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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q


(Mark One)


|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------




For the quarterly period ended June 30, 2002





OR





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




For the transition period from
 to





Commission File Number 1-14671





---




WORONOCO BANCORP, INC.


(Exact name of registrant as specified in its charter)





Delaware

04-3444269(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer Identification
No.)31 Court Street, Westfield, Massachusetts

01085(Address of principal executive offices)

(Zip Code)





(413) 568-9141


(Registrants telephone number, including area code)





Not
Applicable


(Former name, former address and former fiscