delinquent borrowers on amonthly basis.  Nantucket Bank’s Boardof Directors and/or Executive Committee thereof reviews all loans past due twoor more payments each month.

 

The actions takenwith respect to delinquencies vary depending upon the nature of the delinquentloans and the period of delinquency. The Banks’ asset management philosophy is predicated upon earlydetection and response to delinquent and default situations.  The Banks seek to make arrangements to cure the entire default over the shortesttime frame.  Generally, the Banksrequire that a delinquency notice be mailed no later than the 10th day ofdelinquency.  A second notice is mailedon the 15th day of delinquency.   A latecharge is usually assessed on loans where the scheduled payment is unpaid after15 days.  After mailing the delinquencynotices, the Banks’ asset management staff call the borrower to ascertain thereasons for delinquency and the prospects for payment.  On loans secured by one- to four-familyowner- occupied properties, the Banks attempt to work out a payment schedule with the borrower in order toavoid foreclosure.  If these efforts donot achieve a satisfactory arrangement, the loan is referred to legal counseland counsel initiates foreclosure proceedings. At any time prior to a sale of the property at foreclosure, the Bankswill terminate foreclosure proceedings if the borrower is able to work out asatisfactory payment plan.  On loanssecured by commercial real estate properties, the Banks also seek to reach asatisfactory payment plan so as to avoid foreclosure.  Prior to foreclosure, the Banks will generally obtain an updatedappraisal of the property.

 

 

9

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The followingtable sets forth a summary of certain delinquency information as of the datesindicated:

 
|                            |   | **At  December 31, 2001**   |   | **At  December 31, 2000** |   |
|---------------------------------|--------|-----------------------------|--------|---------------------------|--------|
|                            |   | **60-89  days**             |   | **90 days  or more**      |   | **60-89  days** |   | **90 days  or more** |   |
|                            |   | **Number  of loans**        |   | **Principal  balance**    |   | **Number  of loans** |   | **Principal  balance** |   | **Number  of loans** |   | **Principal  balance** |   | **Number  of loans** |   | **Principal  balance** |   |
|                            |   | **(Dollars  in thousands)** |   |
| Real estate loans:              |   |                        |   |                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Residential                     |   | 8                           |   | $                         | 546    |   | 58 |   | $ | 5,886 |   | 26 |   | $ | 2,373 |   | 32 |   | $ | 1,956 |   |
| Commercial                      |   | 1                           |   | 19                        |   | 18 |   | 2,608 |   | 4 |   | 203 |   | 12 |   | 1,333 |   |
| Construction                    |   | 1                           |   | 653                       |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Home equity                     |   | 7                           |   | 350                       |   | 9 |   | 209 |   | 2 |   | 53 |   | 8 |   | 415 |   |
| Commercial loans                |   | 5                           |   | 68                        |   | 28 |   | 3,318 |   | 8 |   | 494 |   | 7 |   | 476 |   |
| Indirect auto loans             |   | 257                         |   | 2,450                     |   | 119 |   | 1,001 |   | 131 |   | 1,164 |   | 61 |   | 655 |   |
| Other consumer loans            |   | 20                          |   | 173                       |   | 1 |   | 15 |   | 37 |   | 85 |   | 13 |   | 40 |   |
| Total                           |   | 299                         |   | $                         | 4,259  |   | 233 |   | $ | 13,037 |   | 208 |   | $ | 4,372 |   | 133 |   | $ | 4,875 |   |
|                            |   |                        |   |                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Delinquent loans to total loans |   |                        |   | 0.17                      | %      |   |   | 0.51 | % |   |   | 0.18 | % |   |   | 0.21 | % |

 

*LoanReview.*  The Banks**use an internal rating system to monitorand evaluate the credit risk inherent in their loan portfolios and to identifypotential problem loans.  At the time ofloan approval, all commercial, commercial real estate and commercialconstruction loans are assigned a rating based on all of the factors consideredin originating the loan.  The initialloan rating is recommended by the loan officer who originated the loan andapproved by the individuals or committee responsible for approving it.

 

Loan qualityratings are utilized as major criteria in the compilation of the Asset WatchList.  All loans with loan ratings of 4(Special Mention), 5 (Substandard) or 6 (Doubtful) are included in a monthlyAsset Watch List.  Watch List ratingsare an integral part of the evaluation of the adequacy of the loan lossreserve. Loan officers are expected to submit appropriate rating changes whenfacts come to their attention that warrant an upgrade or downgrade in a loanrating.  In addition, loan ratings aregenerally reviewed on an annual basis.

 

Loans that arerated Substandard or Doubtful coincide with the classifications used by federalregulators in their examination of financial institutions.  Generally, a loan is considered Substandardif it is inadequately protected by the current net worth and paying capacity ofthe borrowers and/or the collateral pledged. Substandard loans include those characterized by the distinctpossibility that the Banks will sustain some loss if the deficiencies are notcorrected.  Loans classified as Doubtfulhave all the weaknesses inherent in those classified Substandard with the addedcharacteristic that the weaknesses present make collection or liquidation infull, on the basis of currently existing facts, highly questionable andimprobable.  Loans classified as Lossare those considered uncollectible and of such little value that theircontinuance as assets without establishment of a specific loss reserve and/orcharge-off is not warranted.  Loanswhich do not currently expose the Banks to sufficient risk to warrant classification in one of theaforementioned categories but possess weaknesses are designated SpecialMention.

 

Compass alsoutilizes an independent third party to conduct periodic (generally semi-annual)credit analysis of its commercial and commercial real estate loan portfoliosand to analyze trends in loan delinquency and non-performing loans.  The level of Classified Loans as determinedby Compass is reconciled to the level of Classified Loans as determined by theindependent loan review.

 

On a quarterlybasis (monthly at Nantucket Bank), a management group at each bank comprised ofsenior officers reviews the status and classification of each loan assigned arating of Substandard, Doubtful or Loss. Loans, or portions of loans, classified Loss are charged off against theallowance for loan losses.  These groupsalso assess the overall adequacy of the allowance for loan losses at each bank,including the general valuation allowance established to recognize the inherentrisk associated with each specific category of lending.

 

In January 2001, the Company’s Board of Directorsformed a Risk Management Committee at which time the position of Senior CreditOfficer at Compass was created.  TheSenior Credit Officer is responsible for all administrative matters related tothe credit function at Compass and provides management and the Board ofDirectors with such information as loan concentrations, risk rating migration,compliance and tracking of exceptions.

 

 

10

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The classification of loans and the amount of thevaluation allowances set aside for estimated losses is subject to review by theFDIC and the Commissioner.  Based ontheir reviews, these agencies can order the establishment of additional generalor specific loss allowances.  The FDIC,in conjunction with the other federal banking agencies, has adopted aninteragency policy statement on allowances for loan and lease losses.  The policy statement provides guidance forbanks on both the responsibilities of management for the assessment andestablishment of adequate allowances and guidance for banking agency examinersto use in determining the adequacy of a bank’s valuation methodology.  Generally, the policy statement recommendsthat banks have effective systems and controls to identify, monitor and addressasset quality problems; that management analyze all significant factors thataffect the collectibility of loans in a reasonable manner; and that managementestablish acceptable valuation processes that meet the objectives set forth inthe policy statement.  While the Banksbelieve that they have established adequate specific and general allowances forlosses on loans, actual losses are dependent upon future events and, as such,further additions to the allowance for loan losses may become necessary.  See “— Allowance for Loan Losses.”

 

At December 31, 2001, loans designated as Substandardbut which were not classified as non-accrual loans totaled $7.5 million.  Of these potential problem loans, $6.4million were commercial real estate loans and all but $827,000 werecontractually past due less than 60 days.

 

**Non-Accrual Loans, Non-PerformingAssets and Restructured Loans**

 

The following table sets forth information regardingnon-performing assets:

 
|                                                                      |   | **At  December 31,**        |   | **At  October 31,** |   |
|---------------------------------------------------------------------------|--------|-----------------------------|--------|---------------------|--------|
|                                                                      |   | **2001**                    |   | **2000**            |   | **1999** |   | **1998** |   | **1997** |   |
|                                                                      |   | **(Dollars  in thousands)** |   |
| Non-accrual loans (1):                                                    |   |                        |   |                |   |   |   |   |   |   |   |
| Real estate loans:                                                        |   |                        |   |                |   |   |   |   |   |   |   |
| Residential                                                               |   | $                           | 5,875  |                | $      | 3,237 |   | $ | 2,591 |   | $ | 3,685 |   | $ | 4,286 |   |
| Commercial                                                                |   | 3,363                       |   | 2,312               |   | 2,613 |   | 2,330 |   | 8,957 |   |
| Construction                                                              |   | —                      |   | 47                  |   | 56 |   | 42 |   | 220 |   |
| Home equity                                                               |   | —                      |   | —              |   | — |   | 42 |   | 82 |   |
| Commercial loans                                                          |   | 4,170                       |   | 511                 |   | 474 |   | 415 |   | 919 |   |
| Indirect auto loans (4)                                                   |   | —                      |   | —              |   | — |   | — |   | — |   |
| Other consumer loans (4)                                                  |   | —                      |   | —              |   | — |   | — |   | — |   |
| Total non-accrual loans                                                   |   | 13,408                      |   | 6,107               |   | 5,734 |   | 6,514 |   | 14,464 |   |
| Restructured loans (2)                                                    |   | —                      |   | —              |   | — |   | — |   | 235 |   |
| Other real estate owned and repossessed autos                             |   | 1,075                       |   | 86                  |   | 552 |   | 1,299 |   | 2,303 |   |
| Total non-performing assets                                               |   | $                           | 14,483 |                | $      | 6,193 |   | $ | 6,286 |   | $ | 7,813 |   | $ | 17,002 |   |
|                                                                      |   |                        |   |                |   |   |   |   |   |   |   |
| Accruing loans 90 days overdue                                            |   | $                           | 1,320  |                | $      | 1,446 |   | $ | 1,776 |   | $ | 668 |   | $ | 615 |   |
|                                                                      |   |                        |   |                |   |   |   |   |   |   |   |
| Allowance for loan losses as a percent of total loans                     |   | 1.15                        | %      | 1.06                | %      | 0.96 | % | 1.14 | % | 1.24 | % |
| Allowance for loan losses as a percent of total non-performing loans  (3) |   | 220.11                      | %      | 410.69              | %      | 293.48 | % | 232.07 | % | 101.92 | % |
| Non-performing loans as a percent of total loans                          |   | 0.52                        | %      | 0.26                | %      | 0.33 | % | 0.49 | % | 1.21 | % |
| Non-performing assets as a percent of total assets                        |   | 0.43                        | %      | 0.21                | %      | 0.30 | % | 0.43 | % | 1.03 | % |

 

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(1)               Non-accrual loans include loans 90 days ormore past due and other loans which have been identified as presentinguncertainty with respect to the collectibility of interest or principal.  See Note 4 for exception to this policy.

 

(2)               Restructured loans represent performing loansfor which concessions (such as reductions of interest rates to below marketterms and/or extension of repayment terms) have been granted due to borrower’sfinancial condition.  The balancespresented exclude restructured loans on non-accrual status.

 

(3)               Non-performing loans are comprised ofnon-accrual loans and restructured loans.

 

(4)               Consumer loans, including indirect auto loans,are not placed on non-accrual status due to the expedited manner in which theseloans are resolved and the immaterial balance of individual loans.

 

 

11

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**Allowance for Loan Losses**

 

The allowance for loan losses is established throughprovisions for loan losses based on management’s on-going evaluation of therisks inherent in the loan portfolio. Factors considered in the evaluation process include growth of the loanportfolio, the risk characteristics of the types of loans in the portfolio,geographic and large borrower concentrations, current regional economic andreal estate market conditions that could affect the ability of borrowers topay, the value of underlying collateral and trends in loan delinquencies andcharge-offs.  The allowance for loanlosses is maintained at an amount management considers adequate to coverestimated losses in the loan portfolio which are deemed probable and estimablebased on information currently known to management.  See “ — Delinquent Loans and Loan Review.”

 

The following table sets forth activity in the allowance for loanlosses for the periods indicated:

 
|                                      |     | **Years  ended December 31,** |       | **Years  ended October 31,** |     |
|-------------------------------------------|----------|-------------------------------|------------|------------------------------|----------|
|                                      | **2001** |                          | **2000**   |                         | **1999** |   | **1998** |   | **1997** |   |
|                                      |     | **(In  thousands)**           | ** ** |
| Balance at beginning of period            |     | $                             | 25,081     |                         | $        | 16,828 |   | $ | 15,914 |   | $ | 14,742 |   | $ | 14,075 |   |
| Provision for loan losses                 |     | 6,175                         |       | 4,775                        |     | 2,000 |   | 1,736 |   | 2,615 |   |
| Acquired reserves                         |     | —                        |       | 4,557                        |     | — |   | — |   | — |   |
| Charge-offs:                              |     |                          |       |                         |     |   |   |   |   |   |   |
| Mortgage loans:                           |     |                          |       |                         |     |   |   |   |   |   |   |
| Residential                               |     | 2                             |       | 36                           |     | — |   | 229 |   | 196 |   |
| Commercial                                |     | 22                            |       | —                       |     | — |   | 371 |   | 785 |   |
| Home equity                               |     | —                        |       | —                       |     | — |   | 49 |   | — |   |
| Construction                              |     | —                        |       | —                       |     | — |   | — |   | — |   |
| Commercial loans                          |     | 687                           |       | 158                          |     | 379 |   | 213 |   | 688 |   |
| Indirect auto loans                       |     | 1,438                         |       | 1,323                        |     | 1,116 |   | 614 |   | 546 |   |
| Other consumer loans                      |     | 114                           |       | 116                          |     | 143 |   | 124 |   | 199 |   |
|                                      |     |                          |       |                         |     |   |   |   |   |   |   |
| Total charge-offs                         |     | 2,263                         |       | 1,633                        |     | 1,638 |   | 1,600 |   | 2,414 |   |
|                                      |     |                          |       |                         |     |   |   |   |   |   |   |
| Recoveries:                               |     |                          |       |                         |     |   |   |   |   |   |   |
| Mortgage loans:                           |     |                          |       |                         |     |   |   |   |   |   |   |
| Residential                               |     | 169                           |       | 179                          |     | 5 |   | 32 |   | 73 |   |
| Commercial                                |     | 4                             |       | 59                           |     | 6 |   | 41 |   | 134 |   |
| Home equity                               |     | —                        |       | —                       |     | — |   | 3 |   | — |   |
| Construction                              |     | —                        |       | —                       |     | — |   | — |   | — |   |
| Commercial loans                          |     | 82                            |       | 46                           |     | 300 |   | 213 |   | 75 |   |
| Indirect auto loans                       |     | 216                           |       | 235                          |     | 185 |   | 113 |   | 144 |   |
| Other consumer loans                      |     | 49                            |       | 35                           |     | 56 |   | 114 |   | 40 |   |
|                                      |     |                          |       |                         |     |   |   |   |   |   |   |
| Total recoveries                          |     | 520                           |       | 554                          |     | 552 |   | 516 |   | 466 |   |
|                                      |     |                          |       |                         |     |   |   |   |   |   |   |
| Net charge-offs                           |     | (1,743                        | )          | (1,079                       | )        | (1,086 | ) | (1,084 | ) | (1,948 | ) |
|                                      |     |                          |       |                         |     |   |   |   |   |   |   |
| Effect of difference in year-ends         |     | —                        |       | —                       |     | — |   | (277 | ) | — |   |
|                                      |     |                          |       |                         |     |   |   |   |   |   |   |
| Balance at end of period                  |     | $                             | 29,513     |                         | $        | 25,081 |   | $ | 16,828 |   | $ | 15,117 |   | $ | 14,742 |   |
|                                      |     |                          |       |                         |     |   |   |   |   |   |   |
| Ratio of net charge-offs to average loans |     | 0.07                          | %          | 0.06                         | %        | 0.07 | % | 0.09 | % | 0.17 | % |

 

 

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The allowance for loan losses is available foroffsetting credit losses in connection with any loan, but is internallyallocated among loan categories as part of the process for evaluating theadequacy of the allowance for loan losses. The following table sets forth information concerning the allocation ofthe allowance for loan losses at the dates indicated:

 
| ** **              | ** ** | **At December 31,**        | ** ** |
|-------------------------|------------|----------------------------|------------|
| ** **              | ** ** | **2001**                   | ** ** | **2000** | ** ** | **1999** | ** ** |
| ** **              | ** ** | **Amount**                 | ** ** | **Percent of  allowance  to total  allowance** | ** ** | **Percent  of loans  to total  loans** | ** ** | **Amount** | ** ** | **Percent of allowance   to total allowance** | ** ** | **Percent  of loans  to total  loans** | ** ** | **Amount** | ** ** | **Percent of  allowance  to total  allowance** | ** ** | **Percent  of loans  to total  loans** | ** ** |
| ** **              | ** ** | **(Dollars in thousands)** | ** ** |
| Mortgage loans:         |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Residential             |       | $                          | 6,158      |   | 20.9 | % | 50.9 | % | $ | 6,088 |   | 24.3 | % | 51.3 | % | $ | 4,455 |   | 26.5 | % | 51.3 | % |
| Commercial real  estate |       | 9,060                      |       | 30.7 |   | 13.1 |   | 7,341 |   | 29.2 |   | 13.7 |   | 5,311 |   | 31.6 |   | 12.8 |   |
| Construction            |       | 1,067                      |       | 3.6 |   | 4.2 |   | 912 |   | 3.6 |   | 4.6 |   | 547 |   | 3.3 |   | 4.1 |   |
| Home equity             |       | 430                        |       | 1.5 |   | 1.8 |   | 375 |   | 1.5 |   | 1.7 |   | 197 |   | 1.2 |   | 1.5 |   |
| Commercial loans        |       | 4,162                      |       | 14.1 |   | 4.5 |   | 2,627 |   | 10.5 |   | 4.3 |   | 1,933 |   | 11.5 |   | 3.8 |   |
| Indirect auto  loans    |       | 5,345                      |       | 18.1 |   | 23.3 |   | 4,713 |   | 18.8 |   | 22.1 |   | 3,855 |   | 22.9 |   | 24.2 |   |
| Other consumer  loans   |       | 854                        |       | 2.9 |   | 2.2 |   | 825 |   | 3.3 |   | 2.3 |   | 530 |   | 3.0 |   | 2.3 |   |
| Unallocated             |       | 2,437                      |       | 8.2 |   | — |   | 2,200 |   | 8.8 |   | — |   | — |   | — |   | — |   |
| Total                   |       | $                          | 29,513     |   | 100.0 | % | 100.0 | % | $ | 25,081 |   | 100.0 | % | 100.0 | % | $ | 16,828 |   | 100.0 | % | 100.0 | % |
|                         |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                    |     | **At October 31,**         |     |                                           |
|-------------------------|----------|----------------------------|----------|------------------------------------------------|
|                    | **1998** |                       | **1997** |                                           |   |
|                    |     | **Amount**                 |     | **Percent of  allowance  to total  allowance** |   | **Percent of  loans  to total  loans** |   | **Amount** |   | **Percent of  allowance  to total  allowance** |   | **Percent  of loans  to total  loans** |   |   |
|                    |     | **(Dollars in thousands)** |     |                                           |
| Mortgage loans:         |     |                       |     |                                           |   |   |   |   |   |   |   |   |   |   |
| Residential             |     | $                          | 3,548    |                                           | 23.5 | % | 47.7 | % | $ | 3,542 |   | 24.0 | % | 51.9 | % |   |
| Commercial real  estate |     | 5,434                      |     | 35.9                                           |   | 15.8 |   | 5,968 |   | 40.5 |   | 17.0 |   |   |
| Construction            |     | 818                        |     | 5.4                                            |   | 4.8 |   | 716 |   | 4.8 |   | 5.0 |   |   |
| Home equity             |     | 220                        |     | 1.5                                            |   | 2.1 |   | 217 |   | 1.5 |   | 2.3 |   |   |
| Commercial loans        |     | 1,767                      |     | 11.7                                           |   | 3.8 |   | 2,021 |   | 13.7 |   | 3.7 |   |   |
| Indirect auto  loans    |     | 2,837                      |     | 18.8                                           |   | 23.2 |   | 1,837 |   | 12.5 |   | 17.5 |   |   |
| Other consumer  loans   |     | 493                        |     | 3.2                                            |   | 2.6 |   | 441 |   | 3.0 |   | 2.6 |   |   |
| Total                   |     | $                          | 15,117   |                                           | 100.0 | % | 100.0 | % | $ | 14,742 |   | 100.0 | % | 100.0 | % |
|                         |          |                            |          |                                                |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Allocated reserves for loan losses are determinedusing both a formula-based approach applied to groups of loans and an analysisof certain individual loans for impairment.

 

The formula-based approach evaluates groups of loansto determine the allocation appropriate within each portfolio segment.  Individual loans within the real estate(residential, commercial, construction, and home equity), commercial andconsumer (indirect auto and other consumer) loan portfolio segments are assignedinternal risk ratings to group them with other loans possessing similar creditrisk characteristics.  The level ofreserve apportionable to each group of risk-rated loans is then determined bymanagement applying a loss factor that estimates the amount of probable loss ineach category.  The assigned loss factorfor each risk rating is a formula based assessment of historical loss data,portfolio characteristics, economic trends, overall market conditions, pastexperience, and management’s subjective analysis of considerations of probableloan loss based on these factors. Allocations for loan categories are then determined by applying lossfactors that represent management’s estimate of inherent losses in thosecategories to the appropriate loan balances outstanding.

 

The other method used to allocate the reserve for loanlosses entails the assignment of reserve amounts to individual loans on thebasis of loan impairment.  Certain loansare evaluated individually and are judged to be impaired when managementbelieves it is probable that the Company will not collect all of thecontractual interest and principal payments as scheduled in the loanagreement.  Under this method loans areselected for evaluation based on a change in internal risk rating, occurrenceof delinquency, loan classification or non-accrual status.  An identifiable reserve amount is allocatedto an individual loan when such loan has been deemed impaired and when theamount of a probable loss is estimable on the basis of fair value ofcollateral, present value of anticipated future cash flows or the loansobservable fair market price.  Loanswith an identifiable reserve and the amount of such reserve totaled $6,177,002and $2,465,765 at December 31, 2001, respectively.

 

 

13

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A portion of the reserve for loan loss is notallocated to any specific segment of the loan portfolio.  This unallocated reserve is maintained fortwo primary reasons; there exists an inherent subjectivity and imprecision tothe analytical processes employed and the prevailing business environment, asit is affected by changing economic conditions and various external factors,which may impact the portfolio in ways currently unforeseen.  Moreover, management has identified certainrisk factors, which could impact the degree of loss sustained within theportfolio.  These include: market riskfactors, such as the effects of economic variability on the entire portfolio,and unique portfolio risk factors that are inherent characteristics of theCompany’s loan portfolio.  Market riskfactors may consist of changes to general economic and business conditions thatmay impact the Company’s loan portfolio customer base in terms of ability torepay and that may result in changes in value of underlying collateral.  Unique portfolio risk factors may includeindustry concentration or covariant industry concentrations, geographicconcentrations, or trends that may exacerbate losses resulting from economicevents which the Company may not be able to fully diversify out of itsportfolio.  Management, therefore, hasestablished and maintains an unallocated reserve for loan losses.  The amount of this unallocated reserve was$2.4 million at December 31, 2001, compared to $2.2 million at December 31,2000.

 

As of December 31, 2001, the reserve for loan lossestotaled $29.5 million as compared to $25.1 million at December 31, 2000.  Based on the processes described above,management believes that the level of the reserve for loan losses at December31, 2001 is adequate.

 

**Investment Activities**

 

The primary objectives of the investment portfolio areto achieve a competitive rate of return over a reasonable period of time and toprovide liquidity.  In view of theBanks’  lending capacity and generallyhigher rates of return on loans, management prefers lending activities as itsprimary source of revenue with the securities portfolio serving a secondaryrole. The investment portfolio, however, is expected to continue to represent ameaningful (not less than 10%)  portionof total assets.

 

The current investment strategy has emphasized thepurchase of  U.S. Government and agencyobligations and corporate bonds generally maturing or callable within two tofive years.   The investment policypermits investments in mortgage-backed investments which typically have longerweighted average lives.

 

At December 31, 2001, the Company had $467.2 million,or 14.0% of total assets, in securities consisting primarily of  U.S. Government and agency obligations ($263.2million), corporate bonds ($89.5 million), mortgage-backed investments ($50.9million), and marketable equity securities ($17.2 million).  Also included in investments is $40.8million in restricted equity securities, $40.4 million of which is in the stockof the FHLB. To avail itself of services offered by that organization, inparticular the ability to borrow funds, the Banks are required to invest in thestock of the FHLB in an amount determined on the basis of their residentialmortgage loans and borrowings from the FHLB. The stock is redeemable at par andearns dividends at the discretion of the FHLB.

 

Statement of Financial Accounting Standards (SFAS) No.115 requires the Company to designate its securities as either held tomaturity, available for sale or trading depending on management’s intent at thetime of purchase.  As of December 31,2001, $405.8 million, or 86.9% of the portfolio, was classified as availablefor sale, $20.6 million, or 4.4% of the portfolio was classified as held tomaturity and $40.8 million, or 8.7% of the portfolio was invested in restrictedequity securities.  As of December 31,2001, the net unrealized gain on securities classified as available for salewas $5.9 million, consisting of net unrealized gains of $2.1 million onmarketable equity securities and $3.8 million on debt securities.

 

The Company’s investment policy requires thatcorporate bonds be rated “A” or better at the time of purchase.  Due to a subsequent adjustment in creditrating, the portfolio of corporate bonds included one issue with a carryingvalue of $1.8 million at December 31, 2001 which was rated below investmentgrade.  The issuer of such bond isneither in default as to the payment of interest nor has declaredbankruptcy.  This bond traded at 89.2%of par value at December 31, 2001.  Inthe opinion of management, no writedown in carrying value was required atDecember 31, 2001.

 

 

14

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The following table sets forth a summary of theCompany’s investment securities at the dates indicated:

 
|                                    |     | **At December 31,** |     |
|-----------------------------------------|----------|---------------------|----------|
|                                    | **2001** |                | **2000** |   | **1999** |   |
|                                    |     | **(In thousands)**  |     |
| Securities  available for sale:         |     |                |     |   |   |   |   |
| Debt securities:                        |     |                |     |   |   |   |   |
| U.S. Government  and agency obligations |     | $                   | 248,221  |   | $ | 123,352 |   | $ | 113,644 |   |
| Corporate bonds                         |     | 89,137              |     | 44,737 |   | 39,055 |   |
| State and  municipal obligations        |     | 1,584               |     | 950 |   | — |   |
| Mortgage-backed  investments            |     | 49,610              |     | 67,430 |   | 82,921 |   |
| Total debt  securities                  |     | 388,552             |     | 236,469 |   | 235,620 |   |
| Marketable  equity securities           |     | 17,236              |     | 12,386 |   | 9,963 |   |
| Total securities  available for sale    |     | $                   | 405,788  |   | $ | 248,855 |   | $ | 245,583 |   |
|                                    |     |                |     |   |   |   |   |
| Securities held  to maturity:           |     |                |     |   |   |   |   |
| U.S. Government  and agency obligations |     | $                   | 14,975   |   | $ | 22,569 |   | $ | 12,408 |   |
| Corporate bonds                         |     | 403                 |     | 800 |   | — |   |
| State and  municipal obligations        |     | 3,854               |     | 4,036 |   | — |   |
| Mortgage-backed  investments            |     | 1,319               |     | 2,323 |   | — |   |
| Total securities  held to maturity      |     | $                   | 20,551   |   | $ | 29,728 |   | $ | 12,408 |   |
|                                    |     |                |     |   |   |   |   |
| Restricted  equity securities:          |     |                |     |   |   |   |   |
| Federal Home  Loan Bank of Boston stock |     | $                   | 40,394   |   | $ | 28,505 |   | $ | 14,478 |   |
| Other                                   |     | 443                 |     | 469 |   | 458 |   |
| Total restricted  equity securities     |     | $                   | 40,837   |   | $ | 28,974 |   | $ | 14,936 |   |
|                                    |     |                |     |   |   |   |   |
| Total investment  securities            |     | $                   | 467,176  |   | $ | 307,557 |   | $ | 272,927 |   |
| Percent of total  assets                |     | 13.96               | %        | 10.64 | % | 12.86 | % |

 

15

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The following table sets forth the book value,fully-taxable weighted average yield and contractual maturities of  investment securities as of December 31,2001:

 
| ** **                                    | ** ** | **One year or  less**       | ** ** | **After one  year********through five years** | ** ** | **After five  years********through ten years** | ** ** | **After ten  years** | ** ** | **Total**       | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|-----------------------------------------------|------------|------------------------------------------------|------------|----------------------|------------|-----------------|------------|
| ** **                                    | ** ** | **Book  value**             | ** ** | **Yield**                                     | ** ** | **Book  value**                                | ** ** | **Yield**            | ** ** | **Book  value** | ** ** | **Yield** | ** ** | **Book  value** | ** ** | **Yield** | ** ** | **Book  value** | ** ** | **Yield** | ** ** |
| ** **                                    | ** ** | **(Dollars in  thousands)** | ** ** |
| Securities available for sale:                |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   |   |   |   |   |
| Debt securities:                              |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and agency bonds              |       | $                           | 82,370     |                                          | 3.61       | %                                              | $          | 79,646               |       | 4.57            | %          | $ | 82,472 |   | 6.14 | % | $ | 3,733 |   | 6.60 | % | $ | 248,221 |   | 4.81 | % |
| Corporate bonds                               |       | 8,678                       |       | 6.82                                          |       | 74,261                                         |       | 6.64                 |       | 6,198           |       | 6.24 |   | — |   | — |   | 89,137 |   | 6.63 |   |
| State and municipal obligations               |       | —                      |       | —                                        |       | 658                                            |       | 6.84                 |       | 926             |       | 8.48 |   | — |   | — |   | 1,584 |   | 7.80 |   |
| Mortgage-backed securities and CMOs           |       | 28                          |       | 6.24                                          |       | 5,027                                          |       | 7.14                 |       | 3,960           |       | 6.37 |   | 40,595 |   | 6.55 |   | 49,610 |   | 6.65 |   |
| Total debt securities                         |       | 91,076                      |       | 3.91                                          |       | 159,592                                        |       | 5.63                 |       | 93,556          |       | 6.18 |   | 44,328 |   | 6.55 |   | 388,552 |   | 5.47 |   |
| Marketable equity securities and mutual funds |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   | 17,236 |   | 4.85 |   |
| Total securities available for sale           |       | 91,076                      |       | 3.91                                          |       | 159,592                                        |       | 5.63                 |       | 93,556          |       | 6.18 |   | 44,328 |   | 6.55 |   | 405,788 |   | 5.44 |   |
|                                          |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   |   |   |   |   |
| Securities held to maturity:                  |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and agency obligations        |       | 7,506                       |       | 5.69                                          |       | 6,969                                          |       | 4.46                 |       | 500             |       | 7.00 |   | — |   | — |   | 14,975 |   | 5.16 |   |
| Corporate bonds                               |       | 403                         |       | 7.98                                          |       | —                                         |       | —               |       | —          |       | — |   | — |   | — |   | 403 |   | 7.98 |   |
| State and municipal obligations               |       | —                      |       | —                                        |       | 3,412                                          |       | 7.18                 |       | 442             |       | 7.72 |   | — |   | — |   | 3,854 |   | 7.24 |   |
|                                          |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   |   |   |   |   |
| Mortgage -backed securities and CMOs          |       | 37                          |       | 6.50                                          |       | —                                         |       | —               |       | 449             |       | 6.63 |   | 833 |   | 7.00 |   | 1,319 |   | 6.86 |   |
| Total securities held to maturity             |       | 7,946                       |       | 5.81                                          |       | 10,381                                         |       | 5.35                 |       | 1,391           |       | 7.11 |   | 833 |   | 7.00 |   | 20,551 |   | 5.71 |   |
|                                          |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   |   |   |   |   |
| Restricted equity securities:                 |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   |   |   |   |   |
| Federal Home Loan Bank of Boston stock        |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   | 40,394 |   | 4.50 |   |
| Other                                         |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   | 443 |   | 4.79 |   |
| Total restricted equity securities            |       |                        |       |                                          |       |                                           |       |                 |       |            |       |   |   |   |   |   |   | 40,837 |   | 4.50 |   |
| Total securities                              |       | $                           | 99,022     |                                          | 4.06       | %                                              | $          | 169,973              |       | 5.61            | %          | $ | 94,947 |   | 6.19 | % | $ | 45,161 |   | 6.56 | % | $ | 467,176 |   | 5.37 | % |
|                                               |            |                             |            |                                               |            |                                                |            |                      |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

16

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**Sources of Funds**

 

*General.*  The Banks use deposits, repayments andprepayments of loans, proceeds from sales of loans and securities and proceedsfrom maturing securities, borrowings and cash flows generated by operations tofund its lending, investing and general operations.  Deposits have historically represented the Banks’ primary sourceof funds.  Since the Company’s initialpublic offering in November 1998 it has relied to a greater extent onborrowings to fund the growth in the loan portfolio.

 

*Deposits.*  The Banks offer a variety of depositaccounts with a range of interest rates and other terms.  The accounts include passbook savingsaccounts, NOW accounts (checking), demand deposit accounts, money marketdeposit accounts, club accounts and certificates of deposit. The Banks alsooffer IRA, Roth/IRA, Education IRA, Simple IRA and SEP accounts.  The FDICinsures deposits up to certain limits (generally, $100,000 per depositor).  The DIF fully insures amounts in excess ofsuch limits.

 

At December 31, 2001, deposits of $2,192.4 millionwere comprised of $180.9 million of non-interest-bearing checking accounts and$2,011.5 million of interest-bearing deposit accounts, of which $992.1 millionwere certificates of deposit.  Of thetotal of certificates of deposit at December 31, 2001, $792.0 million, or 79.8%were scheduled to mature within one year. Based on the monitoring of historical trends, the current pricingstrategy for deposits and the general avoidance of brokered deposits,  management believes that the Banks  will retain a significant portion of theircertificate of deposit accounts upon maturity.

 

Deposit flows are influenced greatly by economicconditions, the general level of interest rates and the relative attractivenessof competing deposit and investment alternatives.  Nantucket Bank’s deposit flows are also affected by the seasonaleconomy of its market.  In recent years,the strength of the stock market has adversely affected deposit flows withinthe banking industry as some customers have opted to place a greater portion oftheir funds in instruments, such as mutual funds, not directly offered by theBanks (other than through Compass’s contractual relationship with INVESTFinancial Corporation (INVEST) and Nantucket Bank’s Investment ServicesDivision), rather than in deposit accounts which they perceived to have lessattractive returns.  The recent declinein the stock market may make some investors more inclined to seek less riskyalternatives such as insured deposit accounts.

 

Compass has generally experienced steady depositinflows in recent  years, primarilyinfluenced by regional bank consolidations, competitive pricing and its strongcommunity bank image.  Compass’sstrategy has been to grow deposit levels through targeted promotions, branchexpansion and renovation (three new branches and a new main office were openedin 2000 and one new branch as well as two major renovations were completed in2001) and bank acquisition.   Due to theseasonal tourist-related economies on Cape Cod, Martha’s Vineyard andNantucket, the Banks’ deposits generally peak during the summer months.

 

Compass maintains a “call center” with extended hours,staffed with 12 individuals trained to answer telephone inquiries aboutcustomer accounts and about Compass’s various products and services.  Compass also utilizes a 24-hour automatedtouch-tone telephone voice response system, which allows customers to obtaininformation about their accounts, to make account transfers, to pay bills andto receive information about Compass’s products and services.  Compass offers several relationship-basedchecking account products, entitled Flagship Checking, Compass 50 Checking andPreferred Checking which offer  packagesof select benefits.  Services tocommercial customers also include a Sweep Account, Simple IRA accounts, atouch-tone telephone electronic tax filing service, merchant credit cardservices, and web-based cash management products.

 

Compass uses direct mail and customer servicepersonnel at each of its branches and at its main office to solicit depositsand advertises its deposits through the print media, on billboards, through itswebsite (www.compassbank.com) and through radio and television.  Compass also offers its on-line bankingservices, including a bill payment service, over the Internet.  Nantucket Bank also offers a 24-hourautomated touch-tone telephone voice response system, merchant credit cardservices and on-line banking, with a bill payment service, over the Internet.

 

 

17

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The following table sets forth certain informationregarding the distribution of the average balance of deposit accounts and theweighted average interest rate on each category of deposits during the periodsindicated:

 
|                            |   | **Years Ended December 31,** |      |
|---------------------------------|--------|------------------------------|-----------|
|                            |   | **2001**                     |      | **2000** |   | **1999** |   |
|                            |   | **Average balance**          |      | **Weighted average  rate** |   | **Average balance** |   | **Weighted Average average rate** |   | **Average balance** |   | **Weighted average  rate** |   |
|                            |   | **(Dollars in thousands)**   |      |
| NOW accounts                    |   | $                            | 246,034   |   | 0.56 | % | $ | 166,776 |   | 0.73 | % | $ | 151,180 |   | 0.97 | % |
| Savings accounts                |   | 254,134                      |      | 1.65 |   | 217,433 |   | 2.01 |   | 215,088 |   | 2.31 |   |
| Money market deposit accounts   |   | 389,511                      |      | 2.71 |   | 292,037 |   | 2.91 |   | 295,393 |   | 2.92 |   |
| Demand deposit accounts         |   | 184,979                      |      | — |   | 131,108 |   | — |   | 118,956 |   | — |   |
| Total non-certificate accounts  |   | 1,074,658                    |      | 1.50 |   | 807,354 |   | 1.74 |   | 780,617 |   | 1.93 |   |
| Certificate of deposit accounts |   | 1,009,557                    |      | 5.54 |   | 846,746 |   | 5.84 |   | 734,995 |   | 5.19 |   |
| Total average deposits          |   | $                            | 2,084,215 |   | 3.46 | % | $ | 1,654,100 |   | 3.84 | % | $ | 1,515,612 |   | 3.51 | % |
|                                 |        |                              |           |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Certificates of deposit of $100,000 or moreoutstanding as of December 31, 2001 are scheduled to mature as follows (inthousands):

 

| Three months or  less       |   | $      | 84,423  |   |
|-----------------------------|--------|--------|---------|--------|
| Over three to  six months   |   | 48,129 |    |
| Over six to  twelve months. |   | 76,802 |    |
| Over twelve  months         |   | 58,972 |    |
|                        |   | $      | 268,326 |   |

 

*Borrowings*.  The Banks borrow funds from the FHLB topartially finance their loan and other funding needs.  FHLB loans are collateralized by a blanket-type pledge on the Banks’FHLB stock, first mortgages on residential property and securities issued,insured or guaranteed by the U.S. Government and its agencies, includingmortgage-backed securities.  The FHLBcharges a fixed rate of interest on its loans. The maximum amount that the FHLB will loan varies based on the FHLB’spolicies.  At December 31, 2001, Compassand Nantucket Bank had approximately $411.9 million and $59.2 million,respectively, in available borrowing capacity with the FHLB that is contingentupon the purchase of additional FHLB stock.

 

Short-term borrowings include funds drawn under theBanks’ lines of credit with the FHLB, securities sold under agreements torepurchase and funds held in connection with the U.S. Treasury’s tax and loannote program.

 

The following table sets forth certain informationregarding borrowed funds during the periods indicated:

 
|                                             |   | **Years ended December 31,** |    |
|--------------------------------------------------|--------|------------------------------|---------|
|                                             |   | **2001**                     |    | **2000** |   | **1999** |   |
|                                             |   | **(Dollars in thousands)**   |    |
| **Total Short-term borrowings:**                 |   |                         |    |   |   |   |   |
| Average balance                                  |   | $                            | 32,122  |   | $ | 32,562 |   | $ | 30,079 |   |
| Maximum month end amount                         |   | 37,464                       |    | 57,637 |   | 46,895 |   |
| Balance at end of period                         |   | 34,584                       |    | 31,427 |   | 40,787 |   |
| Weighted average interest rate during the period |   | 3.69                         | %       | 4.68 | % | 4.79 | % |
| Weighted average interest rate at end of period  |   | 2.48                         | %       | 4.35 | % | 4.42 | % |
| **Federal Home Loan Bank of Boston advances:**   |   |                         |    |   |   |   |   |
| Average balance                                  |   | $                            | 714,248 |   | $ | 337,733 |   | $ | 147,486 |   |
| Maximum month end amount                         |   | 786,872                      |    | 556,869 |   | 271,900 |   |
| Balance at end of period                         |   | 786,872                      |    | 556,869 |   | 271,900 |   |
| Weighted average interest rate during the period |   | 5.62                         | %       | 6.26 | % | 5.86 | % |
| Weighted average interest rate at end of period  |   | 5.31                         | %       | 6.05 | % | 5.81 | % |

 

18

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**Subsidiaries**

 

In addition to its 100% ownership of the common stockof Compass and Nantucket Bank, the Company directly owns 100% of LighthouseSecurities Corporation and, through its bank subsidiaries, six othercorporations. At December 31, 2001, a summary of the Company’s and the Banks’subsidiaries, all of which are Massachusetts corporations, was as follows:

 

*LighthouseSecurities Corporation**.***** **LighthouseSecurities Corporation (“Lighthouse”) was established in 1998 as aMassachusetts securities corporation and, as such, is authorized to engage inbuying, selling and holding investment securities on its own behalf and not asa broker.  The income earned onLighthouse’s investment securities is subject to a significantly lower rate ofstate tax than that assessed on pretax income earned by the Banks.  At December 31, 2001, Lighthouse had totalassets of $1.0 million, consisting primarily of cash maintained at Compass.

 

*SandwichSecurities Corporation.* Sandwich Securities Corporation (“Sandwich Corporation”) is awholly-owned subsidiary of Compass established in 1993 as a Massachusetts securitiescorporation.  Sandwich Corporationengages exclusively in buying, selling and holding investment securities on itsown behalf and not as a broker.  Theincome earned on Sandwich Corporation’s investment securities is subject to asignificantly lower rate of state tax than that assessed on pretax incomeearned by the Banks.  At December 31,2001, Sandwich Corporation had total assets of $128.3 million, consistingprimarily of investment securities.

 

*SextantSecurities Corporation.* Sextant Securities Corporation (“SSC”) is a wholly-owned subsidiary ofCompass established in 1995 as a Massachusetts securities corporation.  SSC engages exclusively in buying, sellingand holding investment securities on its own behalf and not as a broker.  The income earned on SSC’s investmentsecurities is subject to a significantly lower rate of state tax than thatassessed on pretax income earned by the Banks. At December 31, 2001, SSC had total assets of $85.8 million, consistingprimarily of investment securities.

 

*CompassPreferred Capital Corporation*.  Compass Preferred Capital Corporation (“Compass Preferred”) is asubsidiary of Compass.  It wasestablished in 1998 to engage in real estate business activities (including theacquisition and holding of securities and real estate loans) that enable it tobe taxed as a “real estate investment trust” under federal and Massachusettstax laws.  Compass Preferred had totalassets of $673.8 million at December 31, 2001, of which $544.5 million weremortgage loans originated by Compass and $120.3 million was cash maintained atCompass.

 

*TheSextant Corporation.* The Sextant Corporation (“Sextant”) is a wholly-owned subsidiary ofCompass originally formed to purchase equipment on behalf of Compass for taxfavored purposes.  Sextant has alsoengaged in limited real estate development activities.   At December 31, 2001, Sextant had totalassets of $2.0 million.

 

*The1855 Corporation*.  The1855 Corporation (“1855 Corporation”) is a wholly-owned subsidiary of Compassestablished in 1971 as a Massachusetts corporation.  1855 Corporation is principally engaged in the acquisition andholding of real estate used for banking purposes. At December 31, 2001, 1855Corporation had total assets of $1.6  million, of which $1.2 million consisted of real estate used for bankingpurposes.

 

*N.Realty Corp. *N.Realty Corp. (“NRC”) is a subsidiary of Nantucket Bank established in 1998 toengage in real estate business activities (including the acquisition andholding of securities and real estate loans) that enable it to be taxed as areal estate investment trust under federal and Massachusetts tax laws. NRC hadtotal assets of $170.3  million atDecember 31 2001, of which $142.0 million were mortgage loans originated byNantucket Bank.

 

19

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**Supervision and Regulation**

 

As Massachusetts-chartered stock savings banks,Compass and Nantucket Bank are subject to regulation by the MassachusettsDivision of Banks (the “Division”) and the FDIC.  The Banks are required to file reports with, and are periodicallyexamined by, the FDIC and the Division concerning their activities andfinancial condition and must obtain regulatory approvals prior to entering intocertain transactions, including, but not limited to, mergers with oracquisitions of other financial institutions. The Banks are members of the FHLB and are subject to certain limitedregulation by the FRB.  SeacoastFinancial, as a bank holding company, is subject to regulation by the FRB andis required to file reports with the FRB.

 

***Massachusetts BankRegulation***

 

*General.* Compass and NantucketBank are subject to supervision, regulation and examination by the Division andare subject to various Massachusetts statutes and regulations which govern,among other things, investment powers, lending and deposit-taking activities,borrowings, maintenance of surplus and reserve accounts, distribution ofearnings and payment of dividends.  Inaddition, the Banks are subject to Massachusetts consumer protection and civilrights laws and regulations.  TheCommissioner’s approval is required for a Massachusetts bank to establish orclose branches, merge with other banks, organize a holding company, issuestock, engage in insurance agency activities and undertake certain otheractivities.

 

In response to a Massachusetts law enacted in 1996,the Commissioner adopted rules that generally give Massachusetts banks powersequivalent to those of national banks. The Commissioner also has adopted procedures reducing regulatory burdensand expense and expediting branching by well-capitalized and well-managedbanks.

 

*DIF.*  All Massachusetts-chartered savings banksare required to be members of the DIF, a corporation that insures savings bankdeposits not covered by federal deposit insurance.  The DIF is authorized to charge an annual assessment of up to1/16th of 1% of a savings bank’s deposits.

 

***Insurance ofAccounts and Regulation by the FDIC***

 

As an insurer, the FDIC charges deposit insurancepremiums and is authorized to conduct examinations of and to require reportingby FDIC-insured institutions.  It alsomay prohibit any FDIC-insured institution from engaging in any activity thatthe FDIC determines by regulation or order to pose a risk to the insurancefund.  The FDIC also has the authorityto initiate enforcement actions against banks, after giving the Commissioner anopportunity to take such action.

 

***Regulatory CapitalRequirements***

 

The Banks are required to maintain certain levels of regulatory capital in relation torisk-weighted assets.  The ratio of suchregulatory capital to risk-weighted assets is referred to as the “risk-basedcapital ratio.”   Risk-based capitalratios are determined by allocating assets and specified off-balance sheetitems to four risk-weighted categories ranging from 0% to 100%, with higherlevels of capital being required for the categories perceived as representinggreater risk.

 

These guidelines divide a bank’s capital into twotiers.  The first tier (“Tier 1”)includes common equity, retained earnings, certain non-cumulative perpetualpreferred stock (including trust preferred securities, to a maximum of 25%  of Tier 1 capital) and minority interests inequity accounts of consolidated subsidiaries, less goodwill and otherintangible assets (except mortgage servicing rights and purchased credit cardrelationships subject to certain limitations). Supplementary (“Tier 2”) capital includes, among other items, cumulativeperpetual and long-term limited-life preferred stock, mandatory convertible securities,certain hybrid capital instruments, term subordinated debt and the allowancefor loan  losses, subject to certainlimitations, less required deductions. Banks are required to maintain a totalrisk-based capital ratio equal to at least 8% of risk-weighted assets, and atleast half of such capital must be Tier 1 capital.

 

In addition, the FDIC has established regulationsprescribing a minimum Tier 1”leverage ratio” (Tier 1 capital to adjusted average total assets as specified in theregulations).  These regulations providefor a minimum Tier 1 leverage ratio of 3% plus an additional cushion of atleast 100 to 200 basis points.  The FDICmay, however, set higher leverage and risk-based capital requirements forindividual institutions when particular circumstances warrant.

 

20

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International bank supervisory organizations,principally the Basel Committee on Banking Supervision, currently areconsidering changes to the risk-based capital adequacy framework whichultimately could affect the FDIC’s guidelines concerning capital adequacy.

 

***Limitations onDividends and Other Capital Distributions***

 

The FDIC has the authority to use its enforcementpowers to prohibit a bank from paying dividends if, in its opinion, the paymentof dividends would constitute an unsafe or unsound practice.  Federal law also prohibits the payment ofdividends by a bank that would result in the bank failing to meet itsapplicable capital requirements on a pro forma basis.  Massachusetts law also restricts a bank from declaring a dividendwhich would reduce its capital below (i) the amount required to be maintainedby state and federal law and regulations or (ii) the amount of theirliquidation account established in connection with the conversion  from mutual to stock form.  In addition, Massachusetts law requires theCommissioner’s approval if the total of dividends declared by a bank in anycalendar year exceed net income for that year combined with the retained netincome of the preceding two years.

 

***Prompt CorrectiveAction***

 

The federal banking agencies have promulgatedregulations to implement a system of prompt corrective action required byfederal law.  Under the regulations, abank is deemed to be: (i) “well capitalized” if it has total risk-based capitalof 10% or more, has a Tier 1 risk-based capital ratio of 6% or more, has a Tier1 leverage ratio of 5% or more and is not subject to any written capital orderor directive; (ii) “adequately capitalized” if it has a total risk-basedcapital ratio of 8% or more, a Tier 1 risk-based capital ratio of 4% or moreand Tier 1 leverage ratio of 4% or more (3% under certain circumstances) anddoes not meet the definition of “well capitalized”; (iii) “undercapitalized” ifit has a total risk-based capital ratio that is less than 8%, a Tier 1risk-based capital ratio that is less than 4% or a Tier 1 leverage  ratio that is less than 4% (3% under certaincircumstances); (iv) “significantly undercapitalized” if it has a totalrisk-based capital ratio that is less than 6%, a Tier 1 risk-based capitalratio that is less than 3% or a Tier 1 leverage ratio that is less than 3%; and(v) “critically undercapitalized” if it has a ratio of tangible equity to totalassets that is equal to or less than 2%.

 

Based on the foregoing, Compass and Nantucket Bank arecurrently classified as “well capitalized” banks.

 

***Holding CompanyRegulation***

 

*General.*  Seacoast Financial, as a bank holdingcompany, is subject to comprehensive regulation and regular examinations by theFRB.  The FRB also has extensiveenforcement authority over bank holding companies, including, among otherthings, the ability to assess civil money penalties, to issue cease and desistor removal orders and to require that a holding company divest subsidiaries(including its bank subsidiaries).  Ingeneral, enforcement actions may be initiated for violations of law andregulations and unsafe or unsound practices.

 

Seacoast Financial is subject to capital adequacyguidelines for bank holding companies (on a consolidated basis) which aresubstantially similar to those of the FDIC for the Banks.

 

Under FRB policy, a bank holding company must serve asa source of strength for its subsidiary banks. Under this policy, the FRB may require, and has required in the past, aholding company to contribute additional capital to an undercapitalizedsubsidiary bank.

 

Seacoast Financial must obtain Massachusetts Board ofBank Incorporation and FRB approval before: (i) acquiring, directly orindirectly, ownership or control of any voting shares of another bank or bankholding company if, after such acquisition, it would own or control more than5% of such shares (unless it already owns or controls the majority of suchshares); (ii) acquiring all or substantially all of the assets of another bankor bank holding company; or (iii) merging or consolidating with another bankholding company.

 

The BHCA also prohibits a bank holding company, withcertain exceptions, from acquiring direct or indirect ownership or control of morethan 5% of the voting shares of any company which is not a bank or bank holdingcompany, or from engaging directly or indirectly in activities other than thoseof banking, managing or controlling banks, or providing services for itssubsidiaries.

 

21

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*Dividends.*  FRB policy specifies that a bank holdingcompany should pay cash dividends only to the extent that the holding company’snet income for the past year is sufficient to cover both the cash dividends anda rate of earning retention that is consistent with the holding company’scapital needs, asset quality and overall financial condition.  Under the prompt corrective actionregulations adopted by the FRB, the FRB may prohibit a bank holding company frompaying any dividends if any of the holding company’s bank subsidiaries isclassified as “undercapitalized.”

 

Bank holding companies are required to give the FRBprior written notice of any purchase or redemption of its outstanding equitysecurities if the gross consideration for the purchase or redemption, whencombined with the net consideration paid for all such purchases or redemptionsduring the preceding 12 months, is equal to 10% or more of the consolidated networth of the bank holding company.  TheFRB may disapprove such a purchase or redemption if it determines that theproposal would constitute an unsafe or unsound practice or would violate anylaw, regulation, FRB order or any condition imposed by, or written agreementwith, the FRB.

 

This notification requirement does not apply to anybank holding company that meets the well-capitalized standard for banks, is“well managed” within the meaning of the FRB regulations and is not subject toany unresolved supervisory issues.

 

*FinancialServices Modernization.* In November 1999, the Gramm-Leach-Bliley Act (“Gramm-Leach”), whichsignificantly altered banking laws in the United States, became law.  Gramm-Leach permits combinations amongbanks, securities firms and insurance companies.  Under Gramm-Leach, bank holding companies are permitted to offertheir customers virtually any type of financial service that is financial innature or incidental thereto, including banking, securities underwriting,insurance (both underwriting and agency) and merchant banking.

 

In order to engage in these new financial activities,a bank holding company must qualify and register with the FRB as a “financialholding company” by demonstrating that each of its bank subsidiaries is “wellcapitalized,” “well managed” and has at least a “satisfactory” rating under theCommunity Reinvestment Act of 1977, as amended (“CRA”).

 

A “financial subsidiary”of a national or state bankmay engage in the new financial activities authorized by Gramm-Leach except forinsurance or annuity underwriting, insurance company portfolio investments,real estate investment and development and merchant banking , which must beconducted by a financial holding company. In order for a financial subsidiary of a national or state bank toengage in the new financial activities, Gramm-Leach requires that each of theparent bank (and its sister-bank affiliates) be well capitalized and wellmanaged; that the aggregate consolidated assets of all of the bank’s financialsubsidiaries not exceed the lesser of 45% of its consolidated total assets or$50 billion; that the bank must have at least a satisfactory CRA rating; and,if the bank is one of the 100 largest national banks, it meet certain financialrating or other comparable requirements.

 

Gramm-Leach established a system of functionalregulation, under which the federal banking agencies will regulate the bankingactivities of financial holding companies and banks’ financial subsidiaries,the U.S. Securities and Exchange Commission will regulate their securitiesactivities and state insurance regulators will regulate their insuranceactivities.  Gramm-Leach also providesnew protections against the transfer and use by financial institutions ofconsumers’ nonpublic, personal information.

 

Although the Company meets the qualifications forelecting to become a financial holding company under Gramm-Leach, the Companyhas elected to retain its pre-Gramm-Leach status for the present time.

 

***Federal ReserveSystem***

 

The FRB requires all depository institutions tomaintain noninterest-bearing reserves at specified levels against theirtransaction accounts (primarily depositor checking and NOW accounts).  Banks are authorized to borrow from theFRB’s “discount window,” but FRB regulations require banks to exhaust otherreasonable alternative sources of funds, including FHLB borrowings, beforeborrowing from the FRB.

 

 

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***Federal Home LoanBank System***

 

The Banks are members of the FHLB, which is one of 12regional Federal Home Loan Banks that administer the home financing creditfunction of savings institutions.  EachFederal Home Loan Bank serves as a central bank for members within itsregion.  It makes loans to members(i.e., advances) in accordance with policies and procedures established by theboard of directors of each Federal Home Loan Bank.  All advances are required to be fully secured by sufficientcollateral as determined by the FHLB. As members, the Banks are required to purchase and maintain stock in theFHLB.  At December 31, 2001, the Banksowned $40.4 million of FHLB stock.

 

**Personnel**

 

As of December 31, 2001, the Banks had 618 full-timeemployees and 129 part-time employees. None of the  Banks’ employees arerepresented by a labor union and management considers its relationship with itsemployees to be good.

 

**Item 2.    Properties**

 

At December 31, 2001, the Company conducted businessthrough 42 full-service branches, two seasonal high school offices, 7 remoteATMs and the corporate headquarters.

 

In July 2000, the Company completed construction ofits new corporate headquarters and main banking office in downtown NewBedford.  The cost of construction ofthis  five story office building with147,000 square feet of space was $21.5 million, including land acquisition andsite work as well as all furniture and equipment.  The Company estimates that it currently is utilizingapproximately 70% of the building capacity with the remainder earmarked forfuture expansion of business.

 

In the Greater New Bedford market, Compass operatesten full-service branches, including seven branches in the City of New Bedford(six of which are owned by Compass or a subsidiary while the other is operatedunder a land lease), one owned branch in Fairhaven and one leased branch ineach of Mattapoisett and Dartmouth. Compass’s corporate headquarters are also located in the City of NewBedford.  Two of Compass’s remote ATMsand one of its limited service high school branches are also located in theCity of New Bedford.

 

In the Greater Fall River market, Compass operatesseven full-service branches, including one owned and one leased branch in theCity of Fall River, one leased branch in Assonet and owned branches in each ofSeekonk (subject to a land lease), Somerset, Swansea and Westport.  One of Compass’s remote ATMs is also locatedin the City of Fall River, as is one of Compass’s limited service high schoolbranches.

 

In the Greater Plymouth market, Compass operates sixfull-service branches, including two owned and two leased branches in Plymouthand a leased branch in Carver.  Compassalso leases a non-branch mortgage office in Lakeville, located in the GreaterPlymouth market.

 

In the Martha’s Vineyard market, Compass operates fivefull-service branches, including one owned and one leased branch in Edgartown,and owned branches in each of Chilmark, Vineyard Haven and Oak Bluffs.  One of Compass’s remote ATMs is located onMartha’s Vineyard in West Tisbury.

 

In the Cape Cod market, Compass operates twelvefull-service branches, including two leased offices in Sandwich, leased officesin Buzzards Bay, South Yarmouth and Wareham, and owned offices in Pocasset,Falmouth, Hyannis (two), Chatham, Dennis and Orleans.

 

In the Nantucket market, Nantucket Bank operates threefull-service branches all of which are owned. In addition, Nantucket Bank leases office space.

 

See Note 5 of the Notes to Consolidated FinancialStatements included herein for additional information.

 

**Item 3.    Legal Proceedings**

 

The Company is not involved in any pending legal proceedingsother than routine legal proceedings occurring in the ordinary course ofbusiness.  Management believes thatthose routine proceedings involve, in the aggregate, amounts which areimmaterial to the consolidated financial condition and results of operations ofthe Company.

 

 

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**Item 4.    Submission of Matters to a Vote of Security Holders**

 

Not applicable.

 

**PART II**

 

**Item 5.    Market for Registrant’s Common Equity and Related StockholderMatters**

 

Seacoast Financial’scommon stock is traded on the Nasdaq National Market System under the symbol“SCFS”.  At March 15, 2002, there were24,238,886 shares of common stock outstanding and 5,635 shareholders of record.  This does not reflect the number of personsor entities who hold their stock in nominee or street name through variousbrokerage firms.  As of that date, theclosing sales price, as reported by Nasdaq, was $19.39.

 

High and low sales pricesand dividends declared, stated on a per share basis, are as follows:

 
|                                    |   | **High** |   | **Low** |   | **Dividends   Declared** |   |
|-----------------------------------------|--------|----------|--------|---------|--------|--------------------------|--------|
| **2002**                                |   |     |   |    |   |                     |   |
| First quarter  (through March 15, 2002) |   | $        | 19.45  |    | $      | 16.72                    |   | $ | 0.10 |   |
|                                    |   |     |   |    |   |                     |   |
| **2001**                                |   |     |   |    |   |                     |   |
| Fourth quarter                          |   | 17.83    |   | 14.13   |   | 0.09                     |   |
| Third quarter                           |   | 17.90    |   | 13.25   |   | 0.09                     |   |
| Second quarter                          |   | 16.33    |   | 12.88   |   | 0.08                     |   |
| First quarter                           |   | 15.38    |   | 10.75   |   | 0.08                     |   |
|                                    |   |     |   |    |   |                     |   |
| **2000**                                |   |     |   |    |   |                     |   |
| Fourth quarter                          |   | 12.06    |   | 9.44    |   | 0.07                     |   |
| Third quarter                           |   | 11.38    |   | 9.06    |   | 0.07                     |   |
| Second quarter                          |   | 10.13    |   | 8.50    |   | 0.06                     |   |
| First quarter                           |   | 10.13    |   | 8.75    |   | 0.06                     |   |
|                                         |        |          |        |         |        |                          |        |  |  |  |

 

The Company’s Board ofDirectors reviews the payment of dividends on a quarterly basis.  The declaration of dividends is dependentupon a number of factors, including capital requirements, regulatoryconsiderations, the financial condition and operating results of bank subsidiariesand general economic conditions.  Basedon its assessment of these factors, the Board of Directors may elect to eitherpay the same dividend as the previous quarter or to increase, decrease or omitthe dividend.

 

The Company initiated thepayment of a dividend in the third quarter of 1999 and has increased thedividend rate by $.01 per share semi-annually since then.  While there can be no assurance that it willcontinue to do so, the Company expects that dividends which are comparable inrelation to net income as those currently being paid will continue to be paidin the foreseeable future.

 

 

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**Item 6.    Selected Consolidated Financial Data**

 

The selected consolidatedfinancial data are derived in part from, and should be read in conjunctionwith, the Company’s consolidated financial statements and notes theretopresented elsewhere herein.

 
|                                    |                                      | **At December 31,** |      | **At October 31,** |         |
|-----------------------------------------|-------------------------------------------|---------------------|-----------|--------------------|--------------|
|                                    | **2001**                                  |                | **2000**  |               | **1999 (1)** |   | **1998** |   | **1997** | ** ** |
|                                    | **(In thousands, except per share data)** |                |
| **Selected  Financial Condition Data:** |                                      |                |      |               |         |   |   |   |   |   |   |
| Total assets                            |                                      | $                   | 3,347,467 |               | $            | 2,890,765 |   | $ | 2,122,785 |   | $ | 1,806,523 |   | $ | 1,625,260 |   |
| Loans (2)                               |                                      | 2,574,982           |      | 2,363,332          |         | 1,747,206 |   | 1,320,680 |   | 1,190,939 |   |
| Allowance for  loan losses              |                                      | 29,513              |      | 25,081             |         | 16,828 |   | 15,117 |   | 14,742 |   |
| Debt securities  :                      |                                      |                |      |               |         |   |   |   |   |   |   |
| Available for  sale                     |                                      | 388,552             |      | 236,469            |         | 235,620 |   | 282,732 |   | 316,384 |   |
| Held to maturity                        |                                      | 20,551              |      | 29,728             |         | 12,408 |   | 13,694 |   | 12,633 |   |
| Marketable  equity securities           |                                      | 17,236              |      | 12,386             |         | 9,963 |   | 8,200 |   | 3,512 |   |
| Deposits                                |                                      | 2,192,357           |      | 1,989,630          |         | 1,515,622 |   | 1,531,663 |   | 1,360,962 |   |
| Borrowed funds                          |                                      | 823,341             |      | 590,266            |         | 314,622 |   | 102,906 |   | 108,042 |   |
| Stockholders’  equity/Surplus      |                                      | 305,724             |      | 288,188            |         | 274,021 |   | 153,570 |   | 140,128 |   |
| Non-performing  loans                   |                                      | 13,408              |      | 6,107              |         | 5,734 |   | 6,514 |   | 14,464 |   |
| Non-performing  assets                  |                                      | 14,483              |      | 6,193              |         | 6,286 |   | 7,813 |   | 16,767 |   |
|                                         |                                           |                     |           |                    |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                                 |   | **Years Ended**  |    |
|------------------------------------------------------|--------|------------------|---------|
|                                                 |   | **December 31,** |    | **October 31,** | ** ** |
|                                                 |   | **2001**         |    | **2000** |   | **1999(1)** |   | **1998** |   | **1997** | ** ** |
| **Selected  Operating Data:**                        |   |             |    |   |   |   |   |   |   |   |   |
| Interest income                                      |   | $                | 216,389 |   | $ | 166,439 |   | $ | 137,952 |   | $ | 122,934 |   | $ | 115,949 |   |
| Interest expense                                     |   | 113,491          |    | 86,336 |   | 63,510 |   | 62,692 |   | 58,025 |   |
| Net interest  income                                 |   | 102,898          |    | 80,103 |   | 74,442 |   | 60,242 |   | 57,924 |   |
| Provision for  loan losses                           |   | 6,175            |    | 4,775 |   | 2,000 |   | 1,736 |   | 2,615 |   |
| Net interest  income after provision for loan losses |   | 96,723           |    | 75,328 |   | 72,442 |   | 58,506 |   | 55,309 |   |
| Gains on sale of  securities, net                    |   | 99               |    | 4 |   | 164 |   | 67 |   | 92 |   |
| Gains on sales  of loans, net                        |   | 1,352            |    | 30 |   | 56 |   | 1,755 |   | 717 |   |
| Gains on pension  plan termination/settlement        |   | 1,504            |    | — |   | 1,472 |   | — |   | — |   |
| Other  noninterest income                            |   | 13,388           |    | 9,953 |   | 8,302 |   | 8,220 |   | 7,727 |   |
| Noninterest  expense                                 |   | 65,376           |    | 49,071 |   | 44,516 |   | 39,807 |   | 37,036 |   |
| Income before  income taxes                          |   | 47,690           |    | 36,244 |   | 37,920 |   | 28,741 |   | 26,809 |   |
| Provision for  income taxes                          |   | 16,723           |    | 12,315 |   | 13,394 |   | 10,651 |   | 10,165 |   |
| Net income                                           |   | $                | 30,967  |   | $ | 23,929 |   | $ | 24,526 |   | $ | 18,090 |   | $ | 16,644 |   |
|                                                 |   |             |    |   |   |   |   |   |   |   |   |
| Earnings per  share - diluted (8)                    |   | $                | 1.31    |   | $ | 1.01 |   | $ | 0.97 |   |   |   |   |   |
| Cash dividends  per share (8)                        |   | $                | 0.34    |   | $ | 0.26 |   | $ | 0.10 |   |   |   |   |   |

 

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|                                                                      |   | **December 31,** |   | **October 31,** |   |
|---------------------------------------------------------------------------|--------|------------------|--------|-----------------|--------|
|                                                                      |   | **2001**         |   | **2000**        |   | **1999 (1)** |   | **1998** |   | **1997** |   |
| **Selected  Financial Ratios and Other Data (3):**                        |   |             |   |            |   |   |   |   |   |   |   |
| Performance  Ratios:                                                      |   |             |   |            |   |   |   |   |   |   |   |
| Return on  average assets                                                 |   | .98              | %      | 1.03            | %      | 1.23 | % | 1.06 | % | 1.07 | % |
| Return on  average stockholders’equity/surplus                       |   | 10.38            |   | 8.54            |   | 8.97 |   | 12.00 |   | 12.66 |   |
| Average equity  to average total assets                                   |   | 9.45             |   | 12.07           |   | 13.77 |   | 8.87 |   | 8.41 |   |
| Net interest  rate spread (4)                                             |   | 3.00             |   | 2.98            |   | 3.26 |   | 3.20 |   | 3.38 |   |
| Net interest  margin (5)                                                  |   | 3.47             |   | 3.63            |   | 3.93 |   | 3.72 |   | 3.88 |   |
| Average  interest-earning assets to average interest-bearing liabilities  |   | 112.34           |   | 116.43          |   | 120.12 |   | 113.36 |   | 113.03 |   |
| Total  noninterest expense to average assets                              |   | 2.07             |   | 2.11            |   | 2.24 |   | 2.34 |   | 2.37 |   |
| Efficiency ratio  (6)                                                     |   | 53.01            |   | 53.81           |   | 52.85 |   | 55.53 |   | 54.45 |   |
| Dividend payout  ratio (8)                                                |   | 26.12            |   | 26.41           |   | 10.33 |   |   |   |   |   |
| Regulatory  Capital Ratios (3):                                           |   |             |   |            |   |   |   |   |   |   |   |
| Tier 1 leverage  capital                                                  |   | 8.04             |   | 10.15           |   | 13.11 |   | 8.34 |   | 8.38 |   |
| Tier 1  risk-based-capital                                                |   | 12.04            |   | 12.78           |   | 18.98 |   | 12.45 |   | 12.94 |   |
| Total risk-based  capital                                                 |   | 13.34            |   | 14.04           |   | 20.17 |   | 13.70 |   | 14.19 |   |
| Asset Quality  Ratios (3):                                                |   |             |   |            |   |   |   |   |   |   |   |
| Non-performing  loans as a percent of loans (7)                           |   | .52              |   | .26             |   | .33 |   | .49 |   | 1.23 |   |
| Non-performing  assets as a percent of total assets                       |   | .43              |   | .21             |   | .30 |   | .43 |   | 1.05 |   |
| Allowance for  loan losses as a percent of loans (2)                      |   | 1.15             |   | 1.06            |   | .96 |   | 1.14 |   | 1.24 |   |
| Allowance for  loan losses as a percent of total non-performing loans (7) |   | 220.11           |   | 410.69          |   | 293.48 |   | 232.07 |   | 100.29 |   |
| Number of  Full-Service Customer Facilities                               |   | 42               |   | 41              |   | 35 |   | 34 |   | 33 |   |

 

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(1)               In January 1999,the Board of Directors voted to change the Company’s year-end to December31.  Selected consolidated financialdata for the two month transition period ended December 31, 1998 is notpresented herein.

 

(2)               Loans are comprisedof gross loan balances, less unearned discounts, loans held for sale and  net unadvanced funds on loans plus netdeferred loan origination costs and fees.

 

(3)               Asset QualityRatios and Regulatory Capital Ratios are end-of-period ratios.  With the exception of end-of-period ratios,all ratios are based on average daily balances during the periods indicated.

 

(4)               The net interestrate spread represents the difference between the fully-taxable weightedaverage yield on average interest-earning assets and the weighted average costof average interest-bearing liabilities.

 

(5)               The net interestmargin represents net interest income (fully taxable equivalent) as apercentage of average interest-earning assets.

 

(6)               The efficiencyratio represents the ratio of noninterest expenses (excluding amortization ofintangible assets) to the sum of net interest income and noninterest income(excluding gains on pension plan termination and settlement).

 

(7)               Non-performingloans consist of all nonaccrual loans and restructured loans.

 

(8)               Diluted earningsand cash dividends per share and the dividend payout ratio are inapplicable forperiods prior to the Company’s mutual to stock conversion in November 1998.

 

 

26

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**Item 7.    Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

**Forward-Looking Statements**

 

This Form 10-K containscertain “forward-looking statements” within the meaning of Section 21E of theSecurities Exchange Act of 1934.  Whenused in this report, the words or phrases, “will likely result,”  “are expected to,” “will continue,” “isanticipated,” “estimate,” “believe,” or similar expressions are intended toidentify such forward-looking statements. Actual results could differ materially from those anticipated in theforward-looking statements.  Importantfactors that might cause such a difference include, among other things, generaleconomic conditions, particularly the real estate market, in the Company’sprimary market area, credit risk management, asset/liability management,changes in government regulation and supervision, changes in interest rates,the availability of and costs associated with sources of liquidity andincreased competition and bank consolidations in the Company’s market area.

 

The Company does notundertake, and specifically disclaims any obligation, to publicly release theresult of any revisions which may be made to any forward-looking statements toreflect the occurrence of anticipated events or circumstances after the date ofsuch statements.

 

**General**

The Company’s results ofoperations depend primarily on its net interest income, which is the differencebetween the income earned on its loan and securities portfolios and its cost offunds, consisting of the interest paid on deposits and borrowings.  Results of operations are also affected bythe provision for loan losses, as well as noninterest income and expenses.  Noninterest income consists principally ofdeposit and other banking fees. Noninterest expenses consist principally of employee compensation andbenefits, occupancy, data processing, marketing and professional servicescosts.  Results of operations are alsosignificantly affected by general economic and competitive conditions andchanges in interest rates as well as government policies and actions ofregulatory authorities.

 

**Critical Accounting Policies**

Management’s discussionand analysis of the Company’s financial condition are based on the consolidatedfinancial statements which are prepared in accordance with accountingprinciples generally accepted in the United States.  The preparation of such financial statements requires managementto make estimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses and related disclosure of contingent assetsand liabilities.  On an ongoing basis,management evaluates its estimates, including those related to the allowancefor loan losses.  Management bases itsestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis in making judgments about the carrying values of assets that are notreadily apparent from other sources. Actual results could differ from the amount derived from management’sestimates and assumptions under different assumptions or conditions.

 

Management believes theallowance for loan losses is a critical accounting policy that requires themost significant estimates and assumptions used in the preparation of theconsolidated financial statements.  Theallowance for loan losses is based on management’s evaluation of the level ofthe allowance required in relation to the estimated loss exposure in the loanportfolio.  Management believes theallowance for loan losses is a significant estimate and therefore regularlyevaluates it for adequacy by taking into consideration factors such as priorloan loss experience, the character and size of the loan portfolio, businessand economic conditions and management’s estimation of future losses.  The use of different estimates orassumptions could produce different provisions for loan losses.  Refer to the discussion of Allowance forLoan Losses in the Business Section and Notes 1 and 4 of the Notes toConsolidated Financial Statements for a detailed description of management’sestimation process and methodology related to the allowance for loan losses.

 

In June 2001, theFinancial Accounting Standards Board (FASB) issued SFAS No. 141, “BusinessCombinations,” which is effective for transactions initiated after June 30,2001.  Under SFAS No. 141, all businesscombinations must be accounted for using the purchase method of accounting; useof the pooling-of-interests method is no longer permitted.  In addition, this Statement requires thatcertain intangible assets acquired in a business combination be recognized apartfrom goodwill.  Under the transitionprovisions of SFAS No. 141, no change in the amount of the purchase priceassigned to the assets acquired and liabilities assumed in a businesscombination completed before July 1, 2001 and accounted for by the purchasemethod shall occur except for certain identified intangible assets which wereseparately recognized at the time of the transaction.

 

Also in June 2001, theFASB issued SFAS No. 142, “Goodwill and Other Intangible Assets,” which iseffective for fiscal years beginning after December 15, 2001.  Under prior accounting standards, goodwillresulting from a business combination is amortized against income over itsestimated useful life.  Under SFAS No.142, goodwill is generally no longer amortized as an expense after 2001, butinstead is reviewed and tested for impairment using a fair value methodologyprescribed in this Statement.  Goodwillwill be tested for impairment at least annually, or more frequently as a resultof an event or change in circumstances (for example, recurring operating lossesby an acquired entity) that would indicate an impairment adjustment may benecessary.  Based on its assessment ofthe current economic environment, management does not anticipate an impairmentadjustment to the goodwill reflected in the consolidated balance sheet setforth in the Consolidated Financial Statements due to the adoption of SFAS No142. 

 

27

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A significant effect of adopting SFAS No. 141 and No.142 is that the Company will no longer amortize the goodwill balance of $33.9million, which will have the effect of reducing goodwill amortization by $2.4million in 2002 and increasing net income.

 

Refer to Note 1 of theNotes to Consolidated Financial Statement for additional information about SFAS141 and 142.

 

**Acquisition of Home Port**

On December 31, 2000, theCompany completed its acquisition of Home Port and its bank subsidiary,Nantucket Bank, in a transaction accounted for under the purchase method ofaccounting.  Accordingly, theconsolidated assets and liabilities of Home Port as of December 31, 2000 havebeen reflected in the Company’s consolidated balance sheet at that date attheir respective fair values.  HomePort’s results of operations have been included in the Company’s consolidatedstatements of income from the date of acquisition.

 

**Comparison of Financial Condition atDecember 31, 2001 and 2000**

Total assets increased by$456.7 million, or 15.8%, from $2,890.8 million at December 31, 2000 to$3,347.5 million at December 31, 2001. This growth was due to a $207.2 million, or an 8.9% increase in netloans and, to a lesser extent, increases in federal funds sold ($87.0 million)and investment securities ($159.6 million). The combined increase in federal funds sold and investment securities during2001 amounted to nearly $250 million and is mainly attributable to twofactors.  First, deposit growth duringthe second half of the year, particularly the third quarter, totaled $142.6million.  This unusually high level ofgrowth is considered by management to be primarily caused by the decline in thestock market in the wake of an economic slowdown and the acts of terrorismagainst the United States occurring in September 2001.  Second, the Company’s borrowings from theFederal Home Loan Bank (FHLB) exceeded its actual funding needs as managementconsidered the rates being offered to be favorable.  At December 31, 2001, the Company’s weighted average rate on itsoutstanding FHLB advances was 5.31% compared to 6.05% at December 31, 2000.

 

The loan portfolio,excluding loans held for sale, increased in 2001 due primarily to increases inresidential mortgage loans ($99.0 million), indirect auto loans ($78.4 million) and commercial and commercial realestate loans ($29.3 million).  Thegrowth in residential mortgage loans largely reflects the lower interest rateenvironment which prevailed throughout the year.  This factor was partially offset when Compass decided to sellsome of its current production of 15 year fixed rate mortgage loans in thesecondary market.  Such sales began inthe fourth quarter and amounted to $43.9 million in 2001.  Compass continues to expand its network ofautomobile dealers throughout Eastern Massachusetts in order to grow itsportfolio of indirect auto loans and expects to continue its geographicexpansion into  Southern New Hampshirein 2002.  During 2001, Compassoriginated $364.7 million of indirect loans and increased its portfolio of suchloans by $78.4 million, or 15.0%.  TheCompany’s commercial loan portfolios, including both commercial real estateloans and commercial and industrial loans increased 6.9% during 2001 andrepresented 17.6% of loans at December 31, 2001 compared to 17.9% at December31, 2000.  The moderate growth incommercial lending in 2001 reflects the impact of the current economic slowdownand the competition for creditworthy customers.  The Company’s growth in commercial lending was primarily withexisting customers.

 

Deposits at December 31,2001 were $2,192.4 million, an increase of $202.8 million, or 10.2%, comparedto $1,989.6 million at December 31, 2000, due to an increase in coredeposits.  Core deposit account balancesincreased by $227.2 million, or 23.4%, during 2001 which was generallyattributable to expansion of the branch network (including deposits of $24million assumed from another bank in December 2001), the shift in balances fromcertificates of deposit caused by the lower interest rates offered in 2001 andthe migration of funds from the stock market in the wake of an economic slowdownand the acts of terrorism against the United States occurring in September2001.

 

Borrowed funds were$823.3 million at December 31, 2001 compared to $590.3 million at December 31,2000, an increase of $233.0 million, or 39.5%. During the year ended December 31, 2001, Compass increased its netborrowings from the Federal Home Loan Bank in order to partially fund loan andliquidity growth.  Management believesthat it will continue to rely on Federal Home Loan Bank borrowings in 2002 topartially fund anticipated loan growth.

 

The increase instockholders’ equity of $17.5 million to $305.7 million at December 31, 2001resulted from net income of $31.0 million for the year then ended which waspartially offset by cash dividends ($8.1 million) and stock repurchases ($10.5million).  During 1999 and 2000, theCompany announced three stock repurchase programs, the most recent of which wasapproved in July 2000, aggregating 3,486,212 shares.  As of December 31, 2001, 3,027,000 shares had beenrepurchased.  Management anticipatesrepurchasing the remaining 459,212 shares during 2002 and initiating a newrepurchase program.

 

28

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**Comparison of Financial Condition atDecember 31, 2000 and 1999**

 

Total assets increased by$768.0 million, or 36.2%, from $2,122.8 million at December 31, 1999 to$2,890.8 million at December 31, 2000, of which $378.7 million was due to theacquisition of Home Port.  The remainingincrease in assets of $389.3 million was due to a $339.4 million, or 19.4%increase in loans and, to a lesser extent, increases in cash and due from banks($28.1 million) and banking premises and equipment ($15.8 million).  Asset growth was funded primarily by a$199.3 million, or 63.3% increase in borrowings and a $242.9 million, or 16.0%,increase in deposits.

 

Exclusive of Home Port,the increase in loans occurred primarily in Compass’s indirect auto andresidential mortgage loan portfolios. From December 31, 1999 to December 31, 2000, indirect auto loans (net ofunearned discounts) increased by $99.5 million, or 23.6%.  This growth is primarily attributable to thegenerally favorable economic conditions which prevailed during the period andthe continued geographic expansion of Compass’s network of participating dealers.  Residential mortgage loans increased by$154.4 million, or  17.2%, during2000.  Because of the higher interestrates which prevailed in 2000, Compass originated $219.9 million of residentialmortgage loans in 2000, a 32.1% decrease compared to 1999.  The net growth in residential mortgage loanswas also affected by the strategy to retain fixed rate mortgage loanoriginations in the loan portfolio.

 

Exclusive of Home Port,deposits at December 31, 2000 were $1,758.5 million, an increase of $242.9 million,or  16.0%, compared to $1,515.6 millionat December 31, 1999, due largely to an increase in certificates of deposit of$193.9 million during the period. This increase was fueled by the introductionand promotion, in February 2000, of a 7 month certificate at 6.30% and, to alesser extent, the promotion of 9 and 18 month certificates of deposit duringthe second quarter.  Core depositaccount balances increased by $49.0 million, or 6.3%, during the year ended December31, 2000.  This growth was generallyattributable to the promotion of a free checking account product, partiallyoffset by the shift in funds to higher yielding certificates of deposit.  Management believes that the bankconsolidation and divestitures which occurred in the Compass market area during2000 as a result of the Fleet/Bank Boston merger have contributed to the growthin deposits and continue to offer Compass an opportunity to increase 

its deposits. As discussed later herein, the market opportunity created by this mergeralso increased the level of interest rates for time deposits as numerous banksin the local market attempted to attract new customers affected by the merger.

 

Exclusive of Home Port,borrowed funds were $513.9 million at December 31, 2000 compared to $314.6 millionat December 31, 1999, an increase of $199.3 million, or 63.3%.  Duringthe year ended December 31, 2000, Compass increased its net borrowings from theFederal Home Loan Bank in order to partially fund loan growth as well as theHome Port acquisition ($69 million).

 

The increase instockholders’ equity of $14.2 million to $288.2 million at December 31, 2000resulted from net income of $23.9 million for the year then ended which waspartially offset by cash dividends ($6.3 million) and stock repurchases ($8.7million).  During 1999 and 2000, theCompany announced three stock repurchase programs, the most recent of which wasapproved in July 2000, aggregating 3,486,212 shares.  As of December 31, 2000, 2,359,775 shares had been repurchased.

 

**Results of Operations**

**NetInterest Income**

 

The Company’s operatingperformance is highly dependent upon the level of net interest income.  General economic conditions, corporatestrategies, asset/liability management, interest rates and the policies ofregulatory authorities all have a significant impact on the level of netinterest income achieved.  During theperiod 1999 to 2001, the Company’s net interest income increased from $74.4 to$102.9 million, an increase of $28.5 million, or 38.3%.  This achievement has been primarilyattributable to the growth in the loan portfolio.

 

29

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The following tablepresents average balances, interest income and expense and yields earned orrates paid on the major categories of assets and liabilities for the yearsindicated.

 
|                                                      |   | **Years ended December 31,** |      |
|-----------------------------------------------------------|--------|------------------------------|-----------|
|                                                      |   | **2001**                     |      | **2000** |   | **1999** |   |
|                                                      |   |                         |      |   |   | **Average** |   |   |   |   |   | **Average** |   |   |   |   |   | **Average** |   |
|                                                      |   | **Average**                  |      |   |   | **yield/** |   | **Average** |   |   |   | **yield/** |   | **Average** |   |   |   | **yield/** |   |
|                                                      |   | **balance**                  |      | **Interest** |   | **cost** |   | **balance** |   | **Interest** |   | **cost** |   | **balance** |   | **Interest** |   | **cost** |   |
|                                                      |   | **(Dollars in thousands)**   |      |
| **Assets:**                                               |   |                         |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                                 |   |                         |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold and other short-term investments      |   | $                            | 95,308    |   | $ | 3,250 |   | 3.41 | % | $ | 11,307 |   | $ | 832 |   | 7.36 | % | $ | 8,206 |   | $ | 377 |   | 4.59 | % |
| Debt securities  (1)                                      |   | 284,064                      |      | 17,278 |   | 6.08 |   | 233,901 |   | 15,265 |   | 6.53 |   | 265,204 |   | 16,086 |   | 6.07 |   |
| Equity securities  (1)                                    |   | 51,567                       |      | 2,829 |   | 5.49 |   | 30,332 |   | 1,993 |   | 6.57 |   | 21,875 |   | 1,271 |   | 5.81 |   |
| Mortgage loans  (2)                                       |   | 1,794,617                    |      | 136,270 |   | 7.59 |   | 1,327,017 |   | 101,513 |   | 7.65 |   | 1,121,684 |   | 84,235 |   | 7.51 |   |
| Commercial loans  (2)                                     |   | 120,253                      |      | 9,467 |   | 7.87 |   | 77,887 |   | 7,514 |   | 9.65 |   | 66,178 |   | 5,846 |   | 8.83 |   |
| Indirect auto  loans                                      |   | 571,295                      |      | 42,752 |   | 7.48 |   | 479,084 |   | 35,442 |   | 7.40 |   | 373,088 |   | 27,017 |   | 7.24 |   |
| Other consumer  loans                                     |   | 57,042                       |      | 4,823 |   | 8.46 |   | 47,093 |   | 3,880 |   | 8.24 |   | 36,833 |   | 3,120 |   | 8.47 |   |
| Total  interest-earning assets                            |   | 2,974,146                    |      | 216,669 |   | 7.29 |   | 2,206,621 |   | 166,439 |   | 7.54 |   | 1,893,068 |   | 137,952 |   | 7.29 |   |
| Allowance for  loan losses                                |   | (27,663                      | )         |   |   |   |   | (18,428 | ) |   |   |   |   | (16,153 | ) |   |   |   |   |
| Non-interest  earning assets                              |   | 209,191                      |      |   |   |   |   | 134,973 |   |   |   |   |   | 109,540 |   |   |   |   |   |
| Total assets                                              |   | $                            | 3,155,674 |   |   |   |   |   | $ | 2,323,166 |   |   |   |   |   | $ | 1,986,455 |   |   |   |   |   |
| **Liabilities  and Equity:**                              |   |                         |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                            |   |                         |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                 |   |                         |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                              |   | $                            | 246,034   |   | $ | 1,378 |   | 0.56 | % | $ | 166,776 |   | $ | 1,210 |   | 0.73 | % | $ | 151,180 |   | $ | 1,466 |   | 0.97 | % |
| Savings accounts                                          |   | 254,134                      |      | 4,181 |   | 1.65 |   | 217,433 |   | 4,370 |   | 2.01 |   | 215,088 |   | 4,978 |   | 2.31 |   |
| Money market  savings accounts                            |   | 389,511                      |      | 10,566 |   | 2.71 |   | 292,037 |   | 8,499 |   | 2.91 |   | 295,393 |   | 8,638 |   | 2.92 |   |
| Certificates of  deposit                                  |   | 1,009,557                    |      | 55,892 |   | 5.54 |   | 846,746 |   | 49,482 |   | 5.84 |   | 734,995 |   | 38,171 |   | 5.19 |   |
| Total  interest-bearing deposits                          |   | 1,899,236                    |      | 72,017 |   | 3.79 |   | 1,522,992 |   | 63,561 |   | 4.17 |   | 1,396,656 |   | 53,253 |   | 3.81 |   |
| Borrowed funds:                                           |   |                         |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings (3)                                |   | 33,979                       |      | 1,359 |   | 4.00 |   | 34,471 |   | 1,645 |   | 4.77 |   | 31,896 |   | 1,610 |   | 5.05 |   |
| FHLB advances                                             |   | 714,248                      |      | 40,115 |   | 5.62 |   | 337,733 |   | 21,130 |   | 6.26 |   | 147,486 |   | 8,647 |   | 5.86 |   |
| Total borrowings                                          |   | 748,227                      |      | 41,474 |   | 5.54 |   | 372,204 |   | 22,775 |   | 6.12 |   | 179,382 |   | 10,257 |   | 5.72 |   |
| Total interest-bearing liabilities                        |   | 2,647,463                    |      | 113,491 |   | 4.29 |   | 1,895,196 |   | 86,336 |   | 4.56 |   | 1,576,038 |   | 63,510 |   | 4.03 |   |
| Non-interest  bearing demand deposit accounts             |   | 184,979                      |      |   |   |   | ** ** | 131,108 | ** ** |   | ** ** |   | ** ** | 117,416 | ** ** |   | ** ** |   | ** ** |
| Other liabilities                                         |   | 25,027                       |      |   |   |   |   | 16,527 |   |   |   |   |   | 19,542 |   |   |   |   |   |
| Total liabilities                                         |   | 2,857,469                    |      |   |   |   |   | 2,042,831 |   |   |   |   |   | 1,712,996 |   |   |   |   |   |
| Stockholders’  equity / surplus                      |   | 298,205                      |      |   |   |   | ** ** | 280,335 | ** ** |   | ** ** |   | ** ** | 273,459 | ** ** |   | ** ** |   | ** ** |
| Total liabilities  and stockholders’ equity /surplus |   | $                            | 3,155,674 |   |   |   |   | ** ** | $ | 2,323,166 | ** ** |   | ** ** |   | ** ** | $ | 1,986,455 | ** ** |   | ** ** |   | ** ** |
| Net  interest-earning assets                              |   | $                            | 326,683   |   |   |   |   | ** ** | $ | 311,425 | ** ** |   | ** ** |   | ** ** | $ | 317,030 | ** ** |   | ** ** |   | ** ** |
| Net interest  income/interest rate spread (4)             |   |                         |      | $ | 103,178 |   | 3.00 | %  |   |   | $ | 80,103 |   | 2.98 | % |   |   | $ | 74,442 |   | 3.26 | % |
| Net interest  margin (5)                                  |   |                         |      |   |   |   | 3.47 | % |   |   |   |   |   | 3.63 | % |   |   |   |   | 3.93 | % |

 

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(1)               Average balances include unrealized gains onsecurities available for sale.  Equitysecurities include marketable equity securities and restricted equitysecurities.

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

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

(4)               Interest rate spread represents the differencebetween the fully-taxable yield on interest-earning assets and the cost ofinterest-bearing liabilities.

(5)               Net interest margin represents net interestincome (fully-taxable equivalent)  dividedby average interest-earning assets.  Thetax equivalent adjustment in 2001 was $280,000.  In prior years, the amount was immaterial.

 

 

30

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*Rate/VolumeAnalysis.*  Thefollowing table presents the extent to which changes in interest rates andchanges in volume of interest-earning assets and interest-bearing liabilitieshave affected the Company’s interest income and interest expense during theperiods indicated.  Information isprovided in each category with respect to: (i) changes attributable to changesin volume (changes in volume multiplied by prior rate); (ii) changesattributable to changes in rate (changes in rate multiplied by prior volume);and (iii) the net change (change in rate times change in volume).  The net change has been allocatedproportionately to the changes due to volume and the changes due to rate.

 
|                                                 |   | **Years  ended December 31,**                  |       |
|------------------------------------------------------|--------|------------------------------------------------|------------|
|                                                 |   | **2001 vs.  2000  Increase (decrease) due to** |       | **2000 vs.  1999  Increase (decrease) due to** | ** ** |
|                                                 |   | **Volume**                                     |       | **Rate** |   | **Net** |   | **Volume** |   | **Rate** |   | **Net** | ** ** |
|                                                 |   | **(In  thousands)**                            | ** ** |
| Interest-earning  assets:                            |   |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold and other short-term investments |   | $                                              | 3,088      |   | $ | (670 | ) | $ | 2,418 |   | $ | 176 |   | $ | 279 |   | $ | 455 |   |
| Debt securities                                      |   | 3,105                                          |       | (1,092 | ) | 2,013 |   | (1,986 | ) | 1,165 |   | (821 | ) |
| Equity  securities                                   |   | 1,209                                          |       | (373 | ) | 836 |   | 539 |   | 183 |   | 722 |   |
| Mortgage loans                                       |   | 35,512                                         |       | (755 | ) | 34,757 |   | 15,681 |   | 1,597 |   | 17,278 |   |
| Commercial loans                                     |   | 3,525                                          |       | (1,572 | ) | 1,953 |   | 1,097 |   | 571 |   | 1,668 |   |
| Indirect auto  loans                                 |   | 6,896                                          |       | 414 |   | 7,310 |   | 7,828 |   | 644 |   | 8,472 |   |
| Other consumer  loans                                |   | 839                                            |       | 104 |   | 943 |   | 849 |   | (136 | ) | 713 |   |
| Total  interest-earning assets                       |   | $                                              | 54,174     |   | $ | (3,944 | ) | $ | 50,230 |   | $ | 24,184 |   | $ | 4,303 |   | $ | 28,487 |   |
| Interest-bearing  liabilities:                       |   |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                            |   |                                           |       |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                         |   | $                                              | 486        |   | $ | (318 | ) | $ | 168 |   | $ | 140 |   | $ | (396 | ) | $ | (256 | ) |
| Savings accounts                                     |   | 673                                            |       | (862 | ) | (189 | ) | 54 |   | (662 | ) | (608 | ) |
| Money market  savings accounts                       |   | 2,677                                          |       | (610 | ) | 2,067 |   | (98 | ) | (41 | ) | (139 | ) |
| Certificates of  deposit                             |   | 9,121                                          |       | (2,711 | ) | 6,410 |   | 6,202 |   | 5,109 |   | 11,311 |   |
| Total deposits                                       |   | 12,957                                         |       | (4,501 | ) | 8,456 |   | 6,298 |   | 4,010 |   | 10,308 |   |
| Borrowed funds:                                      |   |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                               |   | (23                                            | )          | (263 | ) | (286 | ) | 125 |   | (90 | ) | 35 |   |
| FHLB advances                                        |   | 21,349                                         |       | (2,364 | ) | 18,985 |   | 11,866 |   | 617 |   | 12,483 |   |
| Total borrowings                                     |   | 21,326                                         |       | (2,627 | ) | 18,699 |   | 11,991 |   | 527 |   | 12,518 |   |
| Total  interest-bearing liabilities                  |   | 34,283                                         |       | (7,128 | ) | 27,155 |   | 18,289 |   | 4,537 |   | 22,826 |   |
| Net interest  income (fully-taxable equivalent)      |   | $                                              | 19,891     |   | $ | 3,184 |   | $ | 23,075 |   | $ | 5,895 |   | $ | (234 | ) | $ | 5,661 |   |

 

31

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**ComparisonOf Operating Results for the Years Ended December 31, 2001 and 2000**

 

As previouslynoted, the acquisition of Home Port on December 31, 2000 had a significantimpact on changes in the components of the Company’s consolidated statements ofincome for the years ended December 31, 2001 and 2000.  The following table segregates NantucketBank’s impact on such changes (in thousands):

 
|                        |   | **Year Ended  December 31, 2000** |    | **Year Ended  December 31,  2000** |   |    |   |
|-----------------------------|--------|-----------------------------------|---------|------------------------------------|--------|---------|--------|
|                        |   | **Consolidated**                  |    | **Nantucket  Bank**                |   | **Net** |   |   | **Net   Changes** |   |
| Interest income             |   | $                                 | 216,389 |                               | $      | 26,397  |   | $ | 189,992 |   | $ | 166,439 |   | $ | 23,553 |   |
| Interest expense            |   | 113,491                           |    | 15,129                             |   | 98,362  |   | 86,336 |   | 12,026 |   |
| Provision for  loan losses  |   | 6,175                             |    | 200                                |   | 5,975   |   | 4,775 |   | 1,200 |   |
| Noninterest  income         |   | 16,343                            |    | 2,269                              |   | 14,074  |   | 9,987 |   | 4,087 |   |
| Noninterest  expense        |   | 65,376                            |    | 9,636                              |   | 55,740  |   | 49,071 |   | 6,669 |   |
| Income before  taxes        |   | 47,690                            |    | 3,701                              |   | 43,989  |   | 36,244 |   | 7,745 |   |
| Provision for  income taxes |   | 16,723                            |    | 1,922                              |   | 14,801  |   | 12,315 |   | 2,486 |   |
| Net income                  |   | $                                 | 30,967  |                               | $      | 1,779   |   | $ | 29,188 |   | $ | 23,929 |   | $ | 5,259 |   |

 

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

 

*InterestIncome.*  Interestincome for the year ended December 31, 2001 was $190.0 million compared to$166.4 million for the year ended December 31, 2000, an increase of $23.6million, or 14.2%.  The increase ininterest income resulted from growth in average interest-earning assets of$423.2 million, or 19.2%, partially offset by a decrease in the overall yieldon interest-earning assets of 30 basis points in the 2001 period.  The principal areas of growth in averagebalances were related to real estate loans (up $181.2 million, or 13.7%) andindirect auto loans (up $92.2 million, or 19.2%).  Most of the real estate loan growth resulted from increasedoriginations and retention in portfolio, until September 2001, of residentialmortgage loans.  The increase inindirect auto loans resulted from the continued geographic expansion of thenetwork of participating dealers.

 

*InterestExpense.*  Interestexpense for the year ended December 31, 2001 was $98.4 million compared to$86.3 million for the year ended December 31, 2000, an increase of $12.0million or 13.9%.  This increaseresulted from a higher average balance of interest-bearing liabilities (up$384.1 million, or 20.3%), partially offset by a 24 basis points decrease inthe cost of funds from 4.56% in 2000 to 4.32% in 2001.  Average interest-bearing deposit balancesincreased $168.5 million, or 11.1%, during 2001 compared to 2000.

 

Interest expense onborrowed funds increased $9.7 million in the year ended December 31, 2001 dueto a $215.7 million  increase in theaverage balance of such funds, partially offset by a 59 basis points decreasein the average rate paid on borrowed funds to 5.53% in the 2001 period.

 

The decrease of 24 basispoints in the cost of funds in 2001 reflected the series of reductions ininterest rates initiated by the Federal Reserve Board in 2001 and the repricingof nearly 90% of certificates of deposit outstanding at December 31, 2000 in2001 (particularly in the second half of the year).  The cost of funds is expected to decrease again in 2002 as certificatesof deposit with a weighted average rate of 4.02% and FHLB advances with aweighted average rate of 5.16% are scheduled to mature during the year and bereplaced at lower rates.

 

*Provisionfor Loan Losses.*  TheCompany provides for loan losses in order to maintain the allowance for loanlosses at a level that management believes is adequate to absorb futurecharge-offs of loans deemed uncollectible. In determining the appropriate level of the allowance for loan losses,management considers past and anticipated loss experience, evaluations ofunderlying collateral, prevailing economic conditions, the nature and volume ofthe loan portfolio and the levels of nonperforming and other classifiedloans.  The amount of the allowance isbased on estimates and  ultimate lossesmay vary from such estimates. Management assesses the allowance for loan losses on a quarterly basisand provides for loan losses monthly in order to maintain the adequacy of theallowance.

 

 

32

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Compass provided $6.0million for loan losses in the year ended December 31, 2001 compared to $4.8million in the  year ended December 31,2000.  The increase of $1.2 million in2001 was primarily attributable to both growth in the loan portfolio and anincrease in non-performing loans.  Thetotal allowance (including Nantucket Bank) of $29.5 million at December 31,2001 represented 1.15% of total loans compared to 1.06% at December 31, 2000.  At December 31, 2001, the allowance for loanlosses as a percentage of non-performing loans was 220.1% compared to 410.7% atDecember 31, 2000.  The Companyexperienced a gradual increase in non-performing loans during 2001 from $6.1million at December 31, 2000 to $13.4 million at December 31, 2001, or .52% oftotal loans.  The increase innon-performing loans was primarily attributable to several commercial creditsaffected by the current economic slowdown and does not appear to be reflectiveof a more pervasive adverse trend in the economy of southeastern Massachusetts.  Management has committed additionalpersonnel resources to the credit administration and collection functions inthe past two years to monitor its growing loan portfolio.  With the continuing uncertainty in theeconomy in 2002, the Company may experience an increase in its non-performingloans but believes that the resources are in place to appropriately addresspotential problem loans as they arise.

 

*NoninterestIncome.*  Totalnoninterest income was $14.1 million for the year ended December 31, 2001compared to $10.0 million in the same period of 2000.  Included in noninterest income in 2001 is a $1.5 million gain onthe settlement of Compass’s pension plan. Exclusive of this non-recurring item, noninterest income increased $2.6million, or 25.9%.  This increase wasprincipally caused by gains on loan sales ($1.0 million), checking accountrelated income ($820,000) and ATM/Debit card usage ($670,000).

 

*NoninterestExpense.*   Noninterestexpense increased by $6.6 million from $49.1 million for the year endedDecember 31, 2000 to $55.7 million for the year ended December 31, 2001.  Exclusive of a non-recurring item related tothe acquisition of Sandwich Bancorp, Inc. recognized in 2000, noninterest expenseincreased $6.3 million, or 12.7%, in 2001. This increase reflected increases in salaries and employee benefits($2.5 million), occupancy and equipment ($1.1 million), data processing($638,000), marketing ($242,000), professional services ($940,000) and othernoninterest expense ($928,000).

 

Salaries and employeebenefits increased $2.5 million, or 9.5%, in 2001 due primarily to increases instaffing ($1.0 million) necessitated by franchise expansion (first full yearfor 2 branches and one new branch opened in 2001) and the start-up of Compass’sprivate banking initiative, salary increases averaging 4.5% ($722,000), anincrease in ESOP expense due to the Company’s higher stock price in 2001($256,000), increases in employee-related insurance costs ($222,000) and anincrease in 401(k) expense ($109,000).

 

Occupancy and equipmentexpenses increased $1.1 million , or 16.3%, in 2001.  This increase was primarily due to higher costs associated withthe new corporate offices which opened during the third quarter of 2000 and newbranches in Dennis, Seekonk and Mattapoisett, as well as higher utility costscaused by increases in usage and rates charged by service providers.

 

Data processing expensesincreased $638,000,  or 12.8%, in 2001due primarily to volume-related services such as item processing and ATMusage.  These increases were partiallyoffset by a rate decrease received from the Company’s core processing serviceprovider.

 

Marketing expensesincreased $242,000, or 9.1% in 2001. This increase was attributable to production and media costs for televisioncommercials, partially offset by decreases in promotions, print advertising anddirect marketing.

 

Professional servicesexpenses increased $940,000, or 53.4%, in 2001.  This increase reflects consulting and legal fees associated withthe start-up of Compass’s private banking initiative and other legal andconsulting services primarily related to analysis of business expansionopportunities.

 

Other noninterest expenseincreased by $928,000, or 14.5%, in 2001. This increase reflects primarily volume-related items such as printing,postage and telephone costs as well as the increased use of security personnelin the branches during the fourth quarter.

 

*IncomeTaxes.* The effective tax rate (including Nantucket Bank) in2001 was 35.1% compared to 34.3% in 2000. In 2001, the Company completed an analysis addressing the impact of arecent Tax Court decision on the deductibility of certain merger-related costsincurred in connection with the acquisition of Sandwich Bancorp, Inc. in1998.  Based on this analysis, theprovision for income taxes was reduced by $479,000.  Exclusive of this non-recurring item, the effective tax rate in2001 was 36.1%.  This increase from 2000reflected the impact of nondeductible goodwill amortization resulting from theHome Port acquisition.

 

 

33

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**Comparison of Operating Results forthe Years Ended December 31, 2000 and 1999**

 

*Overview*  Net income was $23.9 million, or $1.01 perdiluted share, in 2000 compared to $24.5 million, or $.97 per diluted share in1999.  Included in net income for 1999was a curtailment gain on the pending termination of Compass’s defined benefitpension plan which, after taxes, amounted to $856,000, or $.03 per dilutedshare.  Exclusive of this non-recurringitem, net income and earnings per share increased by 1.1% and 7.4%,respectively.   Due primarily to anincrease in average interest-earning assets of $313.6 million, or 16.6%, netinterest income increased by $5.7 million, or 7.6%, from $74.4 million in 1999to $80.1 million in 2000.  Offsettingthis increase in net interest income was an increase of $2.8 million in theprovision for loan losses and an increase of $4.6 million in noninterestexpense.  The Company’s effective taxrate declined to 34.0% in 2000 from 35.3% in 1999.

 

*InterestIncome.*  Interestincome was $166.4 million in 2000, compared to $138.0 million in 1999, anincrease of $28.4  million, or20.6%.  This increase in interest incomeresulted  from the growth in averageinterest-earning assets of $313.6 million and an increase in the yield oninterest-earning assets of 25 basis points from 7.29% in 1999 to 7.54% in 2000. A significant portion of the increase in average interest-earning assetswas attributable to the indirect auto loan portfolio, which increased from$373.1 million in 1999 to $479.1 million in 2000, and the mortgage loanportfolio, which increased from $1,121.7 million to $1,327.0 million for thoseyears, respectively.  The increase inthe yield on interest-earning assets reflects the series of rate increasesinitiated by the Federal Reserve Board beginning in June 1999 and continuinginto 2000.

 

*InterestExpense.*  Interestexpense increased by $22.8 million, or 35.9%, from $63.5 million in 1999 to$86.3 million in 2000.  The increaseresulted from a $319.2 million  increasein average interest-bearing liabilities and a 53 basis point increase in theaverage rate paid on such liabilities. Total average interest-bearing deposits increased by $126.3million,  with most of the increaseoccurring in higher cost certificates of deposit.  Because of the level of loan growth, Compass increased itsadvances from the FHLB with the average amount of such borrowings outstandingincreasing by $190.2 million from $147.5 million in 1999 to $337.7 million in2000.

 

The increase in the costof funds on interest-bearing liabilities reflects the series of rate increasesinitiated by the Federal Reserve Board beginning in June 1999 and continuinginto 2000 as well as the greater utilization of higher cost certificates ofdeposit and FHLB advances as a funding source. The incremental increase of 28 basis points in the cost of funds overthe yield on interest-earning assets reflects the faster repricingcharacteristics of Compass’s interest-bearing liabilities as compared to itsinterest-earning assets and the competitive pricing for certificates ofdeposits in 2000.

 

*Provisionfor Loan Losses.*  Theprovision for loan losses increased by $2.8 million  from $2.0 million in 1999 to $4.8 million in 2000.   This increase was primarily attributable tothe growth in the loan portfolio as internal indicators of credit qualitycontinue to be positive.  The totalallowance of $25.1 million at December 31, 2000 represented 1.06% of totalloans, an increase from .96% at December 31, 1999.  At December 31, 2000, the allowance for loan losses as apercentage of non-performing loans was 410.7% compared to 293.5% at December 31, 1999.

 

*NoninterestIncome.*  Totalnoninterest income was $10.0 million in 2000 and 1999.  Included in noninterest income in 1999 was a$1.5 million gain on termination of Compass’s pension plan.  Exclusive of this non-recurring item,noninterest income increased $1.5 million, or 17.2%, in 2000.  This increase was principally caused by increasesin loan fees, ATM/Debit card usage and checking account related fees.  Such increases more than offset a decreaseof $186,000 in gains on sales of investment securities and loans.

 

*NoninterestExpense.*  Noninterestexpense increased by $4.6 million, or 10.2%, from $44.5 million for the yearended December 31, 1999 to $49.1 million for the year ended December 31,2000.  Of this increase, $4.1million  related to salaries andemployee benefits, which rose 18.4% to $26.5 million in 2000.** **Thisincrease is due to annual wage adjustments and increases in staffingnecessitated by franchise expansion ($1.9 million), a full year of costassociated with the restricted stock awards granted in July 1999 ($725,000),employment taxes ($272,000), employee-related insurance costs ($413,000) andthe cost of a new sales incentive program for retail branch personnel($187,000).   In addition, the amountaccrued for Compass’s management incentive plan increased $795,000 in 2000 partiallydue to reduced expense in 1999 resulting from utilization of amounts accruedbut not paid during the two month transition period ended December 31,1998.  These increases were partiallyoffset by a net savings of $183,000 due to changes made in September 1999 toCompass’s employee retirement plans.

 

Occupancy and equipmentexpenses increased $752,000, or 12.9%, to $6.6 million for the year endedDecember 31, 2000.  This increase wasprimarily due to an increase in depreciation and utility costs attributable to thecompletion of Compass’s new corporate offices and the opening of new branchesin New Bedford, Seekonk and Mattapoisett. In addition, non-recurring moving and storage costs of $205,000 wereincurred in connection with the relocation to the new corporate offices.

 

 

34

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Data processing expensesincreased $517,000, or 11.5%, to $5.0 million for the year ended December 31,2000.  This increase was primarily dueto expansion of the ATM network on Cape Cod and volume-related core processingcosts due to increases in loans and deposits.

 

Marketing expensesincreased $371,000, or 15.1%, to $2.8 million for the year ended December 31,2000.  Such increase was attributable tovarious initiatives promoting the grand opening of Compass’s new main bankingoffice and corporate  headquarters aswell as customer acquisition programs targeted at individuals and businessesaffected by the branch divestitures required by the Fleet/Bank Boston merger.

 

Other components ofnoninterest expense decreased $1.2 million, or 12.7%, for the year endedDecember 31, 2000.  This decrease wasdue primarily to the change between years in certain non-recurring itemsassociated with the merger with Sandwich Bank.

 

*IncomeTaxes*.  Total incometax expense was $12.3 million in 2000 compared to $13.4 million in 1999.  The effective tax rate was lower in 2000(34.0%) than in 1999 (35.3%) primarily because of greater utilization ofnon-bank subsidiaries that were taxed at a lower rate for state tax purposes,an increase in tax-favored investment income and the reversal of reserves nolonger required.

 

**Liquidity and Capital Resources**

 

The Banks’ liquidity,represented by cash and cash equivalents and debt securities is a product oftheir operating, investing, and financing activities.  The primary sources of funds are deposits, borrowings, principaland interest payments on outstanding loans and mortgage-backed securities,maturities of investment securities and funds provided from operations.  While scheduled payments from the amortizationof loans and mortgage related securities and maturing investment securities arerelatively predictable sources of funds, deposit flows and loan prepayments aregreatly influenced by general interest rates and, in the case of deposits,other instruments available to the public such as mutual funds and annuities.

 

As voluntary members ofthe FHLB, Compass and Nantucket Bank are entitled to borrow an amount up to thevalue of their qualified collateral that has not been pledged to others.  Qualified collateral generally consists ofresidential first mortgage loans, U.S. Government and agency securities andfunds on deposit at the FHLB.  AtDecember 31, 2001, Compass and Nantucket Bank had $411.9 million and $59.2million, respectively, in unused borrowing capacity that is contingent upon thepurchase of additional FHLB stock.  Useof this borrowing capacity may also be impacted by regulatory capitalrequirements.

 

Liquidity management isboth a daily and long term function of business management.  The measure of a bank’s liquidity is itsability to meet its cash commitments at all times with available cash or byconversion of other assets to cash at a reasonable price.  At December 31, 2001, the Banks maintainedcash and due from banks, short-term investments and debt securities maturingwithin one year of $289.8 million, or 8.66% of total assets.  The Banks invest excess funds, if any, infederal funds sold, which provides liquidity to meet lending and other cashrequirements.

 

At December 31, 2001, theBanks had commitments to originate loans, unused outstanding lines of credit,standby letters of credit and undisbursed proceeds of loans totaling $285.2million.  The Banks anticipate that theywill have sufficient funds available to meet their current loancommitments.  Certificates of depositmaturing within one year from December 31, 2001 amounted to $792.0million.  The Banks expect thatsubstantially all maturing certificate accounts will be retained  at maturity, although the percentageretained may be below historical levels due to increased price competition forthese deposits.

 

The Company’s and theBanks’ capital ratios at December 31, 2001 were as follows:

 
|                                      |   | **Seacoast   Financial** |   | **Compass** |   | **Nantucket   Bank** |   |
|-------------------------------------------|--------|--------------------------|--------|-------------|--------|----------------------|--------|
| Total Capital (to risk weighted assets)   |   | 13.34                    | %      | 12.16       | %      | 16.18                | %      |
| Tier 1 Capital  (to risk weighted assets) |   | 12.04                    |   | 10.90       |   | 14.92                |   |
| Tier 1 Capital  (to average assets)       |   | 8.04                     |   | 7.34        |   | 9.87                 |   |

 

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

 

**Impact of Inflation and ChangingPrices**

 

The consolidatedfinancial statements and notes thereto presented herein have been prepared inaccordance with accounting principles generally accepted in the United States,which require the measurement of financial position and operating results interms of historical dollar amounts without considering changes in the relativepurchasing power of money over time due to inflation.  The impact of inflation is reflected in the increased cost of theCompany’s operations.

 

35

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Unlike industrialcompanies, nearly all of the Company’s assets and liabilities are monetary innature.  As a result, interest rateshave a greater impact on its performance than do the effects of general levelsof inflation.  Interest rates do notnecessarily move in the same direction or to the same extent as the prices ofgoods and services.

 

**Item 7a. Quantitative and QualitativeDisclosures about Market Risk**

 

The chief market riskfactor affecting the financial condition and operating results of the Companyis interest rate risk.  This risk ismanaged by periodic evaluation of the interest rate risk inherent in certain balancesheet accounts, determination of the level of risk considered appropriate givencapital and liquidity requirements, business strategy, performance objectivesand operating environment and maintenance of such risks within guidelinesapproved by the Board of Directors. Through such management, the Company seek to reduce the vulnerability ofnet earnings to changes in interest rates. The Banks’ Asset/Liability Committees, comprised of senior management,are responsible for managing interest rate risk and reviewing with their Boardsof Directors on a quarterly basis their activities and strategies, the effectof those strategies on operating results, the Banks’ interest rate riskpositions and the effect changes in interest rates would have on net interestincome.  The extent of movement ofinterest rates is an uncertainty that could have a negative impact on earnings.

 

The principal strategiesthat the Company uses to manage interest rate risk include (i) emphasizing theorigination and retention of adjustable rate loans, origination of indirectauto loans (Compass only) which have relatively short maturities andorigination of loans with maturities at least partially matched with those ofthe deposits and borrowings funding the loans, (ii) investing in debtsecurities with relatively short maturities and (iii) classifying a significantportion of the investment portfolio as available for sale so as to providesufficient flexibility in liquidity management.

 

The Company and the Banksquantify their interest rate risk exposure using a sophisticated simulationmodel.  Simulation analysis is used tomeasure the exposure of net interest income to changes in interest rates over aspecified time horizon.  Simulation analysisinvolves projecting future interest income and expense under various rate scenarios.  Internal guidelines on interest rate riskspecify that for every 100 basis points immediate shift in interest rates,estimated net interest income over the next twelve months should decline by nomore than 5%.

 

In utilizing a 300 basispoint increase in rates in its simulation model, the full impact of annual ratecaps of 200 basis points common to most adjustable rate mortgage loan productsis considered.  The rate shocks usedassume an instantaneous and parallel change in interest rates and that nostrategies are implemented in response to the change in rates.  Prepayment speeds for loans are based onpublished median dealer forecasts for each interest rate scenario.

 

The following tablereflects the estimated percentage exposure of the Company’s net interest incomefor the 12 months following the date indicated assuming an immediate shift ininterest rates as set forth below:

 
|                                         |   | **December 31,** |       |
|----------------------------------------------|--------|------------------|------------|
|                                         |   | **2001**         | ** ** | **2000** | ** ** |
| 300 basis points  increase in rates          |   | (8.50            | )%         | (10.68 | )% |
| 200 basis points  decrease in rates          |   |             |       | (1.39 | )% |
| 150 basis points  decrease in rates (Note 1) |   | (0.50            | )%         |   |   |

 

For each one percentagepoint change in net interest income in the 2001 projections, the effect on netincome would be $793,000, assuming a 36% tax rate.

 

(1) Due to the low interest rate environment in effect at December 31,2001 (the average Federal Fund overnight rates were trading at 2.00%.) thesimulation model could only be rate shocked down 150 basis points.

 

 

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**Item 8.    Financial Statements and Supplementary Data**

 
| Report of  Independent Public Accountants                                                                              |
|------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                   |
| Consolidated Balance Sheets  as of December 31, 2001 and 2000                                                          |
|                                                                                                                   |
| Consolidated  Statements of Income for the Years Ended December 31, 2001, 2000 and 1999                                |
|                                                                                                                   |
| Consolidated  Statements of Changes in Stockholders’ Equity for the Years Ended December  31, 2001, 2000 and 1999 |
|                                                                                                                   |
| Consolidated Statements  of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999                            |
|                                                                                                                   |
| Notes to  Consolidated Financial Statements                                                                            |

 

All schedules are omitted because they are not required or applicable,or the required information is shown in the financial statements or notesthereto.

 

37

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**REPORTOF INDEPENDENT PUBLIC ACCOUNTANTS**

 

To the Board of Directors of

Seacoast Financial Services Corporation:

 

We have audited the accompanying consolidated balancesheets of Seacoast Financial Services Corporation and subsidiaries (theCompany) as of December 31, 2001 and 2000 and the related consolidatedstatements of income, changes in stockholders’ equity and cash flows for eachof the years in the three year period ended December 31, 2001. Theseconsolidated financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

 

We conducted our audits in accordance with auditingstandards generally accepted in the 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 auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financial positionof Seacoast Financial Services Corporation and subsidiaries as of December 31,2001 and 2000, and the results of their operations and their cash flows foreach of the years in the three year period ended December 31, 2001 inconformity with accounting principles generally accepted in the United States.

 
|                  | ARTHUR ANDERSEN LLP |
|-----------------------|---------------------|
|                  |                |
| Boston, Massachusetts |                |
| January 22, 2002      |                |

 

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** **

**SEACOASTFINANCIAL SERVICES CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(Dollars in thousands, except pershare amounts)**

 
|                                                                                              |     | **December  31** |      |
|---------------------------------------------------------------------------------------------------|----------|------------------|-----------|
|                                                                                              | **2001** |             | **2000**  |   |
| ASSETS:                                                                                           |     |             |      |   |   |
| Cash and due  from banks                                                                          |     | $                | 87,834    |   | $ | 101,665 |   |
| Federal funds  sold                                                                               |     | 92,899           |      | 5,848 |   |
| Short-term  investment                                                                            |     | 10,000           |      | — |   |
| Total cash and  cash equivalents                                                                  |     | 190,733          |      | 107,513 |   |
| Investment  securities (Note 3) —                                                            |     |             |      |   |   |
| Available-for-sale,  at fair value                                                                |     | 405,788          |      | 248,855 |   |
| Held to  maturity, at amortized cost (fair value $20,900 and $29,771)                             |     | 20,551           |      | 29,728 |   |
| Restricted  equity securities                                                                     |     | 40,837           |      | 28,974 |   |
| Loans  held-for-sale (Note 1)                                                                     |     | 19,675           |      | 13,666 |   |
| Loans, net (Note  4)                                                                              |     | 2,545,469        |      | 2,338,251 |   |
| Accrued interest  receivable                                                                      |     | 15,872           |      | 14,927 |   |
| Banking premises  and equipment, net (Note 5)                                                     |     | 51,294           |      | 50,878 |   |
| Other real  estate owned                                                                          |     | 427              |      | 86 |   |
| Net deferred tax  asset (Note 9)                                                                  |     | 9,895            |      | 11,247 |   |
| Goodwill (Notes  1 and 2)                                                                         |     | 33,903           |      | 37,467 |   |
| Intangible  assets (Notes 1 and 2)                                                                |     | 2,370            |      | 1,333 |   |
| Other assets                                                                                      |     | 10,653           |      | 7,840 |   |
| Total assets                                                                                      |     | $                | 3,347,467 |   | $ | 2,890,765 |   |
|                                                                                              |     |             |      |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY:                                                       |     |             |      |   |   |
| Deposits (Note  6)                                                                                |     | $                | 2,192,357 |   | $ | 1,989,630 |   |
| Short-term  borrowings (Note 7)                                                                   |     | 34,584           |      | 31,427 |   |
| Federal Home  Loan Bank advances (Note 8)                                                         |     | 786,917          |      | 556,958 |   |
| Other borrowings  (Note 10)                                                                       |     | 1,840            |      | 1,881 |   |
| Mortgagors’  escrow payments                                                                 |     | 4,761            |      | 4,428 |   |
| Accrued expenses  and other liabilities (Note 12)                                                 |     | 21,284           |      | 18,253 |   |
| Total  liabilities                                                                                |     | 3,041,743        |      | 2,602,577 |   |
| COMMITMENTS AND  CONTINGENCIES (Notes 10 and 14)                                                  |     |             |      |   |   |
| Stockholders’  equity (Notes 11, 13, 17, and 18):                                            |     |             |      |   |   |
| Preferred stock,  par value $.01 per share; authorized 10,000,000 shares; none issued             |     | —           |      | — |   |
| Common stock,  par value $.01 per share; authorized 100,000,000 shares; 26,758,136 shares  issued |     | 268              |      | 268 |   |
| Additional  paid-in capital                                                                       |     | 153,216          |      | 152,795 |   |
| Retained  earnings                                                                                |     | 189,743          |      | 166,865 |   |
| Treasury stock,  at cost, 2,439,000 shares in 2001 and 1,799,775 shares in 2000                   |     | (28,185          | )         | (17,990 | ) |
| Accumulated  other comprehensive income                                                           |     | 3,531            |      | 791 |   |
| Unearned  compensation — ESOP and restricted stock                                           |     | (12,575          | )         | (14,384 | ) |
| Shares held in  employee trust                                                                    |     | (274             | )         | (157 | ) |
| Total  stockholders’ equity                                                                  |     | 305,724          |      | 288,188 |   |
| Total  liabilities and stockholders’ equity                                                  |     | $                | 3,347,467 |   | $ | 2,890,765 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**SEACOASTFINANCIAL SERVICES CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**(Dollars in thousands, except pershare amounts)**

 
|                                                                              |     | **Years Ended  December 31,** |     |
|-----------------------------------------------------------------------------------|----------|-------------------------------|----------|
|                                                                              | **2001** |                          | **2000** |   | **1999** |   |
| INTEREST AND DIVIDEND INCOME:                                                     |     |                          |     |   |   |   |   |
| Interest on loans                                                                 |     | $                             | 193,157  |   | $ | 148,349 |   | $ | 120,218 |   |
| Interest and dividends on investment securities                                   |     | 19,982                        |     | 17,258 |   | 17,357 |   |
| Interest on federal funds sold and short-term investments                         |     | 3,250                         |     | 832 |   | 377 |   |
| Total interest and dividend income                                                |     | 216,389                       |     | 166,439 |   | 137,952 |   |
|                                                                              |     |                          |     |   |   |   |   |
| INTEREST EXPENSE:                                                                 |     |                          |     |   |   |   |   |
| Interest on deposits                                                              |     | 72,017                        |     | 63,561 |   | 53,253 |   |
| Interest on borrowed funds                                                        |     | 41,474                        |     | 22,775 |   | 10,257 |   |
| Total interest expense                                                            |     | 113,491                       |     | 86,336 |   | 63,510 |   |
| Net interest income                                                               |     | 102,898                       |     | 80,103 |   | 74,442 |   |
|                                                                              |     |                          |     |   |   |   |   |
| PROVISION FOR LOAN LOSSES (Note 4)                                                |     | 6,175                         |     | 4,775 |   | 2,000 |   |
| Net interest income after provision for loan losses                               |     | 96,723                        |     | 75,328 |   | 72,442 |   |
|                                                                              |     |                          |     |   |   |   |   |
| NONINTEREST INCOME:                                                               |     |                          |     |   |   |   |   |
| Deposit and other banking fees                                                    |     | 8,946                         |     | 6,413 |   | 5,514 |   |
| Loan servicing fees, net                                                          |     | 959                           |     | 689 |   | 587 |   |
| Merchant card fee income, net                                                     |     | 534                           |     | 506 |   | 385 |   |
| Other loan fees                                                                   |     | 1,453                         |     | 849 |   | 428 |   |
| Gain on sales of investment securities, net (Note 3)                              |     | 99                            |     | 4 |   | 164 |   |
| Gain on sales of loans, net                                                       |     | 1,352                         |     | 30 |   | 56 |   |
| Gain on pension plan termination and settlement (Note 12)                         |     | 1,504                         |     | — |   | 1,472 |   |
| Other income (Note 5)                                                             |     | 1,496                         |     | 1,496 |   | 1,388 |   |
| Total noninterest income                                                          |     | 16,343                        |     | 9,987 |   | 9,994 |   |
|                                                                              |     |                          |     |   |   |   |   |
| NONINTEREST EXPENSE:                                                              |     |                          |     |   |   |   |   |
| Salaries and employee benefits (Note 12)                                          |     | 33,079                        |     | 26,469 |   | 22,362 |   |
| Occupancy and equipment expenses (Notes 5 and 10)                                 |     | 8,715                         |     | 6,576 |   | 5,824 |   |
| Data processing expenses                                                          |     | 6,468                         |     | 5,003 |   | 4,486 |   |
| Marketing expenses                                                                |     | 3,112                         |     | 2,658 |   | 2,310 |   |
| Professional services expenses                                                    |     | 2,970                         |     | 1,759 |   | 1,727 |   |
| Amortization of goodwill and intangibles (Note 2)                                 |     | 2,959                         |     | 590 |   | 669 |   |
| Other operating expenses                                                          |     | 8,073                         |     | 6,419 |   | 6,936 |   |
| Merger-related expense recovery (Note 2)                                          |     | —                        |     | (403 | ) | — |   |
| Write-down of banking premises and equipment (Note 5)                             |     | —                        |     | — |   | 202 |   |
| Total noninterest expense                                                         |     | 65,376                        |     | 49,071 |   | 44,516 |   |
| Income before provision for income taxes                                          |     | 47,690                        |     | 36,244 |   | 37,920 |   |
|                                                                              |     |                          |     |   |   |   |   |
| PROVISION FOR INCOME TAXES (Note 9)                                               |     | 16,723                        |     | 12,315 |   | 13,394 |   |
| Net income                                                                        |     | $                             | 30,967   |   | $ | 23,929 |   | $ | 24,526 |   |
|                                                                              |     |                          |     |   |   |   |   |
| EARNINGS PER SHARE (Note 1):                                                      |     |                          |     |   |   |   |   |
| Basic                                                                             |     | $                             | 1.32     |   | $ | 1.01 |   | $ | 0.97 |   |
| Diluted                                                                           |     | $                             | 1.31     |   | $ | 1.01 |   | $ | 0.97 |   |
|                                                                              |     |                          |     |   |   |   |   |
| Weighted average common shares outstanding                                        |     | 24,753,758                    |     | 25,291,834 |   | 26,710,211 |   |
| Weighted average unallocated ESOP sharesand unvested restricted stock             |     | (1,374,071                    | )        | (1,525,414 | ) | (1,374,301 | ) |
| Weighted average common shares outstanding - basic                                |     | 23,379,687                    |     | 23,766,420 |   | 25,335,910 |   |
| Dilutive effect of common stock equivalents                                       |     | 333,770                       |     | 22,417 |   | 19,669 |   |
| Weighted average  common and common stock equivalent shares outstanding - diluted |     | 23,713,457                    |     | 23,788,837 |   | 25,355,579 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

40

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**SEACOASTFINANCIAL SERVICES CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

**FOR THEYEARS ENDED DECEMBER 31, 2001, 2000 AND 1999**

 

| ** **                                                                                                                                                            | ** ** | **Common Stock**                             |       | **Additional Paid-In Capital** |   | **Retained Earnings** |   | **Treasury Stock** |    | **Accumulated Comprehensive Income (Loss)** |   | **Unearned ESOP/Rest. Stock** |   | **Shares Held in Employee Trust** |   | **Total** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------|--------|-----------------------|--------|--------------------|---------|---------------------------------------------|--------|-------------------------------|--------|-----------------------------------|--------|-----------|------------|
| ** **                                                                                                                                                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Balance, December  31, 1998                                                                                                                                      |       | $                                            | 268        |                           | $      | 152,936               |   | $                  | 127,263 |                                        | $      | —                        |   | $                                 | 2,337  |      | $          | (11,153) |   | $ | (139) |   | $ | 271,512 |   |
| Grant of restricted stock awards                                                                                                                                      |       | —                                       |       | 6,370                          |   | —                |   | —             |    | —                                      |   | (6,370)                       |   | —                            |   | —    |       |
| Repurchase of common stock                                                                                                                                            |       | —                                       |       | —                         |   | —                |   | (15,939            | )       | —                                      |   | —                        |   | —                            |   | (15,939   | )          |
| Issuance of restricted stock awards                                                                                                                                   |       | —                                       |       | (6,629                         | )      | —                |   | 6,629              |    | —                                      |   | —                        |   | —                            |   | —    |       |
| Net income                                                                                                                                                            |       | —                                       |       | —                         |   | 24,526                |   | —             |    | —                                      |   | —                        |   | —                            |   | 24,526    |       |
| Other comprehensive income — Change in unrealized gain (loss) on  securities available for sale, net of taxes and reclassification adjustment  (Note 1)          |       | —                                       |       | —                         |   | —                |   | —             |    | (4,767)                                     |   | —                        |   | —                            |   | (4,767    | )          |
| Comprehensive income                                                                                                                                                  |       |                                         |       |                           |   |                  |   |               |    |                                        |   |                          |   |                              |   | 19,759    |       |
| Cash dividends - $.10 per share                                                                                                                                       |       | —                                       |       | —                         |   | (2,533                | )      | —             |    | —                                      |   | —                        |   | —                            |   | (2,533    | )          |
| Amortization of unearned compensation                                                                                                                                 |       | —                                       |       | 25                             |   | —                |   | —             |    | —                                      |   | 1,197                         |   | —                            |   | 1,222     |       |
| Balance, December 31, 1999                                                                                                                                            |       | 268                                          |       | 152,702                        |   | 149,256               |   | (9,310             | )       | (2,430                                      | )      | (16,326                       | )      | (139                              | )      | 274,021   |       |
| Repurchase of common stock                                                                                                                                            |       | —                                       |       | —                         |   | —                |   | (8,680             | )       | —                                      |   | —                        |   | —                            |   | (8,680    | )          |
| Net income                                                                                                                                                            |       | —                                       |       | —                         |   | 23,929                |   | —             |    | —                                      |   | —                        |   | —                            |   | 23,929    |       |
| Other comprehensive income — Change in unrealized gain (loss) on  securities available for sale, net of taxes and reclassification adjustment  (Note 1)          |       | —                                       |       | —                         |   | —                |   | —             |    | 3,221                                       |   | —                        |   | —                            |   | 3,221     |       |
| Comprehensive income                                                                                                                                                  |       |                                         |       |                           |   |                  |   |               |    |                                        |   |                          |   |                              |   | 27,150    |       |
| Cash dividends - $.26 per share                                                                                                                                       |       | —                                       |       | —                         |   | (6,320                | )      | —             |    | —                                      |   | —                        |   | —                            |   | (6,320    | )          |
| Amortization of unearned compensation                                                                                                                                 |       | —                                       |       | (8                             | )      | —                |   | —             |    | —                                      |   | 1,942                         |   | —                            |   | 1,934     |       |
| Other                                                                                                                                                                 |       | —                                       |       | 101                            |   | —                |   | —             |    | —                                      |   | —                        |   | (18                               | )      | 83        |       |
| Balance, December 31, 2000                                                                                                                                            |       | 268                                          |       | 152,795                        |   | 166,865               |   | (17,990            | )       | 791                                         |   | (14,384                       | )      | (157                              | )      | 288,188   |       |
| Exercise of stock options                                                                                                                                             |       | —                                       |       | 23                             |   | —                |   | 297                |    | —                                      |   | —                        |   | —                            |   | 320       |       |
| Repurchase of common stock                                                                                                                                            |       | —                                       |       | —                         |   | —                |   | (10,492            | )       | —                                      |   | —                        |   | —                            |   | (10,492   | )          |
| Net income                                                                                                                                                            |       | —                                       |       | —                         |   | 30,967                |   | —             |    | —                                      |   | —                        |   | —                            |   | 30,967    |       |
| Other comprehensive income  —  Change in unrealized gain on securities available available for sale, net of  taxes and reclassification adjustment (Note 1) |       | —                                       |       | —                         |   | —                |   | —             |    | 2,740                                       |   | —                        |   | —                            |   | 2,740     |       |
| Comprehensive income                                                                                                                                                  |       |                                         |       |                           |   |                  |   |               |    |                                        |   |                          |   |                              |   | 33,707    |       |
| Cash dividends - $.34 per   share                                                                                                                                |       | —                                       |       | —                         |   | (8,089                | )      | —             |    | —                                      |   | —                        |   | —                            |   | (8,089    | )          |
| Amortization of unearned compensation                                                                                                                                 |       | —                                       |       | 268                            |   | —                |   | —             |    | —                                      |   | 1,809                         |   | —                            |   | 2,077     |       |
| Other                                                                                                                                                                 |       | —                                       |       | 130                            |   | —                |   | —             |    | —                                      |   | —                        |   | (117)                             |   | 13        |       |
| Balance, December 31, 2001                                                                                                                                            |       | $                                            | 268        |                           | $      | 153,216               |   | $                  | 189,743 |                                        | $      | (28,185                       | )      | $                                 | 3,531  |      | $          | (12,575 | ) | $ | (274 | ) | $ | 305,724 |   |
|                                                                                                                                                                       |            |                                              |            |                                |        |                       |        |                    |         |                                             |        |                               |        |                                   |        |           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**SEACOASTFINANCIAL SERVICES CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
|                                                                                                 |   | **Years  Ended December 31,** |   |
|------------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                                                 |   | **2001**                      |   | **2000** |   | **1999** |   |
|                                                                                                 |   | **(In Thousands)**            |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                               |   |                          |   |   |   |   |   |
| Net income                                                                                           |   | $                             | 30,967 |   | $ | 23,929 |   | $ | 24,526 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities—              |   |                          |   |   |   |   |   |
| Depreciation                                                                                         |   | 4,082                         |   | 2,867 |   | 2,464 |   |
| Amortization and  accretion, net                                                                     |   | 453                           |   | 25 |   | 697 |   |
| Goodwill and  intangibles amortization, net                                                          |   | 2,621                         |   | 575 |   | 649 |   |
| Stock-based  compensation                                                                            |   | 2,077                         |   | 1,934 |   | 1,222 |   |
| Provision for  loan losses                                                                           |   | 6,175                         |   | 4,775 |   | 2,000 |   |
| Gain on sale of  investment securities, net                                                          |   | (99                           | )      | (4 | ) | (164 | ) |
| Provision  (credit) for other real estate losses                                                     |   | (47                           | )      | (71 | ) | (63 | ) |
| Gain on pension  plan termination and settlement                                                     |   | (1,504                        | )      | — |   | (1,472 | ) |
| Net (increase)  decrease in deferred tax asset                                                       |   | (804                          | )      | (638 | ) | 1,209 |   |
| Originations of  loans held-for-sale                                                                 |   | (50,680                       | )      | (749 | ) | (7,655 | ) |
| Proceeds from  sales of loans originated for sale                                                    |   | 69,824                        |   | 1,535 |   | 6,955 |   |
| Gain on sales of  loans, net                                                                         |   | (1,352                        | )      | (30 | ) | (56 | ) |
| (Gain) loss on  disposal of premises and equipment, net of impairment reserve                        |   | (366                          | )      | (285 | ) | (96 | ) |
| Net increase in  accrued interest receivable                                                         |   | (945                          | )      | (3,559 | ) | (903 | ) |
| Net (increase)  decrease in other assets                                                             |   | (2,717                        | )      | (674 | ) | 1,246 |   |
| Net increase  (decrease) in accrued expenses and other liabilities                                   |   | 4,526                         |   | 1,043 |   | (231 | ) |
| Net cash  provided by operating activities                                                           |   | 62,211                        |   | 30,673 |   | 30,328 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                               |   |                          |   |   |   |   |   |
| Purchase of  securities classified as available-for-sale                                             |   | (265,957                      | )      | (57,277 | ) | (68,183 | ) |
| Purchase of  securities classified as held-to-maturity                                               |   | (5,416                        | )      | (4,032 | ) | (5,078 | ) |
| Purchase of  restricted equity securities                                                            |   | (11,959                       | )      | (9,550 | ) | (5,874 | ) |
| Proceeds from  sales, calls, paydowns and maturities of securities classified as  available-for-sale |   | 112,977                       |   | 71,751 |   | 109,101 |   |
| Proceeds from  paydowns, maturities and calls of securities classified as held-to-maturity           |   | 14,585                        |   | 1,000 |   | 5,360 |   |
| Acquisition of  Home Port Bancorp, Inc., net of cash acquired                                        |   | —                        |   | (54,527 | ) | — |   |
| Cash from branch  acquisition                                                                        |   | 22,752                        |   | — |   | — |   |
| Purchase of  premises and equipment                                                                  |   | (4,920                        | )      | (18,621 | ) | (10,331 | ) |
| Proceeds from  sale of restricted equity securities                                                  |   | 96                            |   | — |   | — |   |
| Purchase of  loans                                                                                   |   | —                        |   | (19,501 | ) | (13,343 | ) |
| Net increase in  loans                                                                               |   | (236,696                      | )      | (321,575 | ) | (330,761 | ) |
| Recoveries of  loans previously charged off                                                          |   | 519                           |   | 554 |   | 552 |   |
| Proceeds from  sales of other real estate owned                                                      |   | 471                           |   | 621 |   | 216 |   |
| Net (increase)  decrease in short-term investments                                                   |   | —                        |   | 231 |   | 30,888 |   |
| Proceeds from  sales of premises and equipment                                                       |   | 750                           |   | 208 |   | 529 |   |
| Net cash used in  investing activities                                                               |   | (372,798                      | )      | (410,718 | ) | (286,924 | ) |
|                                                                                                      |        |                               |        |  |  |  |  |  |  |  |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**SEACOASTFINANCIAL SERVICES CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
|                                                                                                                                                                                                                       |   | **Years  Ended December 31,** |    |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|---------|
|                                                                                                                                                                                                                       |   | **2001**                      |    | **2000** |   | **1999** |   |
|                                                                                                                                                                                                                       |   | **(In Thousands)**            |    |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                                                                                                                                      |   |                          |    |   |   |   |   |
| Net increase in  NOW, money market deposit and demand deposit accounts                                                                                                                                                     |   | $                             | 183,896 |   | $ | 46,554 |   | $ | 17,946 |   |
| Net increase in  passbook and other savings accounts                                                                                                                                                                       |   | 39,597                        |    | 2,481 |   | 8,831 |   |
| Net increase  (decrease) in certificates of deposit                                                                                                                                                                        |   | (45,007                       | )       | 193,877 |   | (8,370 | ) |
| Advances from  Federal Home Loan Bank                                                                                                                                                                                      |   | 380,446                       |    | 525,150 |   | 230,000 |   |
| Repayments of  Federal Home Loan Bank advances                                                                                                                                                                             |   | (150,443                      | )       | (316,482 | ) | (42,051 | ) |
| Repurchase of  common stock                                                                                                                                                                                                |   | (10,492                       | )       | (8,680 | ) | (15,939 | ) |
| Cash dividends                                                                                                                                                                                                             |   | (8,089                        | )       | (6,320 | ) | (2,533 | ) |
| Exercise of  stock options                                                                                                                                                                                                 |   | 320                           |    | — |   | — |   |
| Tax benefits of  stock option and award transactions, net                                                                                                                                                                  |   | 130                           |    | — |   | — |   |
| Payment of  merger-related costs                                                                                                                                                                                           |   | —                        |    | — |   | (674 |   |
| Net increase  (decrease) in short-term and other borrowings                                                                                                                                                                |   | 3,116                         |    | (9,414 | ) | 27,900 |   |
| Net increase in  mortgagors’ escrow payments                                                                                                                                                                          |   | 333                           |    | 41 |   | 418 |   |
| Net cash  provided by financing activities                                                                                                                                                                                 |   | 393,807                       |    | 427,207 |   | 215,528 |   |
| Net Increase (Decrease) in Cash and Cash Equivalents                                                                                                                                                                       |   | 83,220                        |    | 47,162 |   | (41,068 | ) |
| Cash and Cash Equivalents, beginning of Year                                                                                                                                                                               |   | 107,513                       |    | 60,351 |   | 101,419 |   |
| Cash and Cash Equivalents, end of year                                                                                                                                                                                     |   | $                             | 190,733 |   | $ | 107,513 |   | $ | 60,351 |   |
|                                                                                                                                                                                                                       |   |                          |    |   |   |   |   |
| Supplemental Disclosure of Cash Flow Information                                                                                                                                                                           |   |                          |    |   |   |   |   |
| Interest paid on  deposits and borrowed funds                                                                                                                                                                              |   | $                             | 112,375 |   | $ | 85,833 |   | $ | 62,731 |   |
| Income taxes  paid                                                                                                                                                                                                         |   | 20,991                        |    | 13,204 |   | 13,892 |   |
|                                                                                                                                                                                                                       |   |                          |    |   |   |   |   |
| Supplemental Disclosure of Noncash Transactions:                                                                                                                                                                           |   |                          |    |   |   |   |   |
| Transfer from  loans to loans held-for-sale                                                                                                                                                                                |   | 23,801                        |    | — |   | — |   |
| Transfers from  loans to other real estate owned                                                                                                                                                                           |   | 833                           |    | 684 |   | 755 |   |
| Financed other  real estate owned sales                                                                                                                                                                                    |   | 68                            |    | 600 |   | 1,441 |   |
|                                                                                                                                                                                                                       |   |                          |    |   |   |   |   |
| The Company  purchased all of the capital stock of Home Port Bancorp, Inc. for $68,150  (Note 2).  In conjunction with this  acquisition, the fair value of assets acquired and liabilities assumed were  as follows: |   |                          |    |   |   |   |   |
| Fair value of  assets acquired                                                                                                                                                                                             |   |                          |    | $ | 380,081 |   |   |   |
| Cash paid for  capital stock and transaction costs                                                                                                                                                                         |   |                          |    | (68,913 | ) |   |   |
| Liabilities  assumed                                                                                                                                                                                                       |   |                          |    | $ | 311,168 |   |   |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**SEACOASTFINANCIAL SERVICES CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER31, 2001**

 

**(1)           SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

**Basis of Presentation**

 

The accompanying consolidated financial statementsinclude the accounts of Seacoast Financial Services Corporation and itswholly-owned subsidiaries, Compass Bank for Savings (“Compass”), Nantucket Bankand Lighthouse Securities Corporation (collectively referred to herein as “theCompany”). Compass and Nantucket Bank are collectively referred to herein as“the Banks”.  All significantintercompany balances and transactions have been eliminated in consolidation.

 

 The Companyand its subsidiaries are subject to regulation of, and periodic examination by,the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board,among other agencies.  All deposits ofthe Banks are insured by the FDIC or the Depositors Insurance Fund, an excessdeposit insurer for Massachusetts-chartered savings banks.

 

The accompanying consolidated financial statementshave been prepared in conformity with accounting principles generally acceptedin the United States and general practice within the banking industry.   In preparing the financial statements,management is required to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities as of the date of the balance sheets and income and expensesduring the reporting periods.  Actualresults could differ from those estimates. Material estimates that are particularly susceptible to change relate tothe determination of the allowance for loan losses.  The following is a description of the more significant accountingpolicies.

 

**Cash and Cash Equivalents**

 

For purposes of reporting cash flows, cash and cashequivalents include cash, amounts due from banks, federal funds sold and othershort-term investments having an original maturity of 90 days or less.  Generally, federal funds are sold forone-day periods.

 

**Investment Securities**

 

Debt securities that management has the positiveintent and ability to hold to maturity are classified as held-to-maturity andreported at cost, adjusted for amortization of premiums and accretion ofdiscounts, both computed by a method that approximates the effective yieldmethod.  Debt and equity securities thatare bought and held principally for the purpose of selling them in the nearterm are classified as trading and reported at fair value, with unrealizedgains and losses included in earnings. Debt and equity securities not classified as either held-to-maturity ortrading are classified as****available-for-saleand reported at fair value, with unrealized gains and losses excluded fromearnings and reported as a separate component of stockholders’ equity andcomprehensive income.

 

Restricted equity securities are reported at cost andconsist principally of the Banks’ investments in the stock of the Federal HomeLoan Bank of Boston.

 

Unrealized losses deemed to be other than temporarydeclines in value are charged to operations. When securities are sold, the adjusted cost of the specific securitiessold is used to compute gains or losses.

 

**Loans, Deferred Costs and Fees**

 

Loans are stated at the principal amounts outstanding,adjusted by partial charge-offs, unearned discount and net deferred loan costsand fees.

 

Unearned discount is recognized on the level-yieldmethod for discounted indirect auto loans. All other interest on loans is recognized on a simple interest basis.Since January 1, 1999 all indirect auto loans have been originated on a simpleinterest basis.  Accordingly, thebalance of unearned discount has declined significantly.

 

44

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Deferred loan origination fees and certain deferredloan origination costs are amortized over the contractual life of the relatedloan using the level-yield method.  AtDecember 31, 2001 and 2000, the Company had net deferred loan costs of$13,566,000 and $12,137,000, respectively, including $15,311,000 and$12,225,000, respectively, paid to auto dealers originating  indirect auto loans.  Amounts paid to auto dealers are generallyrebatable in the event of loan prepayment or default.

 

It is the practice of the Company to discontinue theaccrual of interest on loans, except consumer loans, which are  in excess of 90 days past due or sooner if,in the judgment of management, the ultimate collectibility of principal orinterest becomes doubtful.  When a loanis placed on nonaccrual status, previously accrued and uncollected interest isreversed against interest on loans.  Interestincome is subsequently recognized only to the extent cash payments are received.  When there is doubt regarding the ultimatecollectibility of principal, all cash receipts thereafter are applied to reducethe recorded investment in the loan.

 

Loans are classified as impaired when it is probablethat the Company will not be able to collect principal, interest and feesaccording to the contractual terms of the loan agreement.  Management considers the payment history,net worth and earnings potential of a borrower, and the value and cash flow ofthe collateral as factors to determine whether a loan will be paid inaccordance with its contractual terms. The amount judged to be impaired is the difference between the presentvalue of the expected future cash flows discounted at the loan’s originalcontractual effective interest rate and the net carrying amount of theloan.  If foreclosure on acollateralized loan is probable, impairment is measured based on the fair valueof the collateral compared to the net carrying amount.  If appropriate, a valuation reserve isestablished to recognize the difference between the recorded investment and thepresent value.  Impaired loans arecharged off when management believes that the collectibility of the loan isremote.  The Banks consider nonaccrualloans, except for smaller balance, homogeneous residential mortgage loans, andtroubled debt restructurings to be impaired.

 

**Allowance for Loan Losses**

 

The allowance for loan losses is maintained at a leveldetermined to be adequate by management to absorb future charge-offs of loansdeemed uncollectable.  This allowance isincreased by provisions charged to operating ** **expense and by recoveries on loanspreviously charged off, and reduced by charge-offs on loans.

 

Arriving at an appropriate level of allowance for loanlosses necessarily involves a high degree of judgment.  The allowance for loan losses is evaluatedon a regular basis by management and is based upon management’s  systematic periodic review of the collectabilityof the loans.  Primary considerations inthis evaluation are prior loan loss experience, the character and size of theloan portfolio, business and economic conditions and management’s estimation offuture losses.  The Company evaluatesspecific loan status reports on certain commercial and commercial real estateloans rated “substandard” or worse in excess of a specified dollar amount.  Estimated reserves for each of these****credits is determined by reviewing currentcollateral value, financial information, cash flow, payment history and trendsand other relevant facts surrounding the particular credit.  The remaining commercial and commercial realestate****loans are provided for aspart of pools of similar loans based on a combination of historical lossexperience and qualitative adjustments. Smaller balance, homogeneous loans, including residential real estateloans and consumer loans, are evaluated as a group by applying estimatedcharge-off and recovery percentages, based on historical experience and certainqualitative factors, to the current outstanding balance in each loan category.  Based on these analyses , the resultingallowance is deemed adequate to absorb all probable credit losses in theportfolio.

 

45

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Although management uses available information toestablish the appropriate level of the allowance for loan losses, futureadditions to the allowance may be necessary based on estimates that aresusceptible to change as a result of changes in economic conditions and otherfactors.  In addition, variousregulatory agencies, as an integral part of their examination process,periodically review the Company’s allowance for loan losses.  Such agencies may require the Company torecognize adjustments to the allowance based on their judgments aboutinformation available to them at the time of their examination.** **Changesin estimates are provided currently in earnings.

 

**Loan Sales and Servicing Rights**

 

Loans held for sale are valued at the lower of therecorded loan balance or market value. The Company periodically enters****intoforward commitments to sell loans for the purpose of reducing market riskassociated with the origination of loans for sale.**** Market value isestimated based on outstanding investor commitments or, in the absence of suchcommitments, current investor yield requirements.

 

The Company recognizes, as a separate asset, the rightto service mortgage loans for others. The amount capitalized is based on an allocation of the cost of the loanbased on the total relative fair value of the loan and the servicingright.  The amortization of servicingrights is recognized in proportion to estimated net servicing revenue  and is recorded as a charge against loanservicing fee income.  The value of servicingrights is periodically assessed for impairment based on the fair value of thoserights.  In measuring for impairment,servicing assets are stratified by interest rate, which is the predominant riskcharacteristic affecting the prepayment of loans.

 

Included in other assets in the accompanyingconsolidated balance sheets are mortgage servicing rights of

$1,329,000 and $1,170,000 at December 31, 2001 and 2000,respectively.   The Company recognized$523,900 and $0 of mortgage servicing rights during December 31, 2001 and 2000,respectively.  Amortization expense was$361,000, $180,000 and $390,000 for the years ended December 31, 2001, 2000 and1999, respectively.

 

**Banking Premises and Equipment**

 

Land is stated at cost.  Buildings, leasehold improvements and equipment are stated atcost, less accumulated depreciation and amortization, computed on thestraight-line method over the estimated useful lives of the assets or the termsof the leases, if shorter.  Maintenanceand repairs are expensed when incurred; major expenditures for betterments arecapitalized and depreciated.

 

Interest incurred during construction of the Company’snew corporate headquarters was capitalized based on Compass’s overall cost offunds.  During the years ended December31, 2000 and 1999, interest of $268,000 and $107,000, respectively, wascapitalized.

 

**Other Real Estate Owned**

 

Other real estate owned (OREO) is composed ofproperties acquired through foreclosure or receipt of a deed in lieu offoreclosure.  Foreclosed assets arepresumed to be held-for-sale and are recorded at the lower of the carrying valueof the related loan or the fair value of property, less estimated costs tosell.  The excess, if any, of the loanbalance over the fair value of the property at the time of transfer to OREO ischarged to the allowance for loan losses. Subsequent write-downs of the carrying value of the foreclosed assetsare charged to expense.  Costs relatingto the development and improvement of foreclosed assets are capitalized whileother costs are charged to expense. Such amounts have been insignificant duringthe periods covered by this report.

 

46

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**Income Taxes**

 

The Company utilizes the asset and liability method ofaccounting for income taxes.  Under thismethod, deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases.

 

Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled.  The effect on deferred tax assets andliabilities of a change in tax rates is recognized in income in the period thatincludes the enactment date. Deferred tax assets are recognized subject tomanagement’s judgement that realization is more likely than not.

 

**Goodwill and Intangible Assets**

 

Through December 31, 2001, goodwill was amortized on astraight-line basis over fifteen years. Amortization amounted to $2.4 million in 2001.  As discussed below under the caption “Recent AccountingPronouncements”, amortization of goodwill is generally no longer permittedeffective January 1, 2002.

 

The core deposit intangible asset is being amortized overperiods ranging from six to ten years using accelerated and straight-linemethods.  Amortization expense was$494,000, $542,000 and $619,000 for the years ended December 31, 2001, 2000 and1999, respectively.  The core depositintangible asset amounted to $2,370,000 and $1,333,000 at December 31, 2001 and2000, respectively.

 

Goodwill and intangible assets are periodicallyevaluated for impairment at least annually.

 

**Stock-Based Compensation**

 

Stock options issued to officers and directors areaccounted for in accordance with Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” (APB No. 25) under which there isgenerally no charge to earnings for stock option grants.

 

**Earnings Per Share (EPS)**

 

Basic EPS is computed by dividing net income by theweighted average number of common shares outstanding for the period.  Unallocated ESOP shares and unvestedrestricted stock awards are not considered outstanding in computing basicearnings per share.  Diluted EPSreflects the potential dilution that could occur if contracts to issue commonstock were exercised and has been computed after giving consideration to thedilutive effect of stock options, stock awards and shares held in an employeetrust.

 

**Comprehensive Income**

 

The Company reports comprehensive income in accordancewith Financial Accounting Standards (SFAS) No. 130, “Reporting ComprehensiveIncome.”  This statement establishesstandards for reporting and displaying comprehensive income, which is definedas all changes to equity except investments by and distributions tostockholders.  Net income is a componentof comprehensive income with all other components referred to in the aggregateas “other comprehensive income.”  As ofDecember 31, 2001 and 2000, the Company’s other comprehensive income consistedof unrealized gains (losses) on securities classified as available-for-sale,net of taxes of $2,740,000 and $3,221,000. Included in net income are gains on the sale of investment securities,net of taxes, of $64,000, $3,000 and $106,000 for the years ended December 31,2001, 2000 and 1999, respectively, that had previously been classified withother comprehensive income.

 

47

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**Reclassifications**

 

Certain reclassifications have been made to the prioryear financial statements to conform to the 2001

 presentation.  Such reclassifications have no effect onpreviously reported net income.

 

**Recent Accounting Pronouncements**

 

Effective January****1,2001, the Company adopted SFAS No. 133, “Accounting for Derivative Instrumentsand Hedging Activities,” as amended by SFAS Nos. 137 and 138 (collectively SFASNo. 133).  This standard establishesaccounting and reporting standards for derivative instruments and for hedgingactivities.  SFAS No. 133 requires allderivatives, including certain derivative instruments embedded in othercontracts, to be recognized as assets or liabilities on the balance sheet andmeasured at fair value.  The adoption ofSFAS No. 133 did not have a material impact on the Company’s financial positionor results of operations.

 

In June 2001, the Financial Accounting Standards Board(FASB) issued SFAS No. 141, “Business Combinations” which is effective fortransactions initiated after June 30, 2001. Under SFAS No. 141, all business combinations must be accounted forusing the purchase method of accounting; use of the pooling-of-interests methodis no longer permitted.  In addition,this Statement requires that certain intangible assets acquired in a businesscombination be recognized apart from goodwill.

 

Under the transition provisions of SFAS No. 141, nochange in the amount of the purchase price assigned to the assets acquired andliabilities assumed in a business combination completed before July 1, 2001 andaccounted for by the purchase method shall occur except for certain identifiedintangible assets which were separately recognized at the time of thetransaction.  Management does notbelieve that any reclassification of intangible assets recognized in connectionwith the Company’s acquisition of Home Port Bancorp, Inc. (Home Port) inDecember 2000 is required as a result of the application of SFAS No. 141.

 

In June 2001, the FASB also issued SFAS No. 142,“Goodwill and Other Intangible Assets” which is effective for fiscal yearsbeginning after December 15, 2001. Under prior accounting standards, goodwill resulting from a businesscombination is amortized against income over its estimated useful life. UnderSFAS No. 142, goodwill is generally no longer amortized as an expense after2001 but instead is reviewed and tested for impairment using a fair valuemethodology prescribed in this Statement. Goodwill will be tested for impairment at least annually or morefequently as a result of an event or change in circumstances (e.g. recurringoperating losses by the acquired entity) that would indicate an impairmentadjustment may be necessary.  Based onits assessment of the current economic environment, management does notanticipate an impairment adjustment to the goodwill reflected in theaccompanying consolidated balance sheet upon adoption of SFAS No. 142.  The effect of adopting SFAS No. 141 and No.142 will be the Company will cease amortizing the goodwill balance of $33.9million which will have the effect of reducing goodwill amortization of $2.4million in 2002.

 

**(2)     ACQUISITIONS**

 

On December 31, 2000, the Company completed itsacquisition of Home Port for $68.2 million in cash, exclusive of one-timetransaction costs.  Home Port was theholding company for Nantucket Bank, a three branch savings bank located onNantucket Island, Massachusetts with total assets of approximately $341 millionat the date of acquisition.  The assetsacquired included loans, investments, bank premises, equipment and otherassets.  This transaction has beenaccounted for under the purchase method of accounting.  Based on an allocation of the purchaseprice, goodwill from this acquisition totaled $36.3 million.

 

48

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The results of operations of Home Port are notreflected in the accompanying consolidated statements of operations prior to2001.  The Company’s pro formasummarized results of operations for the years ended December 31, 2000 and1999, assuming Home Port had been acquired as of January 1, 1999, are asfollows (in thousands):

 
|                        |   | **2000** |    | **1999** |   |
|-----------------------------|--------|----------|---------|----------|--------|
| Interest income             |   | $        | 192,107 |     | $      | 160,360 |   |
| Interest expense            |   | 101,485  |    | 76,827   |   |
| Net interest  income        |   | 90,622   |    | 83,533   |   |
| Provision for  loan losses  |   | 4,814    |    | 2,200    |   |
| Noninterest  income         |   | 11,682   |    | 11,574   |   |
| Noninterest  expense        |   | 61,358   |    | 53,694   |   |
| Income before  taxes        |   | 36,132   |    | 39,213   |   |
| Provision for  income taxes |   | 13,657   |    | 14,885   |   |
| Net income                  |   | $        | 22,475  |     | $      | 24,328 |   |
| Earnings per  share         |   | $        | 0.94    |     | $      | 0.96 |   |

 

Included in noninterest expense in the pro forma resultsof operations for 2000 are certain acquisition-related costs incurred by HomePort totaling $1,864,000 which, after the estimated tax effect, reduced the proforma net income and EPS by $1,655,000, or $.07 per share.

 

On December 15, 2001, Compass completed its assumptionof the deposit liabilities of Charter Bank’s Hyannis, Massachusetts branchoffice for cash and an insignificant balance of deposit-related loans.  Compass paid a deposit premium of 5% of the statedbalance of the assumed deposits of $24.0 million.  Charter Bank closed this branch office and customer accounts weretransferred to an existing Compass branch office in Hyannis.  The resulting core deposit intangible ofapproximately $1.2 million is being amortized over 10 years on an acceleratedbasis.

 

In connection with the Company’s acquisition ofSandwich Bancorp, Inc. in 1998, estimated merger-related costs of $6.8 millionwere expensed.  During 2000, the Companyrecognized, as a reduction of noninterest expense, approximately $400,000 dueto an overestimate of such costs.

 

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**(3)     INVESTMENTSECURITIES**

 

The amortized cost and fair value of securitiesavailable-for-sale at December 31, 2001 and 2000 are as follows:

 
|                                           |   | **December  31, 2001** |                |
|------------------------------------------------|--------|------------------------|---------------------|
|                                           |   | **Amortized   Cost**   |                | **Gross   Unrealized   Gains** |   | **Gross   Unrealized   Losses** |   | **Fair   Value** |   |
|                                           |   |                   | **(In  thousands)** |   |
| U.S. Government  and agency obligations        |   | $                      | 245,479             |   | $ | 3,174 |   | $ | 432 |   | $ | 248,221 |   |
| Corporate bonds                                |   | 88,712                 |                | 1,798 |   | 1,373 |   | 89,137 |   |
| State and municipal  obligations               |   | 1,583                  |                | 10 |   | 9 |   | 1,584 |   |
| Mortgage-backed  investments                   |   | 48,905                 |                | 847 |   | 142 |   | 49,610 |   |
| Total debt  securities                         |   | 384,679                |                | 5,829 |   | 1,956 |   | 388,552 |   |
| Marketable  equity securities and mutual funds |   | 15,160                 |                | 2,852 |   | 776 |   | 17,236 |   |
| Total securities  available-for-sale           |   | $                      | 399,839             |   | $ | 8,681 |   | $ | 2,732 |   | $ | 405,788 |   |

 
|                                           |   | **December  31, 2000** |    |
|------------------------------------------------|--------|------------------------|---------|
|                                           |   | **Amortized   Cost**   |    | **Gross   Unrealized   Gains** |   | **Gross   Unrealized   Losses** |   | **Fair   Value** |   |
|                                           |   | **(In  thousands)**    |    |
| U.S. Government  and agency obligations        |   | $                      | 123,125 |   | $ | 973 |   | $ | 746 |   | $ | 123,352 |   |
| Corporate bonds                                |   | 45,118                 |    | 631 |   | 1,012 |   | 44,737 |   |
| State and  municipal obligations               |   | 950                    |    | — |   | — |   | 950 |   |
| Mortgage-backed  investments                   |   | 67,362                 |    | 435 |   | 367 |   | 67,430 |   |
| Total debt  securities                         |   | 236,555                |    | 2,039 |   | 2,125 |   | 236,469 |   |
| Marketable  equity securities and mutual funds |   | 10,841                 |    | 2,171 |   | 626 |   | 12,386 |   |
| Total securities  available-for-sale           |   | $                      | 247,396 |   | $ | 4,210 |   | $ | 2,751 |   | $ | 248,855 |   |
|                                                |        |                        |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The amortized cost and fair value of securitiesheld-to-maturity at December 31, 2001 and 2000 are as follows:

 
|                                    |   | **December  31, 2001** |   |
|-----------------------------------------|--------|------------------------|--------|
|                                    |   | **Amortized   Cost**   |   | **Gross   Unrealized   Gains** |   | **Gross   Unrealized   Losses** |   | **Fair   Value** |   |
|                                    |   | **(In  thousands)**    |   |
| U.S. Government  and agency obligations |   | $                      | 14,975 |   | $ | 305 |   | $ | 74 |   | $ | 15,206 |   |
| Corporate bonds                         |   | 403                    |   | — |   | 3 |   | 400 |   |
| State and  municipal obligations        |   | 3,854                  |   | 101 |   | — |   | 3,955 |   |
| Mortgage-backed  investments            |   | 1,319                  |   | 21 |   | 1 |   | 1,339 |   |
| Total securities  held-to-maturity      |   | $                      | 20,551 |   | $ | 427 |   | $ | 78 |   | $ | 20,900 |   |

 

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|                                    |   | **December  31, 2000** |   |
|-----------------------------------------|--------|------------------------|--------|
|                                    |   | **Amortized   Cost**   |   | **Gross   Unrealized  Gains** |   | **Gross   Unrealized   Losses** |   | **Fair   Value** |   |
|                                    |   | **(In  thousands)**    |   |
| U.S. Government  and agency obligations |   | $                      | 22,569 |   | $ | 53 |   | $ | 10 |   | $ | 22,612 |   |
| Corporate bonds                         |   | 800                    |   | — |   | — |   | 800 |   |
| State and  municipal obligations        |   | 4,036                  |   | — |   | — |   | 4,036 |   |
| Mortgage-backed  investments            |   | 2,323                  |   | — |   | — |   | 2,323 |   |
| Total securities  held-to-maturity      |   | $                      | 29,728 |   | $ | 53 |   | $ | 10 |   | $ | 29,771 |   |

 

The maturity distribution of debt securities atDecember 31, 2001 is as follows:

 
|                      |   | **Available-for-Sale** |    | **Held-to-Maturity** |   |
|---------------------------|--------|------------------------|---------|----------------------|--------|
|                      |   | **Amortized   Cost**   |    | **Fair   Value**     |   | **Amortized   Cost** |   | **Fair   Value** |   |
|                      |   | **(In thousands)**     |    |
| One year or less          |   | $                      | 90,013  |                 | $      | 91,076 |   | $ | 7,946 |   | $ | 8,154 |   |
| Over 1 year to 5  years   |   | 158,539                |    | 159,592              |   | 10,381 |   | 10,462 |   |
| Over 5 years to  10 years |   | 92,246                 |    | 93,556               |   | 1,391 |   | 1,446 |   |
| Over 10 years             |   | 43,881                 |    | 44,328               |   | 833 |   | 838 |   |
|                      |   | $                      | 384,679 |                 | $      | 388,552 |   | $ | 20,551 |   | $ | 20,900 |   |

 

Mortgage-backed investments and collateralizedmortgage obligations are shown at their contractual maturity dates, but actualmaturities may differ as borrowers have the right to prepay obligations withoutincurring prepayment penalties.

 

Proceeds from sales of investment securities andrelated gains and losses for the years ended December 31, 2001, 2000, and 1999(all classified as available-for-sale) were as follows:

 
|                 |   | **2001**            |   | **2000** |   | **1999** |   |
|----------------------|--------|---------------------|--------|----------|--------|----------|--------|
|                 |   | **(In  thousands)** |   |
| Proceeds from  sales |   | $                   | 41,647 |     | $      | 16,062   |   | $ | 24,191 |   |
| Gross gains          |   | 251                 |   | 12       |   | 165      |   |
| Gross losses         |   | 152                 |   | 8        |   | 1        |   |
|                      |        |                     |        |          |        |          |        |  |  |  |

 

At December 31, 2001, investment securities carried at$54,900,000 were pledged to secure public deposits under the Treasury, Tax andLoan program, deposits held by various municipalities and retail repurchaseagreements.  In addition, investmentsecurities carried at $250,200,000 were pledged under a blanket lien topartially secure the advances from the Federal Home Loan Bank (Note 8).  Pledged investment securities are maintainedunder the Company’s control.

 

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**(4)     LOANS****AND ALLOWANCE FOR LOAN LOSSES**

 

The Company’s lending activities are conductedprincipally in Southeastern Massachusetts, including the islands of Nantucketand Martha’s Vineyard and, to a lesser extent, Eastern Massachusetts and RhodeIsland.  A summary of the loan portfoliofollows:

 
|                              |   | **December  31,**  |      |
|-----------------------------------|--------|--------------------|-----------|
|                              |   | **2001**           |      | **2000** |   |
|                              |   | **(In thousands)** |      |
| Real estate  loans:               |   |               |      |   |   |
| Residential  (one-to-four family) |   | $                  | 1,311,606 |   | $ | 1,212,595 |   |
| Commercial                        |   | 337,277            |      | 322,724 |   |
| Construction                      |   | 108,556            |      | 109,360 |   |
| Home equity  lines of credit      |   | 45,709             |      | 39,932 |   |
| Total real  estate loans          |   | 1,803,148          |      | 1,684,611 |   |
| Commercial loans                  |   | 115,562            |      | 100,789 |   |
| Consumer loans:                   |   |               |      |   |   |
| Indirect auto  loans              |   | 601,884            |      | 528,653 |   |
| Less: Unearned  discount          |   | 1,651              |      | 6,781 |   |
| Indirect auto  loans, net         |   | 600,233            |      | 521,872 |   |
| Other                             |   | 56,039             |      | 56,060 |   |
| Total consumer  loans, net        |   | 656,272            |      | 577,932 |   |
| Total loans                       |   | 2,574,982          |      | 2,363,332 |   |
| Less-Allowance  for loan losses   |   | 29,513             |      | 25,081 |   |
| Total loans, net                  |   | $                  | 2,545,469 |   | $ | 2,338,251 |   |

 

Loans serviced for others on a non-recourse basis atDecember 31, 2001 and 2000 amounted to $363,123,000 and $382,680,000,respectively.

 

At December 31, 2001 and 2000, troubled debtrestructurings,  all of which areincluded in nonaccrual loans, totaled $755,500 and $936,400, respectively.  There are no commitments to extendadditional credit on these loans. Nonaccrual loans amounted to $13,408,000 and $6,107,000, at December 31,2001 and 2000, respectively.

 

The following table presents information aboutimpaired loans:

 
|                                                               |   | **December  31,**   |   |
|--------------------------------------------------------------------|--------|---------------------|--------|
|                                                               |   | **2001**            |   | **2000** |   |
|                                                               |   | **(In  thousands)** |   |
| At year-end—                                                  |   |                |   |   |   |
| Impaired loans                                                     |   | $                   | 8,149  |   | $ | 2,182 |   |
| Impaired loans  with valuation allowance                           |   | 6,040               |   | 1,600 |   |
| Total valuation  allowances (included inallowance for loan losses) |   | 1,649               |   | 304 |   |
| During the year—                                              |   |                |   |   |   |
| Average balance  of impaired loans                                 |   | 5,759               |   | 2,248 |   |
| Interest income  recognized on impaired loans                      |   | 290                 |   | 131 |   |
|                                                                    |        |                     |        |  |  |  |  |

 

For the year ended December  31, 1999, the average balance of impaired loans was $2,346,000and the interest income recognized on impaired loans was $163,000.

 

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In the ordinary course of business, the Company grantsloans to its executive officers, directors and related parties on substantiallythe same terms as loans made to unrelated borrowers.  Related party loan activity for the years ended December 31, 2001and 2000 is as follows:

 
|                           |   | **2001**           |   | **2000** |   |
|--------------------------------|--------|--------------------|--------|----------|--------|
|                           |   | **(In thousands)** |   |
| Balance,  beginning of year    |   | $                  | 4,125  |     | $      | 614 |   |
| New loans                      |   | 3,272              |   | 890      |   |
| Payments                       |   | (1,508             | )      | (477     | )      |
| Acquisition of  Nantucket Bank |   | —             |   | 3,098    |   |
| Balance, end of  year          |   | $                  | 5,889  |     | $      | 4,125 |   |

 

A summary of changes in the allowance for loan lossesfollows:
|                        |   | **Years  Ended December 31,** |   |
|-----------------------------|--------|-------------------------------|--------|
|                        |   | **2001**                      |   | **2000** |   | **1999** |   |
|                        |   | **(In  thousands )**          |   |
| Balance,  beginning of year |   | $                             | 25,081 |   | $ | 16,828 |   | $ | 15,914 |   |
| Provision for  loan losses  |   | 6,175                         |   | 4,775 |   | 2,000 |   |
| Acquired  reserves (Note 2) |   | —                        |   | 4,557 |   | — |   |
| Charge-offs                 |   | (2,263                        | )      | (1,633 | ) | (1,638 | ) |
| Recoveries                  |   | 520                           |   | 554 |   | 552 |   |
| Balance, end of  year       |   | $                             | 29,513 |   | $ | 25,081 |   | $ | 16,828 |   |

 

Allocated reserves for loan losses are determinedusing both a formula-based approach applied to groups of loans and an analysisof certain individual loans for impairment.

 

The formula-based approach evaluates groups of loansto determine the allocation appropriate within each portfolio segment.  Individual loans within the real estate(residential, commercial, construction, and home equity), commercial andconsumer (indirect auto and other consumer) loan portfolio segments areassigned internal risk ratings to group them with other loans possessingsimilar credit risk characteristics. The level of reserve apportionable to each group of risk-rated loans isthen determined by management applying a loss factor that estimates the amountof probable loss in each category.  Theassigned loss factor for each risk rating is a formula based assessment ofhistorical loss data, portfolio characteristics, economic trends, overallmarket conditions, past experience, and management’s subjective analysis ofconsiderations of probable loan loss based on these factors.  Allocations for loan categories are thendetermined by applying loss factors that represent management’s estimate ofinherent losses in those categories to the appropriate loan balancesoutstanding.

 

The other method used to allocate the reserve for loanlosses entails the assignment of reserve amounts to individual loans on the abasis of loan impairment.  Certain loansare evaluated individually and are judged to be impaired when managementbelieves it is probable that the Company will not collect all of the contractualinterest and principal payments as scheduled in the loan agreement.  Under this method loans are selected forevaluation based on a change in internal risk rating, occurrence ofdelinquency, loan classification or non-accrual status.  An identifiable reserve amount is allocatedto an individual loan when such loan has been deemed impaired and when theamount of a probable loss is estimable on the basis of fair value ofcollateral, present value of anticipated future cash flows or the loans observablefair market price.  Loans with anidentifiable reserve and the amount of such reserve totaled $6,177,002 and$2,465,765 at December 31, 2001, respectively.

** **

** **

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A portion of the reserve for loan loss is notallocated to any specific segment of the loan portfolio.  This unallocated reserve is maintained fortwo primary reasons; there exists an inherent subjectivity and imprecision tothe analytical processes employed and the prevailing business environment, asit is affected by changing economic conditions and various external factors,which may impact the portfolio in ways currently unforeseen.  Moreover, management has identified certainrisk factors, which could impact the degree of loss sustained within theportfolio.  These include: market riskfactors, such as the effects of economic variability on the entire portfolio,and unique portfolio risk factors that are inherent characteristics of theCompany’s loan portfolio.  Market riskfactors may consist of changes to general economic and business conditions thatmay impact the Company’s loan portfolio customer base in terms of ability torepay and that may result in changes in value of underlying collateral.  Unique portfolio risk factors may includeindustry concentration or covariant industry concentrations, geographicconcentrations, or trends that may exacerbate losses resulting from economicevents which the Company may not be able to fully diversify out of itsportfolio.  Management, therefore, has establishedand maintains an unallocated reserve for loan losses.  The amount of this unallocated reserve was $2.4 million atDecember 31, 2001, compared to $2.2 million at December 31, 2000.

 

As of December 31, 2001, the reserve for loan lossestotaled $29.5 million as compared to $25.1 million at December 31, 2000.  Based on the processes described above,management believes that the level of the reserve for loan losses at December31, 2001 is adequate.

 

**(5)     BANKINGPREMISES AND EQUIPMENT**

 

A summary of banking premises and equipment follows:

 
|                               |   | **December  31,**   |   | **Estimated  Useful Lives** |   |
|------------------------------------|--------|---------------------|--------|-----------------------------|--------|
|                               |   | **2001**            |   | **2000**                    |   |   |
|                               |   | **(In  thousands)** |   |                        |   |
| Land and  improvements             |   | $                   | 9,734  |                        | $      | 8,908 |   |   |   |
| Buildings and  improvements        |   | 33,940              |   | 33,712                      |   | 30 to 50 years |   |
| Property under  capital lease      |   | 1,738               |   | 1,738                       |   | 20 years |   |
| Leasehold  improvements            |   | 2,568               |   | 2,786                       |   | 8 to 10 years |   |
| Furniture and  equipment           |   | 16,690              |   | 13,821                      |   | 3 to 20 years |   |
| Construction-in-progress           |   | 231                 |   | 1,606                       |   |   |   |
|                               |   | 64,901              |   | 62,571                      |   |   |   |
| Less-accumulated  depreciation and |   |                |   |                        |   |   |   |
| amortization                       |   | 13,607              |   | 11,693                      |   |   |   |
|                               |   | $                   | 51,294 |                        | $      | 50,878 |   |   |   |

 

Depreciation for the years ended December 31, 2001,2000 and 1999,amounted to $4,082,000, $2,867,000 and $2,464,000, respectively,and is included in occupancy and equipment expenses in the accompanyingconsolidated statements of income.

 

During 2001, and 2000, the Company  recognized net gains of $372,000 and$329,000, respectively, upon the disposition of banking premises and equipmentcaused by the relocation to its new corporate and banking offices  which are included in other noninterestincome in the accompanying consolidated statements of income.

 

54

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**(6)     DEPOSITS**

 

A summary of deposit balances follows:

 
|                                   |   | **December  31,**   |      |
|----------------------------------------|--------|---------------------|-----------|
|                                   |   | **2001**            |      | **2000** |   |
|                                   |   | **(In  thousands)** |      |
| Demand deposit  accounts               |   | $                   | 180,916   |   | $ | 159,740 |   |
| NOW and money  market deposit accounts |   | 744,155             |      | 577,778 |   |
| Passbook and  other savings accounts   |   | 275,163             |      | 235,470 |   |
| Total  noncertificate accounts         |   | 1,200,234           |      | 972,988 |   |
| Certificates of  deposit–         |   |                |      |   |   |
| Certificates of  $100,000 and over     |   | 268,326             |      | 265,583 |   |
| Certificates  less than $100,000       |   | 723,797             |      | 751,059 |   |
| Total  certificates of deposit         |   | 992,123             |      | 1,016,642 |   |
|                                   |   | $                   | 2,192,357 |   | $ | 1,989,630 |   |

 

A summary of the maturity distribution of certificatesof deposit with weighted average interest rates follows:

 
|               |   | **December  31,**            |    |
|--------------------|--------|------------------------------|---------|
|               |   | **2001**                     |    | **2000** |   |
|               |   | **Amount**                   |    | **Rate** |   | **Amount** |   | **Rate** |   |
|               |   | **(Dollars  in thousands )** |    |
| Within 1 year      |   | $                            | 791,960 |   | 4.02 | % | $ | 896,082 |   | 6.22 | % |
| Over 1 to 3  years |   | 153,915                      |    | 4.90 |   | 111,144 |   | 6.46 |   |
| Over 3 to 5  years |   | 46,248                       |    | 5.10 |   | 9,416 | ** ** | 6.45 | ** ** |
|               |   | $                            | 992,123 |   | 4.21 | % | $ | 1,016,642 |   | 6.25 | % |
|                    |        |                              |         |  |  |  |  |  |  |  |  |  |  |  |

 

**(7)     SHORT-TERMBORROWINGS**

 

A summary of short-term borrowings follows:

 
|                                            |   | **December  31,**   |   |
|-------------------------------------------------|--------|---------------------|--------|
|                                            |   | **2001**            |   | **2000** |   |
|                                            |   | **(In  thousands)** |   |
| Securities sold under  agreements to repurchase |   | $                   | 33,854 |   | $ | 29,082 |   |
| Treasury tax and  loan note account             |   | 730                 |   | 2,345 |   |
|                                            |   | $                   | 34,584 |   | $ | 31,427 |   |

 

The weighted average interest rates on short-termborrowings during the years ended December 31, 2001,  2000 and 1999, were 3.69%, 4.68% and 4.79% , respectively.  The****averagedaily balance outstanding was $32,122 and $32,562 for 2001and 2000,respectively.  The maximum balanceoutstanding at any month end was $37,464 and $57,637 for 2001 and 2000,respectively.

 

The Company’s available lines of credit with theFederal Home Loan Bank (FHLB) amounted to $42,500,000 at December 31,2001.  The interest on borrowings underthe lines of credit adjusts daily based on a formula. At December 31, 2001 and2000, the Company had no advances outstanding under these lines.

 

55

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**(8)     FEDERALHOME LOAN BANK ADVANCES**

 

FHLB advances are collateralized by a blanket-typepledge agreement on the Banks’ FHLB stock, certain qualified investmentsecurities, deposits at the FHLB and first mortgages on residentialproperty.  As members of the FHLB, theBanks are required to invest in stock of the FHLB at an amount equal to thegreater of 1% of their outstanding first mortgage residential loans, 3% oftotal assets or 5% of their outstanding advances from the FHLB.  When such stock is redeemed, the Banks willreceive from the FHLB an amount equal to the par value of the stock. 

 

A summary of the maturity distribution of FHLBadvances (based on final maturity dates) with weighted average interest ratesfollows:

 
|                |   | **December  31,**           |    |
|---------------------|--------|-----------------------------|---------|
|                |   | **2001**                    |    | **2000** |   |
|                |   | **Amount**                  |    | **Rate** |   | **Amount** |   | **Rate** |   |
|                |   | **(Dollars  in thousands)** |    |
| Within 1 year       |   | $                           | 160,587 |   | 5.16 | % | $ | 119,967 |   | 6.51 | % |
| Over 1 to 5  years  |   | 268,939                     |    | 5.11 |   | 171,725 |   | 6.03 |   |
| Over 5 to 10  years |   | 346,130                     |    | 5.45 |   | 252,633 |   | 5.80 |   |
| Over 10 years       |   | 11,261                      |    | 6.97 |   | 12,633 |   | 6.91 |   |
|                |   | $                           | 786,917 |   | 5.30 | % | $ | 556,958 |   | 6.05 | % |
|                     |        |                             |         |  |  |  |  |  |  |  |  |  |  |

 

At December 31, 2001, outstanding advances of$402,000,000 are callable at the option of FHLB, of which $282,000,000 arecallable at December 31, 2001, $15,000,000 are initially callable in 2002,$70,000,000 are initially callable in 2003 and $35,000,000 become initiallycallable thereafter.  The Company isgenerally subject to a substantial penalty upon prepayment of FHLB advances.

 

56

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**(9)     INCOMETAXES**

 

The components of the provision for income taxes andthe reconciliation between the statutory federal income tax rate and theeffective income tax rate for the years indicated, are as follows:

 
|                                 |   | **Years  Ended December 31,** |   |
|--------------------------------------|--------|-------------------------------|--------|
|                                 |   | **2001**                      |   | **2000** |   | **1999** |   |
|                                 |   | **(Dollars  in thousands )**  |   |
| Current—                        |   |                          |   |   |   |   |   |
| Federal                              |   | $                             | 17,267 |   | $ | 12,499 |   | $ | 11,735 |   |
| State                                |   | 260                           |   | 454 |   | 450 |   |
| Total current                        |   | 17,527                        |   | 12,953 |   | 12,185 |   |
| Deferred  (prepaid)—            |   |                          |   |   |   |   |   |
| Federal                              |   | (627                          | )      | 112 |   | 924 |   |
| State                                |   | (177                          | )      | (750 | ) | 285 |   |
| Total deferred  (prepaid)            |   | (804                          | )      | (638 | ) | 1,209 |   |
|                                 |   | $                             | 16,723 |   | $ | 12,315 |   | $ | 13,394 |   |
|                                 |   |                          |   |   |   |   |   |
| Statutory tax  rate                  |   | 35.0                          | %      | 35.0 | % | 35.0 | % |
| State taxes, net  of federal benefit |   | (0.1                          | )      | 0.3 |   | 1.3 |   |
| Amortization of  goodwill            |   | 1.8                           |   | — |   | — |   |
| Tax credits                          |   | (0.4                          | )      | (0.4 | ) | (0.5 | ) |
| Merger expenses                      |   | (0.8                          | )      | (0.8 | ) | — |   |
| Other, net                           |   | (0.4                          | )      | (0.1 | ) | (0.5 | ) |
| Effective tax  rate                  |   | 35.1                          | %      | 34.0 | % | 35.3 | % |

 

57

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The Company’s net deferred tax asset consisted of thefollowing tax effects of temporary differences:

 
|                                              |   | **December  31,**   |   |
|---------------------------------------------------|--------|---------------------|--------|
|                                              |   | **2001**            |   | **2000** |   |
|                                              |   | **(In  thousands)** |   |
| Gross deferred  tax assets:                       |   |                |   |   |   |
| Allowance for  loan losses                        |   | $                   | 11,937 |   | $ | 9,390 |   |
| Deferred  compensation and benefits               |   | 3,603               |   | 4,023 |   |
| Core deposit  intangible                          |   | 996                 |   | 983 |   |
| Acquired NOL  carryforward                        |   | —              |   | 208 |   |
| Reserve for  asset impairment                     |   | 38                  |   | 271 |   |
| Deferred income                                   |   | 434                 |   | 448 |   |
| Deferred gain on  sale/leaseback                  |   | 199                 |   | 212 |   |
| Restricted stock                                  |   | 584                 |   | 261 |   |
| Other                                             |   | 9                   |   | 94 |   |
|                                              |   | 17,800              |   | 15,890 |   |
|                                              |   |                |   |   |   |
| Gross deferred  tax liabilities:                  |   |                |   |   |   |
| Unrealized gain  on available-for-sale securities |   | (2,407              | )      | (676 | ) |
| REIT dividend                                     |   | (1,853              | )      | (1,449 | ) |
| Gain on sale of  loans                            |   | (470                | )      | (488 | ) |
| Depreciation                                      |   | (1,040              | )      | (356 | ) |
| Loan fees                                         |   | (812                | )      | (614 | ) |
| Purchase  accounting adjustments                  |   | (1,269              | )      | (616 | ) |
| Other                                             |   | (54                 | )      | (444 | ) |
|                                              |   | (7,905              | )      | (4,643 | ) |
| Net deferred tax  asset                           |   | $                   | 9,895  |   | $ | 11,247 |   |

 

In August 1996, Congress passed legislation whichsuspended the Banks’ bad debt reserve for income tax purposes as of their baseyear (October 31, 1988).  Any bad debtreserve in excess of the base year amount is subject to recapture over asix-year period.  The suspended (i.e.,base year) amount is subject to recapture only upon the occurrence of certainevents, such as excess distributions to stockholders or failure to qualify as abank for income tax purposes.  Since theBanks do not intend to use their suspended bad debt reserves for purposes otherthan to absorb the losses for which they were established, deferred taxes inthe amount of $7,300,000 have not been recorded with respect to such reserves.

 

58

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**(10)  COMMITMENTSAND CONTINGENCIES**

 

Pursuant to the terms of noncancellable leases, futureminimum annual rentals for both operating and capital leases at December 31,2001 are as follows:

 
| **Years Ending December 31,** |   | **Operating   Leases** |   | **Capital   Lease** |   |
|-------------------------------|--------|------------------------|--------|---------------------|--------|
|                          |   |                   |
|                          |   | **(In  thousands)**    |   |
| 2002                          |   | $                      | 863    |                | $      | 182 |   |
| 2003                          |   | 757                    |   | 182                 |   |
| 2004                          |   | 598                    |   | 182                 |   |
| 2005                          |   | 500                    |   | 182                 |   |
| 2006                          |   | 438                    |   | 182                 |   |
| Thereafter                    |   | 3,916                  |   | 2,042               |   |
|                          |   |                   |   | 2,952               |   |
| Less: interest                | (1,374 | )                      |
|                          |   |                   |   | $                   | 1,578  |   |
|                               |        |                        |        |                     |        |  |  |

 

Certain leases contain renewal options the potentialimpact of which is not included above. Rent expense for the years ended December 31, 2001, 2000 and 1999amounted to $884,000, $883,000 and $882,000, respectively, and is included inoccupancy and equipment expenses in the accompanying consolidated statements ofincome.

 

Aggregate cash reserves (in the form of deposits withthe Federal Reserve Bank and vault cash) of $30.4  million were maintained to satisfy regulatory requirements atDecember 31, 2001.

 

In the ordinary course of business, the Company is adefendant in litigation matters. Although there can be no assurance, management believes that, based onits review of current litigation and discussion with legal counsel, theultimate resolution of these legal proceedings would not be likely to have amaterial adverse impact on the Company’s financial position, results ofoperations or liquidity.

 

**(11)  REGULATORYCAPITAL REQUIREMENTS**

 

The Company and the Banks are subject to variousregulatory capital requirements administered by the federal bankingagencies.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, the Banksmust meet specific capital guidelines that involve quantitative measures ofassets, liabilities and certain off-balance-sheet items as calculated underregulatory accounting practices.

 

Quantitative measures established by regulation toensure capital adequacy require the Company and the Banks to maintain minimumamounts and ratios (set forth in the following table) of total and Tier 1capital (as defined in the regulations) to risk-weighted assets (as defined),and of Tier 1 capital (as defined) to average assets (as defined). At December31, 2001 and 2000, the Company and the Banks met all applicable regulatorycapital  requirements.

 

59

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As of December 31, 2001, the most recent notificationfrom the Federal Reserve Bank of Boston classified the Company’s capital assatisfactory and the most recent notifications from the FDIC categorized theBanks as well capitalized under the regulatory framework for prompt correctiveaction.  To be categorized as wellcapitalized, an insured depository institution must maintain minimum totalcapital (to risk weighted assets), Tier 1 capital (to risk weighted assets) andTier 1 leverage capital (to average assets) as set forth in the accompanyingtable and not be subject to a directive, order, or written agreement to meetand maintain specific capital levels. There are no conditions or events since such notifications thatmanagement believes would have changed these classifications.** **TheCompany’s and the Banks’ actual capital amounts and ratios are as follows:

 
| ** **                     | ** ** | **Actual**                  | ** ** | **For  Capital  Adequacy  Purposes** | ** ** | **To Be Well  Capitalized  Under Prompt  Corrective  Action Provisions** | ** ** |
|--------------------------------|------------|-----------------------------|------------|--------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                     | **Amount** | ** **                  | **Ratio**  | ** **                           | **Amount** | ** **                                                               | **Ratio**  | ** ** | **Amount** | ** ** | **Ratio** | ** ** |   |
| ** **                     | ** ** | **(Dollars  in thousands)** | ** ** |
| As of December  31, 2001:      |       |                        |       |                                 |       |                                                                     |       |   |   |   |   |   |   |   |
| Company  (consolidated) — |       |                        |       |                                 |       |                                                                     |       |   |   |   |   |   |   |   |
| Total capital                  |       | $                           | 294,743    |                                 | 13.34      | %                                                                        | $          | 176,756 |   | 3 | 8.0 |  % | N/A |   | N/A |   |   |
| Tier 1 capital                 |       | 266,011                     |       | 12.04                                |       | 88,378                                                                   |       | 3 | 4.0 |   | N/A |   | N/A |   |   |
| Tier 1 leverage  capital       |       | 266,011                     |       | 8.04                                 |       | 132,344                                                                  |       | 3 | 4.0 |   | N/A |   | N/A |   |   |
| Compass —                 |       |                        |       |                                 |       |                                                                     |       |   |   |   |   |   |   |   |
| Total capital                  |       | $                           | 240,109    |                                 | 12.16      | %                                                                        | $          | 157,955 |   | 3 | 8.0 | % | 3 | $ | 197,444 |   | 3 | 10.0 | % |   |
| Tier 1 capital                 |       | 215,175                     |       | 10.90                                |       | 78,978                                                                   |       | 3 | 4.0 |   | 3 |   | 118,466 |   | 3 | 6.0 |   |   |
| Tier 1 leverage  capital       |       | 215,175                     |       | 7.34                                 |       | 117,252                                                                  |       | 3 | 4.0 |   | 3 |   | 146,565 |   | 3 | 5.0 |   |   |
| Nantucket Bank —          |       |                        |       |                                 |       |                                                                     |       |   |   |   |   |   |   |   |
| Total capital                  |       | $                           | 37,542     |                                 | 16.18      | %                                                                        | 3     | $ | 18,565 |   | 3 | 8.0 | % | 3 | $ | 23,206 |   | 3 | 10.0 | % |   |
| Tier 1 capital                 |       | 34,613                      |       | 14.92                                |       | 3                                                                   |       | 9,283 |   | 3 | 4.0 |   | 3 |   | 13,924 |   | 3 | 6.0 |   |   |
| Tier 1 leverage  capital       |       | 34,613                      |       | 9.87                                 |       | 3                                                                   |       | 14,025 |   | 3 | 4.0 |   | 3 |   | 17,531 |   | 3 | 5.0 |   |   |
|                           |       |                        |       |                                 |       |                                                                     |       |   |   |   |   |   |   |   |
| As of December  31, 2000:      |       |                        |       |                                 |       |                                                                     |       |   |   |   |   |   |   |   |
| Company  (consolidated) — |       |                        |       |                                 |       |                                                                     |       |   |   |   |   |   |   |   |
| Total capital                  |       | $                           | 273,158    |                                 | 14.04      | %                                                                        | 3     | $ | 155,647 |   | 3 | 8.0 | % | N/A |   | N/A |   |   |
| Tier 1 capital                 |       | 248,595                     |       | 12.78                                |       | 3                                                                   |       | 77,824 |   | 3 | 4.0 |   | N/A |   | N/A |   |   |
| Tier 1 leverage  capital       |       | 248,595                     |       | 10.15                                |       | 3                                                                   |       | 97,968 |   | 3 | 4.0 |   | N/A |   | N/A |   |   |
| Compass—                  |       |                        |       |                                 |       |                                                                     |       |   |   |   |   |   |   |   |
| Total capital                  |       | $                           | 220,992    |                                 | 12.68      | %                                                                        | 3     | $ | 139,333 |   | 3 | 8.0 | % | 3 | $ | 174,167 |   | 3 | 10.0 | % |   |
| Tier 1 capital                 |       | 199,911                     |       | 11.48                                |       | 3                                                                   |       | 69,667 |   | 3 | 4.0 |   | 3 |   | 104,500 |   | 3 | 6.0 |   |   |
| Tier 1 leverage  capital       |       | 199,911                     |       | 8.05                                 |       | 3                                                                   |       | 99,335 |   | 3 | 4.0 |   | 3 |   | 124,169 |   | 3 | 5.0 |   |   |
| Nantucket Bank—           |       |                        |       |                                 |       |                                                                     |       |   |   |   |   |   |   |   |
| Total capital                  |       | $                           | 32,833     |                                 | 16.37      | %                                                                        | 3     | $ | 16,049 |   | 3 | 8.0 | % | 3 | $ | 20,061 |   | 3 | 10.0 | %  |   |
| Tier 1 capital                 |       | 30,300                      |       | 15.10                                |       | 3                                                                   |       | 8,005 |   | 3 | 4.0 |   | 3 |   | 12,037 |   | 3 | 6.0 |   |   |
| Tier 1 leverage  capital       |       | 30,300                      |       | 8.82                                 |       | 3                                                                   |       | 13,748 |   | 3 | 4.0 |   | 3 |   | 17,184 |   | 3 | 5.0 |   |   |
|                                |            |                             |            |                                      |            |                                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

60

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**(12)  RETIREMENTAND OTHER BENEFIT PLANS**

 

**Pension Plans**

 

Through October 31, 1999, Compass provided basic andsupplemental pension benefits for eligible employees through the Savings Bank’sEmployees Retirement Association Pension Plan (the Compass SBERA Plan).   Benefits were based on an employee’s yearsof service and annual compensation, as defined.  Compass’s funding policy was to contribute annually the maximumdeductible amount for federal income tax purposes.

 

In September 1999, the Board of Directors voted tofreeze benefits under the Compass SBERA Plan effective October 31, 1999 and toterminate this Plan on or about December 31, 1999.  In connection therewith, the Compass SBERA Plan was also amendedto improve the benefit formula for current employees and permit payment of lumpsums.  A curtailment gain of $1,472,000was recognized in 1999 representing the difference between the estimatedbenefit obligation and the accumulated benefit obligation at the effective dateof termination.

 

In October 2001, all obligations of the Compass SBERAPlan were settled with excess assets of $300,000 returned to Compass.  A gain of $1,504,000 was recognized inconnection with this settlement principally related to previously unrecognizeddeferred gains.

 

Nantucket Bank provides pension benefits for itsemployees through the SBERA Plan.  ThisPlan provides for benefits to be paid to eligible employees at retirement basedprimarily upon their years of service with Nantucket Bank and compensationlevel near retirement.  Contributions tothis Plan equal the maximum deductible amount for tax purposes.

 

The following tables summarize the components of netperiodic pension cost and the funded status of each of the  SBERA Plans for the plan years ended October31 (in thousands):

 
|                                                   |     | **Compass** |     | **Nantucket  Bank** |     |
|--------------------------------------------------------|----------|-------------|----------|---------------------|----------|
|                                                   | **2001** |        | **2000** |                | **2001** |   | **2000** |   |
| Benefit  obligation at beginning of year               |     | $           | 11,374   |                | $        | 11,216 |   | $ | 1,749 |   |   |   |
| Service cost                                           |     | —      |     | —              |     | 153 |   |   |   |
| Interest cost                                          |     | 766         |     | 701                 |     | 135 |   |   |   |
| Actuarial  (gain)  loss                           |     | 102         |     | (538                | )        | 109 |   |   |   |
| Benefits paid                                          |     | —      |     | (131                | )        | (218 | ) |   |   |
| Settlements                                            |     | (12,242     | )        | (231                | )        | — |   |   |   |
| Plan amendments                                        |     | —      |     | 357                 |     | — |   |   |   |
| Benefit  obligation at end of year                     |     | $           | —   |                | $        | 11,374 |   | $ | 1,929 |   | $ | 1,749 |   |
| Accumulated  benefit obligation (substantially vested) |     | $           | —   |                | $        | 11,374 |   | $ | 1,034 |   | $ | 1,172 |   |
| Change in plan  assets:                                |     |        |     |                |     |   |   |   |   |
| Fair value of  plan assets at beginning of year        |     | $           | 11,874   |                | $        | 11,609 |   | $ | 1,932 |   |   |   |
| Actual return on  plan assets                          |     | 668         |     | 670                 |     | (204 | ) |   |   |
| Contributions                                          |     | —      |     | —              |     | 104 |   |   |   |
| Benefits paid                                          |     | —      |     | (131                | )        | (218 | ) |   |   |
| Settlements                                            |     | (12,242     | )        | (274                | )        | — |   |   |   |
| Reversion to  employer                                 |     | (300        | )        | —              |     | — |   |   |   |
| Fair value of  plan assets at end of year              |     | $           | —   |                | $        | 11,874 |   | $ | 1,614 |   | $ | 1,932 |   |
| Funding status:                                        |     |        |     |                |     |   |   |   |   |
| Transition asset                                       |     | $           | —   |                | $        | (310 | ) | $ | (600 | ) | $ | (601 | ) |
| Deferred gain  (loss)                                  |     | —      |     | (1,518              | )        | 492 |   | — |   |
| Accrued expense                                        |     | —      |     | 1,328               |     | 423 |   | 418 |   |
| Net amount  recognized                                 |     | $           | —   |                | $        | 500 |   | $ | (315 | ) | $ | 183 |   |

 

61

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|                                      |     | **Compass** |     | **Nantucket  Bank** |     |
|-------------------------------------------|----------|-------------|----------|---------------------|----------|
|                                      | **2001** |        | **2000** |                | **1999** |   | **2001** |   |
| Components of  net periodic benefit cost: |     |        |     |                |     |   |   |   |   |
| Service cost                              |     | $           | —   |                | $        | — |   | $ | 698 |   | $ | 153 |   |
| Interest cost                             |     | 766         |     | 701                 |     | 765 |   | 135 |   |
| Expected return  on plan assets           |     | (711        | )        | (907                | )        | (782 | ) | (155 | ) |
| Amortization of  transition asset         |     | (27         | )        | (27                 | )        | (27 | ) | (1 | ) |
| Net amortization  and deferral            |     | (20         | )        | 253                 |     | (36 | ) | (22 | ) |
| Net periodic  benefit cost                |     | $           | 8        |                | $        | 20 |   | $ | 618 |   | $ | 110 |   |
|                                      |     |        |     |                |     |   |   |   |   |
| Weighted average  assumptions:            |     |        |     |                |     |   |   |   |   |
| Discount rate                             |     | 6.75        | %        | 6.75                | %        | 6.75 | % | 7.75 | % |
| Expected return  on plan assets (1)       |     | 6.00        |     | 8.00                |     | 8.00 |   | 8.00 |   |
| Rate of  compensation increase            |     | N/A         |     | N/A                 |     | N/A |   | 5.50 |   |

 

----

(1)               With plan assetsfrozen at the time of termination, the expected rate of return for 2001 wasreduced to properly reflect the yield associated with current money market fundrates.

 

**Postretirement Benefits Other thanPensions**

 

Compass sponsors a postretirement life insurance plan(the Life Insurance Plan) that primarily covers pre-1996 retirees and apostretirement medical insurance plan that covers certain retirees of theformer Sandwich Bank.   The LifeInsurance Plan generally provides lifetime coverage to retired employees equalto their final annual rate of pay, but not more than $50,000, and to activefull time employees equal to three times the employee’s annual salary, but notmore than $350,000.  Annual expense forthese plans has averaged $60,000 during the past three years.  At December 31, 2001 and 2000, the accruedliability was $567,000 and $568,000, respectively, while the accumulatedbenefit obligation was $841,000 and $799,000, respectively, measured using a7.00% discount rate.

 

**Supplemental Retirement Benefits**

 

Compass has entered into agreements with four officersto provide supplemental retirement benefits based on 25% of the average of thethree highest years of compensation (salary and bonus) paid to the officer inthe ten years immediately preceding the officer’s retirement.  A reduced benefit is payable if the officerretires prior to age 65, but after age 55. The present value of these future payments is being accrued over theestimated remaining terms of employment. The accrued supplemental retirement liability was $1,839,000 and$1,697,000 at December 31, 2001 and 2000, respectively.  The agreements are being funded through alife insurance program with policy benefits accruing to Compass.  The cash surrender value of the policies is$1,918,000 and $1,726,000 at December 31, 2001 and 2000, respectively, and isincluded in other assets in the accompanying consolidated balance sheets.

 

Compass has agreed to calculate each year theadditional amount that would need to be accrued in order to result in theexecutive annually receiving 70% of the average of the three highest years ofthe compensation paid to the officer in the ten years of employment immediatelypreceding the officer’s retirement from a combination of Compass’s formerdefined benefit plan, the 25% supplemental retirement benefit, Compass’scontribution to the executive’s 401(k) plan, the ESOP, social security and anysupplemental funding.  This amount, ifany, is added to the executive’s account under the deferred compensation plan.

 

Net expense for these supplemental retirement benefitsfor the years ended December 31, 2001, 2000 and 1999, amounted to $309,000,$276,000 and $206,000, respectively, and is included in salaries and employeebenefits in the accompanying consolidated statements of income.

 

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**Incentive Compensation Plan**

 

Each of the Banks maintains a bonus plan providing forawards based on a combination of corporate and individual performanceobjectives being met, subject to the approval of the Board of Directors.  Amounts charged to operations under thebonus plans amounted to $1,753,000, $1,840,000 and $1,045,000 for the yearsended December 31, 2001, 2000 and 1999, respectively.

 

**401(k) Plan**

 

The Banks offer a 401(k) retirement savings plan foremployees.  Participating employees maygenerally contribute up to 15% of their W-2 compensation.  The Banks match 50% of a participant’sdeferral contribution on the first 6% of the deferral amount subject to themaximum allowable under federal regulations. Since November 1999, the Compass plan has included a 3% automaticcontribution for all eligible participants. Total 401(k) expense was $969,000, $809,000 and  $437,000 for the years ended December 31,2001, 2000 and 1999, respectively.

 

**ESOP**

 

In connection with its conversion from mutual-to-stockform and initial public offering, the Company established the Compass Bank for Savings Employee Stock Ownership Plan(“ESOP”) which acquired 1,120,000 of the Company’s shares at a price of $10 pershare.  The purchase of the shares bythe ESOP was funded by a loan of $11,200,000 from the Company.  The loan is being repaid in 80 equalquarterly installments with interest at a fixed rate of 7.75% and  is secured by the unallocated shares of theESOP.  The ESOP covers substantially allof Compass’s employees who have attained the age of 21 and who have completedat least 1,000 hours of service.

 

ESOP expense is based on the market value of theCompany’s common stock at the time shares are allocated to employees, whichdiffers from the $10 cost of those shares. Such changes in market value impact the Company’s results of operationsbut have no impact on total stockholders’ equity.  ESOP expense for the years ended December 31, 2001, 2000 and 1999amounted to $828,000, $572,000 and $585,000, respectively.

 

**Other**

 

The former Sandwich Bank, acquired in December 1998,maintained certain employee and director benefit programs, including adirectors deferred compensation plan and supplemental executive retirementplans,  which have been discontinued.Included in accrued expenses and other liabilities are $3,287,000, and$3,283,000, at December 31, 2001 and 2000, respectively, for such plans.

 

**(13)  STOCKINCENTIVE PLAN**

 

In 1999, the Company adopted the 1999 Stock IncentivePlan (the Stock Incentive Plan) for officers, employees and directors.  The maximum number of shares of common stockissuable under the Stock Incentive Plan is 1,960,000 (subject to adjustmentupon the occurrence of a stock dividend, stock split or similar change incapitalization affecting the Company’s common stock).  Of this number, up to 560,000 shares are issuable in connectionwith “conditioned stock awards”.  Aconditioned stock award is an award entitling the recipient to acquire,  at no cost or for a purchase price to bedetermined by the Compensation Committee, shares of common stock subject torestrictions and conditions determined at the date of grant.  Conditions may be based on continuingemployment and/or achievement of performance goals.  The remaining 1,400,000 shares may be either incentive stockoptions (as defined in the Internal Revenue Code) or options that do not soqualify (non-qualified options).

 

Incentive stock options shall have an exercise pricethat is not less than the fair market value of the Company’s stock at the dateof grant and shall not be exercisable more than ten years after the date ofgrant.  All incentive stock options andnon-qualified options shall vest and become exercisable based on thedetermination of the Compensation Committee. Stock options issued to date become exercisable at a rate of 20% peryear.

 

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In July 1999, a conditioned stock award of 560,000 shareswas approved for a group of officers and directors.  Under the terms of the award, there is no cost to the recipientfor the shares, which vest annually over a five year period conditioned oncontinued employment with the Company. Shares that do not vest are forfeited and are returned to theCompany.  Upon the event of death, arecipient’s shares become fully vested. While the shares issued under this conditioned stock award areoutstanding, recipients have both voting and dividend rights in such shares.

 

The total compensation cost of $6,370,000 for theconditioned stock award was determined at the award date since both the numberof shares and price to be paid (zero) were known.  The cost, adjusted for any forfeitures and accelerated vesting,is being amortized ratably over five years when all risks of forfeiture havepassed.  Forfeitures will be recognizedas a reduction of compensation cost in the period in which they occur.  No forfeitures relating to the conditionedstock awards have occurred since the award date.  For the years ended December 31, 2001, 2000 and 1999, the Companyexpensed $1,249,000, $1,362,000 and $637,000, respectively, in connection withits conditioned stock award grants.

 

Stock option activity is as follows:

 
|                        |   | **Number of  Shares** |   | **Weighted   Average  Exercise Price** |       |
|-----------------------------|--------|-----------------------|--------|----------------------------------------|------------|
| Balance, December 31, 1998  |   | **—**            |   | **$**                                  | **—** |   |
| Granted                     |   | 1,258,000             |   | 11.375                                 |       |
| Balance,  December 31, 1999 |   | 1,258,000             |   | 11.375                                 |       |
| Granted                     |   | 20,000                |   | 11.375                                 |       |
| Balance,  December 31, 2000 |   | 1,278,000             |   | 11.375                                 |       |
| Granted                     |   | 90,000                |   | 15.240                                 |       |
| Exercised                   |   | (28,000               | )      | 11.375                                 |       |
| Forfeited                   |   | (7,000                | )      | 11.375                                 |       |
| Balance,  December 31, 2001 |   | 1,333,000             |   | 11.636                                 |       |
|                             |        |                       |        |                                        |            |  |

 

The range of per share prices for outstanding andexercisable stock options at December 31, 2001 are as follows:

 
| **Options  Outstanding** |   | **Options  Exercisable** |      |
|--------------------------|--------|--------------------------|-----------|
| **Exercise  Price**      |   | **Number  Outstanding**  |      | **Weighted  Average  Remaining  Contractual Life** |   | **Number  Outstanding** |   | **Weighted  Average  Exercise Price** |   |
| $                        | 11.375 |                     | 1,243,000 |   | 7.5 |   | 490,800 |   | $ | 11.375 |   |
| 14.570                   |   | 65,000                   |      | 9.4 |   | — |   | — |   |
| 16.950                   |   | 20,000                   |      | 10.0 |   | — |   | — |   |
| 17.050                   |   | 5,000                    |      | 9.6 |   | — |   | — |   |
|                     |   | 1,333,000                |      |   |   | 490,800 |   | 11.375 |   |
|                          |        |                          |           |  |  |  |  |  |  |  |  |

 

As disclosed in Note 1, the Company accounts for itsstock-based compensation plan in accordance with APB No. 25 and, under suchaccounting rules, no compensation cost has been recognized in connection withthe granting of stock options. Alternatively, FASB standards (SFAS No. 123) would permit a method underwhich a compensation cost for all stock awards would be calculated and recognizedover the service period (generally equal to the vesting period).  This compensation cost would be determinedin a manner prescribed by the FASB using option pricing models intended toestimate the fair value of stock options at the grant date.  Such alternative accounting would not have resultedin additional compensation cost recorded for the conditioned stock awarded in1999.

 

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Had the Company applied SFAS No. 123 in accounting forits stock option grants, net income and EPS (basic and diluted) would have beenreduced to the pro forma amounts indicated below (in thousands, except for pershare amounts):

 
|        |     | **Years  Ended December 31,** |     |
|-------------|----------|-------------------------------|----------|
|        | **2001** |                          | **2000** |   | **1999** |   |
| Net Income  |     |                          |     |   |   |   |   |
| As reported |     | $                             | 30,967   |   | $ | 23,929 |   | $ | 24,526 |   |
| Pro forma   |     | 30,506                        |     | 23,393 |   | 24,294 |   |
|        |     |                          |     |   |   |   |   |
| Basic EPS   |     |                          |     |   |   |   |   |
| As reported |     | 1.32                          |     | 1.01 |   | 0.97 |   |
| Pro forma   |     | 1.30                          |     | 0.98 |   | 0.96 |   |
|        |     |                          |     |   |   |   |   |
| Diluted EPS |     |                          |     |   |   |   |   |
| As reported |     | 1.31                          |     | 1.01 |   | 0.97 |   |
| Pro forma   |     | 1.29                          |     | 0.98 |   | 0.96 |   |
|             |          |                               |          |  |  |  |  |  |  |  |

 

The fair value of stock options is estimated on thegrant date using the Black-Scholes option pricing model with the followingvaluation assumptions:

 
|                         |   | **2001** |   | **2000** |   | **1999** |   |
|------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Expected  volatility         |   | 35       | %      | 39       | %      | 21       | %      |
| Risk-free  interest rate     |   | 5.0      | %      | 6.3      | %      | 5.8      | %      |
| Expected annual  forfeitures |   | 5        | %      | 5        | %      | 5        | %      |
| Expected  dividend yield     |   | 2.5      | %      | 2.5      | %      | 2.5      | %      |
| Expected life of  options    |   | 7 years  |   | 7 years  |   | 7 years  |   |

 

The weighted average fair value of stock optionsgranted in 2001, 2000 and 1999, based on the above assumptions, was $5.29,$3.34 and $3.00 per share, respectively.

 

**(14)  FINANCIALINSTRUMENTS WITH OFF-BALANCE SHEET RISK**

 

The Company is party to financial instruments with off-balance sheet risk in the normalcourse of business to meet the financing needs of its  customers.  Thesefinancial instruments include commitments to originate loans and standbyletters of credit.  The instrumentsinvolve, to varying degrees, elements of credit and interest rate risk inexcess of the amounts recognized in the accompanying consolidated balancesheets. The contract amounts of those instruments reflect the extent ofinvolvement the Company has in particular classes of financial instruments.

 

The Company’s exposure to credit loss in the event ofnonperformance by the other party to the financial instrument for loancommitments and standby letters of credit is represented by the contractualamount of those instruments.  TheCompany uses the same credit policies in making commitments and conditionalobligations as they do for on-balance sheet instruments.

 

65

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Off-balance sheet financial instruments whose contractamounts present credit risk included the following:

 
|                                        |     | **December  31,**   |       |
|---------------------------------------------|----------|---------------------|------------|
|                                        | **2001** |                | **2000**   |   |
|                                        |     | **(In  thousands)** | ** ** |
| Unused portion  of existing lines of credit |     | $                   | 128,887    |   | $ | 102,016 |   |
| Firm commitments  to originate loans        |     | 102,053             |       | 66,371 |   |
| Unadvanced  construction loans              |     | 52,435              |       | 53,127 |   |
| Standby letters  of credit                  |     | 1,784               |       | 2,336 |   |
|                                             |          |                     |            |  |  |  |  |

 

Commitments to originate loans are agreements to lendto a customer as long as there is no violation of any condition established inthe contract.  Commitments generallyhave fixed expiration dates or other termination clauses and may requirepayment of a fee.  Since some of thecommitments may expire without being drawn upon, the total commitment amountsdo not necessarily require future cash requirements.  Management evaluates each customer’s creditworthiness on acase-by-case basis.  The amount ofcollateral obtained upon extension of the credit is based on management’scredit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory,property, plant and equipment and income-producing commercial real estate.

 

Standby letters of credit are conditional commitmentsto guarantee performance of a customer to a third party.  The credit risk involved in issuing lettersof credit is essentially the same as that involved in extending loan facilitiesto customers.  The collateral supportingthose commitments varies and may include real property, accounts receivable orinventory.

 

**(15)  FAIRVALUE OF FINANCIAL INSTRUMENTS**

 

The reported fair values of financial instruments arebased on a variety of valuation techniques. In some cases, fair values represent quoted market prices for identicalor comparable instruments.  In othercases, fair values have been estimated based on assumptions concerning theamount and timing of estimated future cash flows, assumed discount ratesreflecting varying degrees of risk and future expected loss assumptions.  These estimates involve a high degree ofjudgment.  The estimates do not reflectany premium or discount that could result from offering significant holdings offinancial instruments at bulk sale.  Taximplications of unrealized gains and losses can also have a significant effecton fair value of the financial instruments. Changes in economic conditions may dramatically affect the fair value offinancial instruments.

 

The following methods and assumptions were used toestimate the fair value of the Banks’ financial instruments:

 

For cash and due from banks and federal funds sold,the carrying amount approximates fair value due to the short maturity of thoseinstruments.

 

The fair values of investment securities are based onpublished market prices or quotations received from securities dealers.

 

The fair values of loans are estimated for loanportfolios with similar financial characteristics.  Loans are segregated by type, fixed- and adjustable-rate interestterms and by performing and nonperforming status.  The fair values of performing residential real estate loans areestimated by discounting the anticipated future cash flows at rates currentlyrequired by the secondary mortgage market for the purchase of similarloans.  For performing commercial realestate loans and performing commercial loans, fair values are estimated bydiscounting the anticipated future cash flows using estimated market discountrates that reflect the credit and interest rate risk inherent in the loan asdetermined by the loan’s terms and credit rating.  For home equity loans and consumer loans,  fair values are estimated by discounting theanticipated cash flows using current interest rates.

 

66

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The fair value of deposits does not include the valueof long-term relationships with depositors and does not reflect the valueassociated with possessing this relatively inexpensive source of funds that maybe available for a considerable length of time.  The reported fair value of deposits with no stated maturity isequal to the amount payable on demand at the reporting date.  The fair value of time deposits is estimatedby discounting the contractual future cash flows at rates currently offered fortime deposits with similar remaining maturities.

 

The fair value of FHLB advances is determined bydiscounting the anticipated future cash payments using rates currentlyavailable for advances with similar terms and remaining maturities.  For other borrowings, the carrying amountapproximates fair value due to the short maturity of those instruments.

 

The fair value of commitments to originate loans isestimated using the fees currently charged to enter into similar agreements,taking into account the remaining terms of the agreements and the presentcreditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers thedifference between current levels of interest rates and the committedrates.  The fair value of financialstandby letters of credit is based on fees currently charged for similaragreements or on the estimated cost to terminate them or otherwise settle theobligations with the counterparties. The estimated fair value of all such commitments is insignificant.

 

Certain items are excluded from disclosurerequirements, including banking premises and equipment, the value of mortgageservicing rights, the intangible value inherent in deposit relationships (i.e.core deposits), leases and pension benefit obligations, among others.  Accordingly, the aggregate fair valueamounts presented in the accompanying table do not include all data integral toa full assessment of the Company’s financial position and the market value ofits net assets.

 

A summary of the estimated fair values of theCompany’s financial instruments follows:

 
|                                |     | **December  31,**    |       |
|-------------------------------------|----------|----------------------|------------|
|                                | **2001** |                 | **2000**   |   |
|                                |     | **Carrying  Amount** | ** ** | **Estimated  Fair Value** | ** ** | **Carrying  Amount** | ** ** | **Estimated  Fair Value** | ** ** |
|                                |     | **(In  thousands)**  | ** ** |
| Financial  assets:                  |     |                 |       |   |   |   |   |   |   |
| Cash and due  from banks            |     | $                    | 87,834     |   | $ | 87,834 |   | $ | 101,665 |   | $ | 101,665 |   |
| Federal funds  sold                 |     | 92,899               |       | 92,899 |   | 5,848 |   | 5,848 |   |
| Short-term  investments             |     | 10,000               |       | 10,000 |   | — |   | — |   |
| Investment  securities              |     | 467,176              |       | 467,525 |   | 307,557 |   | 307,600 |   |
| Loans  held-for-sale                |     | 19,675               |       | 19,727 |   | 13,666 |   | 13,714 |   |
| Total loans, net                    |     | 2,545,469            |       | 2,552,161 |   | 2,338,251 |   | 2,342,343 |   |
| Financial  liabilities:             |     |                 |       |   |   |   |   |   |   |
| Deposits (with  no stated maturity) |     | 1,200,234            |       | 1,200,234 |   | 972,988 |   | 972,988 |   |
| Certificates  of  deposit      |     | 992,123              |       | 1,014,086 |   | 1,016,642 |   | 1,019,601 |   |
| Short-term and  other borrowings    |     | 36,424               |       | 36,424 |   | 33,308 |   | 33,308 |   |
| FHLB advances                       |     | 786,917              |       | 878,689 |   | 556,958 |   | 551,305 |   |
|                                     |          |                      |            |  |  |  |  |  |  |  |  |  |  |

 

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**(16)  CONDENSEDPARENT COMPANY INFORMATION**

 

The condensed unconsolidated financial statements ofthe Parent Company follow:

 
|                                             |     | **December  31,**   |       |
|--------------------------------------------------|----------|---------------------|------------|
|                                             | **2001** |                | **2000**   |   |
|                                             |     | **(In  thousands)** | ** ** |
| **BALANCE  SHEETS**                              |     |                |       |   |   |
| ASSETS:                                          |     |                |       |   |   |
| Due from banks  (primarily at Compass)           |     | $                   | 1,810      |   | $ | 3,644 |   |
| Investment  securities available-for-sale        |     | 4,444               |       | 3,133 |   |
| ESOP loan                                        |     | 10,295              |       | 10,578 |   |
| Investment in  subsidiaries                      |     | 289,482             |       | 271,411 |   |
| Other assets                                     |     | 457                 |       | 377 |   |
| Total assets                                     |     | $                   | 306,488    |   | $ | 289,143 |   |
|                                             |     |                |       |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY:      |     |                |       |   |   |
| Accrued expenses  and other liabilities          |     | $                   | 764        |   | $ | 955 |   |
| Stockholders’  equity                       |     | 305,724             |       | 288,188 |   |
| Total  liabilities and stockholders’ equity |     | $                   | 306,488    |   | $ | 289,143 |   |

 
|                                                                                      | ** ** | **Year Ended  December 31,** |     |
|-------------------------------------------------------------------------------------------|------------|------------------------------|----------|
|                                                                                      | **2001**   |                         | **2000** |   | **1999** |   |
|                                                                                      |       | **(In  thousands)**          |     |
| **STATEMENTS OF INCOME**                                                                  |       |                         |     |   |   |   |   |
| INCOME:                                                                                   |       |                         |     |   |   |   |   |
| Interest and  dividends on investment securities                                          |       | $                            | 130      |   | $ | 136 |   | $ | 88 |   |
| Interest on ESOP  loan                                                                    |       | 809                          |     | 831 |   | 856 |   |
| Dividends from  subsidiaries                                                              |       | 16,000                       |     | 21,514 |   | —  |   |
| Other                                                                                     |       | 40                           |     | —  |   | —  |   |
| Total income                                                                              |       | 16,979                       |     | 22,481 |   | 944 |   |
| NONINTEREST EXPENSE                                                                       |       | 1,563                        |     | 1,240 |   | 1,123 |   |
| Income (loss)  before income taxes and equity in undistributed net income of subsidiaries |       | 15,416                       |     | 21,241 |   | (179 | ) |
| PROVISION (BENEFIT) FOR INCOME TAXES                                                      |       | (451                         | )        | 58 |   | (106 | ) |
| Income (loss)  before equity in undistributed net income of subsidiaries                  |       | 15,867                       |     | 21,183 |   | (73 | ) |
| EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES                                        |       | 15,100                       |     | 2,746 |   | 24,599 |   |
| Net income                                                                                |       | $                            | 30,967   |   | $ | 23,929 |   | $ | 24,526 |   |

 

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|                                                                                         |     | **Years  Ended December 31,** |     |
|----------------------------------------------------------------------------------------------|----------|-------------------------------|----------|
|                                                                                         | **2001** |                          | **2000** |   | **1999** |   |
|                                                                                         |     | **(In  thousands)**           |     |
| **STATEMENTS  OF CASH FLOWS**                                                                |     |                          |     |   |   |   |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                       |     |                          |     |   |   |   |   |
| Net income                                                                                   |     | $                             | 30,967   |   | $ | 23,929 |   | $ | 24,526 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |     |                          |     |   |   |   |   |
| Net amortization                                                                             |     | (3                            | )        | 11 |   | 13 |   |
| Stock-based  compensation                                                                    |     | 237                           |     | 349 |   | 131 |   |
| Equity in  undistributed earnings of subsidiaries                                            |     | (15,100                       | )        | (2,746 | ) | (24,599 | ) |
| Net (increase)  decrease in other assets                                                     |     | (211                          | )        | 24 |   | (80 | ) |
| Net increase  (decrease) in other liabilities, net                                           |     | (281                          | )        | 250 |   | (200 | ) |
| Net cash  provided by (used in) operating activities                                         |     | 15,609                        |     | 21,817 |   | (209 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                       |     |                          |     |   |   |   |   |
| Acquisition of  Home Port Bancorp, Inc., net                                                 |     | (111                          | )        | (68,463 | ) | — |   |
| Investment in  subsidiaries                                                                  |     | —                        |     | — |   | (100,000 | ) |
| Purchase of  securities                                                                      |     | (87                           | )        | (1,358 | ) | (332 | ) |
| Repayments on  ESOP loan                                                                     |     | 283                           |     | 262 |   | 360 |   |
| Net cash used in  investing activities                                                       |     | 85                            |     | (69,559 | ) | (99,972 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                       |     |                          |     |   |   |   |   |
| Non-operating  dividends from subsidiaries                                                   |     | —                        |     | 57,486 |   | — |   |
| Exercise of  stock options                                                                   |     | 320                           |     | — |   | — |   |
| Tax benefit of  stock option and award transactions, net                                     |     | 63                            |     |   |   |   |   |
| Repurchase of  common stock                                                                  |     | (10,492                       | )        | (8,680 | ) | (15,939 | ) |
| Stock award  reimbursement by Compass                                                        |     | 1,012                         |     | 1,012 |   | 506 |   |
| Cash dividends                                                                               |     | (8,431                        | )        | (6,607 | ) | (2,645 | ) |
| Net cash  provided by (used in) financing activities                                         |     | (17,528                       | )        | 43,211 |   | (18,078 | ) |
| Net decrease in  due from banks                                                              |     | (1,834                        | )        | (4,531 | ) | (118,259 | ) |
| DUE FROM BANKS  BEGINNING OF YEAR                                                            |     | 3,644                         |     | 8,175 |   | 126,434 |   |
| DUE FROM BANKS  END OF YEAR                                                                  |     | $                             | 1,810    |   | $ | 3,644 |   | $ | 8,175 |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                           |     |                          |     |   |   |   |   |
| Income taxes  paid                                                                           |     | $                             | 20,991   |   | $ | 13,204 |   | $ | 13,892 |   |

 

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**(17)  STOCKHOLDERS’EQUITY**

 

**Stock Conversion**

 

As part of the conversion from mutual to stock form in1998 (the Conversion), the Company established a liquidation account in anamount equal to its net worth as of May 31, 1998.  The liquidation account is maintained for the benefit of eligibleaccount holders and supplemental eligible account holders who maintain theiraccounts at Compass after the Conversion. The liquidation account is reduced annually to the extent that suchaccount holders have reduced their qualifying deposits as of each anniversarydate.  Subsequent increases do notrestore an account holder’s interest in the liquidation account.  In the event of a complete liquidation, eacheligible account holder is entitled to receive balances for accounts then held.

 

**Stock Repurchase Programs**

 

In July 1999, the Board of Directors authorized theCompany to repurchase up to 1,000,000 shares in the open market to meet theanticipated needs of stock awards and stock options issued in connection withthe Stock Incentive Plan.  In October1999 and July 2000, the Board of Directors, with the approval of the Commissionerof Banks, authorized the Company to repurchase up to an additional 1,231,900and 1,254,312 shares, respectively,  in the openmarket.  The Board of Directorsdelegated to the discretion of senior management the authority to determine thetiming of the repurchase programs’ commencement, the timing of subsequentrepurchases and the prices at which repurchases will be made.

 

As of January 22, 2002, the Company had repurchased3,027,000 shares  of its common stockunder these programs at a total cost of $35.1 million, all of which shares hadbeen repurchased as of December 31, 2001.

 

**Dividend Reinvestment and StockPurchase Plan**

 

In October 1999, the Board of Directors authorized adividend reinvestment and stock purchase plan for up to 500,000 shares of commonstock.  Stockholders owning 100 or moreshares are eligible to enroll and may reinvest part of all of their cashdividends.  Participants may also makeoptional cash payments from $100 to a maximum of $5,000  per quarter to purchase additional shares ofcommon stock.  This plan commenced uponthe Board’s declaration of the Company’s quarterly cash dividend in January 2000.  The Company has directed its agent to acquire shares in openmarket transactions to meet the needs of this plan.

 

**(18)  BUSINESSSEGMENT INFORMATION**

 

The Company has identified its reportable segment as“Community Banking” which consists of commercial and retail banking.  The Company operates under two operatingsegments which have similar economic characteristics, products and services,distribution channels and regulatory environments.  Accordingly, disaggregated segment information for each bank isnot presented.  The community bankingsegment derives its revenue from a wide range of banking services, includinginvesting and lending activities and acceptance of demand, savings and timedeposits, merchant credit card services as well as servicing loans forinvestors.  There is no major customer,as defined, and the banks operate within a single geographic area (southeasternMassachusetts, including the islands of Martha’s Vineyard and Nantucket).

 

Non-reportable operating segments of the Company’soperations which do not have similar characteristics to the community bankingoperations and do not meet the quantitative thresholds requiring disclosure,are included in the Other category in the disclosure of business segmentsbelow.  These non-reportable segmentsinclude the Parent Company (Note 16).

 

70

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The accounting policies used in the disclosure ofbusiness segments are the same as those described in the summary of significantaccounting policies (Note 1).  Theconsolidation adjustments reflect certain eliminations of intersegment revenue,cash and the Parent Company investments in subsidiaries.

 

Reportable segment specific information andreconciliation to consolidated financial information is as follows (inthousands):

 
|                      |   | **Community  Banking** |    | **Other** |   | **Other  Adjustments  and Eliminations** |   | **Consolidated** |   |
|---------------------------|--------|------------------------|---------|-----------|--------|------------------------------------------|--------|------------------|--------|
|                      |   | **(in thousands)**     |    |
| December 31, 2001         |   |                   |    |      |   |                                     |   |             |   |
| Investment securities     |   | $                      | 462,732 |      | $      | 4,444                                    |   | $                | — |   | $ | 467,176 |   |
| Net loans                 |   | 2,545,469              |    | 10,295    |   | (10,295                                  | )      | 2,545,469        |   |
| Total assets              |   | 3,342,693              |    | 305,526   |   | (300,752                                 | )      | 3,347,467        |   |
| Total deposits            |   | 2,192,357              |    | —    |   | —                                   |   | 2,192,357        |   |
| Total borrowings          |   | 823,341                |    | —    |   | —                                   |   | 823,341          |   |
| Total liabilities         |   | 3,040,979              |    | 764       |   | —                                   |   | 3,041,743        |   |
| Net interest income       |   | 102,768                |    | 939       |   | (809                                     | )      | 102,898          |   |
| Provision for loan losses |   | 6,175                  |    | —    |   | —                                   |   | 6,175            |   |
| Total noninterest income  |   | 16,303                 |    | 40        |   | —                                   |   | 16,343           |   |
| Total noninterest expense |   | 63,813                 |    | 1,563     |   | —                                   |   | 65,376           |   |
| Net income                |   | 31,100                 |    | 30,967    |   | (31,100                                  | )      | 30,967           |   |
|                      |   |                   |    |      |   |                                     |   |             |   |
| December 31, 2000         |   |                   |    |      |   |                                     |   |             |   |
| Investment securities     |   | $                      | 304,424 |      | $      | 3,133                                    |   | $                | — |   | $ | 307,557 |   |
| Net loans                 |   | 2,338,251              |    | 10,578    |   | (10,578                                  | )      | 2,338,251        |   |
| Total assets              |   | 2,887,571              |    | 288,191   |   | (284,997                                 | )      | 2,890,765        |   |
| Total deposits            |   | 1,989,630              |    | —    |   | —                                   |   | 1,989,630        |   |
| Total borrowings          |   | 590,266                |    | —    |   | —                                   |   | 590,266          |   |
| Total liabilities         |   | 2,601,622              |    | 955       |   | —                                   |   | 2,602,577        |   |
| Net interest income       |   | 79,967                 |    | 967       |   | (831                                     | )      | 80,103           |   |
| Provision for loan losses |   | 4,775                  |    | —    |   | —                                   |   | 4,775            |   |
| Total noninterest income  |   | 9,987                  |    | —    |   | —                                   |   | 9,987            |   |
| Total noninterest expense |   | 47,831                 |    | 1,240     |   | —                                   |   | 49,071           |   |
| Net income                |   | 24,259                 |    | 23,929    |   | (24,259                                  | )      | 23,929           |   |
|                      |   |                   |    |      |   |                                     |   |             |   |
| December 31, 1999         |   |                   |    |      |   |                                     |   |             |   |
| Investment securities     |   | $                      | 270,794 |      | $      | 2,133                                    |   | $                | — |   | $ | 272,927 |   |
| Net loans                 |   | 1,730,378              |    | 10,840    |   | (10,840                                  | )      | 1,730,378        |   |
| Total assets              |   | 2,120,382              |    | 249,293   |   | (246,890                                 | )      | 2,122,785        |   |
| Total deposits            |   | 1,515,622              |    | —    |   | —                                   |   | 1,515,622        |   |
| Total borrowings          |   | 314,622                |    | —    |   | —                                   |   | 314,622          |   |
| Total liabilities         |   | 1,848,359              |    | 405       |   | —                                   |   | 1,848,764        |   |
| Net interest income       |   | 74,354                 |    | 944       |   | (856                                     | )      | 74,442           |   |
| Provision for loan losses |   | 2,000                  |    | —    |   | —                                   |   | 2,000            |   |
| Total noninterest income  |   | 9,994                  |    | —    |   | —                                   |   | 9,994            |   |
| Total noninterest expense |   | 43,393                 |    | 1,123     |   | —                                   |   | 44,516           |   |
| Net income                |   | 24,599                 |    | 24,526    |   | (24,599                                  | )      | 24,526           |   |

 

71

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**(19)  SELECTEDQUARTERLY FINANCIAL DATA (UNAUDITED)**

 

The following table summarizes the operating results on a quarterlybasis for the years ended December 31, 2001 and 2000.

 
|                                 |   | **2001**                                                  |       | **2000**           |       |
|--------------------------------------|--------|-----------------------------------------------------------|------------|--------------------|------------|
|                                 |   | **Fourth  Quarter**                                       | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
|                                 |   | **(Dollars  in thousands, except for per share amounts)** | ** ** |
| Interest income                      |   | $                                                         | 54,418     |               | $          | 55,349 |   | $ | 53,892 |   | $ | 52,664 |   | $ | 45,542 |   | $ | 43,304 |   | $ | 40,225 |   | $ | 37,368 |   |
| Interest expense                     |   | 26,951                                                    |       | 29,060             |       | 28,749 |   | 28,731 |   | 24,587 |   | 22,944 |   | 20,398 |   | 18,407 |   |
| Net interest  income                 |   | 27,467                                                    |       | 26,289             |       | 25,143 |   | 23,933 |   | 20,955 |   | 20,360 |   | 19,827 |   | 18,961 |   |
| Provision for  loan losses           |   | 1,750                                                     |       | 1,550              |       | 1,475 |   | 1,400 |   | 1,275 |   | 1,250 |   | 1,200 |   | 1,050 |   |
| Gain on pension  plan settlement (1) |   | 1,504                                                     |       | —             |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Other  noninterest income (2)        |   | 4,590                                                     |       | 3,686              |       | 3,565 |   | 3,122 |   | 2,579 |   | 2,928 |   | 2,301 |   | 2,179 |   |
| Noninterest  expense (3)             |   | 17,511                                                    |       | 15,991             |       | 16,067 |   | 15,865 |   | 13,023 |   | 12,760 |   | 11,582 |   | 11,706 |   |
| Income before  income taxes          |   | 14,300                                                    |       | 12,434             |       | 11,166 |   | 9,790 |   | 9,236 |   | 9,278 |   | 9,346 |   | 8,384 |   |
| Provision for  income taxes (4)      |   | 5,099                                                     |       | 4,400              |       | 4,165 |   | 3,059 |   | 2,829 |   | 3,183 |   | 3,347 |   | 2,956 |   |
| Net income                           |   | $                                                         | 9,201      |               | $          | 8,034 |   | $ | 7,001 |   | $ | 6,731 |   | $ | 6,407 |   | $ | 6,095 |   | $ | 5,999 |   | $ | 5,428 |   |
|                                 |   |                                                      |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Earnings per  share:                 |   |                                                      |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                |   | $                                                         | 0.40       |               | $          | 0.34 |   | $ | 0.30 |   | $ | 0.29 |   | $ | 0.27 |   | $ | 0.26 |   | $ | 0.25 |   | $ | 0.23 |   |
| Diluted                              |   | 0.39                                                      |       | 0.34               |       | 0.29 |   | 0.28 |   | 0.27 |   | 0.26 |   | 0.25 |   | 0.23 |   |
|                                 |   |                                                      |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash dividends  per share            |   | 0.09                                                      |       | 0.09               |       | 0.08 |   | 0.08 |   | 0.07 |   | 0.07 |   | 0.06 |   | 0.06 |   |

 

----

(1)               Refer to Note 12 regarding the termination ofthe defined benefits plan.

(2)               In the quarter ending December 31, 2001, theCompany recorded gains on the sale of mortgage loans of approximately$1,024,000.

(3)               In the quarter ending December 31, 2001,salaries and benefits increased ($569,000), data processing increased($276,000), advertising and marketing increased ($227,000) and other expensesincreased ($301,000).

(4)               During the quarter ended December 31, 2000,the Company reversed approximately $300,000 in tax reserves which were deemedno longer required.  During the quarterending March 31, 2001, the Company recorded a tax refund of $341,000 againstthe tax provisions due on amended tax returns related to the Sandwichacquisition.

 

 

72

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**Item 9.    Changes in and Disagreements With Accountants on Accounting andFinancial Disclosure**

 

None.

 

**PART III**

 

**Item 10. Directors and Executive Officers of the Registrant**

 

Information required by Item 10. of this Form isincorporated by reference herein from the Company’s Proxy Statement relating tothe 2002 Annual Meeting of Stockholders of the Company.

 

**Item 11. Executive Compensation**

 

Information required by Item 11. of this Form isincorporated by reference herein from the Company’s Proxy Statement relating tothe 2002 Annual Meeting of Stockholders of the Company.

 

**Item 12. Security Ownership of Certain Beneficial Owners and Management**

 

Information required by Item 12. of this Form isincorporated by reference herein from the Company’s Proxy Statement relating tothe 2002 Annual Meeting of Stockholders of the Company.

 

**Item 13. Certain Relationships and Related Transactions**

 

Information required by Item 13. of this Form isincorporated by reference herein from the Company’s Proxy Statement related tothe 2002 Annual Meeting of Stockholders of the Company.

 

**PART IV**

 

**Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K**

 
| (a)  Contents: |
|---------------------|
|                |   |   |
| 1.                  | Financial Statements: All financial statements are  included in Item 8. of Part II to this report. |
|                |   |   |
| 2.                  | Financial Statement Schedules: All financial  statement schedules have been omitted because they are either not required,  not applicable or are included in the consolidated financial statements or  related notes. |
|                |   |   |
| 3.                  | Exhibits |
|                |   |   |
| 3.1                 | Articles of Organization of Seacoast Financial  Services Corporation+++ |
|                |   |   |
| 3.2                 | By-Laws of Seacoast Financial Services  Corporation+++ |
|                |   |   |
| 4                   | Specimen certificate for the common stock of  Seacoast Financial Services Corporation++ |
|                |   |   |
| 10.1*               | Form of Employment Agreement by and among Seacoast  Financial Services Corporation, Compass Bank for Savings and Kevin G.  Champagne+ |
|                |   |   |
| 10.2*               | Form of Employment Agreement by and among Compass  Bank for Savings, Seacoast Financial Services Corporation and certain  Officers of Compass Bank for Savings+ |
|                |   |   |
| 10.3*               | Form of Change in Control Agreements by and among  Seacoast Financial Services Corporation, Compass Bank for Savings, Kevin G.  Champagne and certain other Officers of Compass Bank for Savings+ |
|                |   |   |
| 10.4*               | Form of Change in Control Agreement by and among  Seacoast Financial Services Corporation, Compass Bank for Savings and certain  Officers of Compass Bank for Savings + |
|                |   |   |
| 10.5*               | Form of Executive Salary Continuation Agreements  made and entered into by and between Compass Bank for Savings and Kevin G.  Champagne, Arthur W. Short, John D. Kelleher and Francis S. Mascianica and  forms of amendments thereto + |
|                     |  |  |  |  |

 

73

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| 10.6*  | Trust Agreement, made as of December 18, 1992, by  and between Compass Bank for Savings and Shawmut Bank, N.A. + |
|--------|------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                             |   |
| 10.7*  | Compass Bank for Savings January 2000 Incentive  Compensation Plan ++++++                                        |
|   |                                                                                                             |   |
| 10.12* | Compass Bank for Savings Executive Deferred  Compensation Plan +                                                 |
|   |                                                                                                             |   |
| 10.13* | Rabbi Trust for Compass Bank for Savings Executive  Deferred Compensation Plan +                                 |
|   |                                                                                                             |   |
| 10.17* | Sandwich Co-operative Bank 1992 Directors Deferred  Compensation Plan +                                          |
|   |                                                                                                             |   |
| 10.20* | Seacoast Financial Services Corporation 1999 Stock  Incentive Plan ++++                                          |
|   |                                                                                                             |   |
| 11     | A statement regarding earnings per share is included  in Item 8., Note 1, of this report.                        |
|   |                                                                                                             |   |
| 21     | Subsidiaries (See Item 1. of Part I to this report.)                                                             |
|   |                                                                                                             |   |
| 23     | Consent of Arthur Andersen LLP                                                                                   |
|   |                                                                                                             |   |
| 99     | Letter from The Company to the Commission Pursuant  to Temporary Note 3T to Article No. 3 of Regulation S-X      |

 
|        |                                                                                                                                                                                                                           |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *      | Management compensatory plan or arrangement.                                                                                                                                                                                   |   |
|   |                                                                                                                                                                                                                           |   |   |
| +      | Incorporated by reference to the Company’s  Registration Statement on Form S-1 (333-52889), filed with the SEC under the  Company’s prior name, “The 1855 Bancorp”, on May 15, 1998.                       |   |
|   |                                                                                                                                                                                                                           |   |   |
| ++     | Incorporated by reference to Amendment No. 1 to the  Company’s Registration Statement on Form S-1 (333-52889), filed with the SEC  under the Company’s prior name, “The 1855 Bancorp”, on August 14, 1998. |   |
|   |                                                                                                                                                                                                                           |   |   |
| +++    | Incorporated by reference to the Company’s  Registration Statement on Form 8-A filed with the SEC on  November 18, 1998.                                                                                             |   |
|   |                                                                                                                                                                                                                           |   |   |
| ++++   | Incorporated by reference to the Company’s Proxy  Statement on Schedule 14A filed with the SEC on April 16, 1999.                                                                                                         |   |
|   |                                                                                                                                                                                                                           |   |   |
| +++++  | Incorporated by reference to the Company’s Current  Report on Form 8-K filed with the SEC on August 30, 2000.                                                                                                             |   |
|   |                                                                                                                                                                                                                           |   |   |
| ++++++ | Incorporated by reference to the Company’s Annual  Report on Form 10-K filed with the SEC on March 27, 2000                                                                                                               |   |
|        |                                                                                                                                                                                                                                |  |  |  |

 

(b) Reports of Form 8-K:No reports were filed during the fourthquarter.

 

74

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**SIGNATURES**

 

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 

 
|                 |  Seacoast  Financial Services Corporation |
|----------------------|------------------------------------------------|
|                 |                                           |
|                 |                                           |
| DATE: March 28, 2002 | By:                                            | /s/  Kevin G.  Champagne |
|                 | Kevin G.  Champagne                            |
|                 | President and  Chief Executive Officer         |
|                 |                                           |
|                 |                                           |
|                 | By:                                            | /s/  Francis  S. Mascianica, Jr. |
|                 | Francis S.  Mascianica, Jr.                    |
|                 | Treasurer, as  Principal Financial and         |
|                 | Accounting  Officer                            |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the Registrant and in the capacities and on the datesindicated.

 

 
| /s/  Kevin G.  Champagne      |                                              |           |
|------------------------------------|---------------------------------------------------|----------------|
| Kevin G. Champagne                 | President, Chief  Executive  Officer and Director | March 28, 2002 |
|                               |                                              |           |
| /s/  David P.  Cameron        |                                              |           |
| David P. Cameron                   | Director                                          | March 28, 2002 |
|                               |                                              |           |
| /s/  Howard  C. Dyer, Jr.     |                                              |           |
| Howard C. Dyer, Jr.                | Director                                          | March 28, 2002 |
|                               |                                              |           |
| /s/  Mary F.  Hebditch        |                                              |           |
| Mary F. Hebditch                   | Director                                          | March 28, 2002 |
|                               |                                              |           |
| /s/  Glen F.  Johnson         |                                              |           |
| Glen F. Johnson                    | Director                                          | March 28, 2002 |
|                               |                                              |           |
| /s/  Thornton  P. Klaren, Jr. |                                              |           |
| Thornton P. Klaren, Jr.            | Director                                          | March 28, 2002 |
|                               |                                              |           |
| /s/  J. Louis  LeBlanc        |                                              |           |
| J. Louis LeBlanc                   | Director                                          | March 28, 2002 |
|                               |                                              |           |

 

75

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| /s/  Frederic  D. Legate    |     |           |
|----------------------------------|----------|----------------|
| Frederic D. Legate               | Director | March 28, 2002 |
|                             |     |           |
| /s/  Reale J.  Lemieux      |     |           |
| Reale J. Lemieux                 | Director | March 28, 2002 |
|                             |     |           |
| /s/  A.  William Munro      |     |           |
| A. William Munro                 | Director | March 28, 2002 |
|                             |     |           |
| /s/  Philip  W. Read        |     |           |
| Philip W. Read                   | Director | March 28, 2002 |
|                             |     |           |
| /s/  Carl  Ribeiro          |     |           |
| Carl Ribeiro                     | Director | March 28, 2002 |
|                             |     |           |
| /s/  Joseph  H. Silverstein |     |           |
| Joseph H. Silverstein            | Director | March 28, 2002 |
|                             |     |           |
| /s/  Gerald  H. Silvia      |     |           |
| Gerald H. Silvia                 | Director | March 28, 2002 |

 

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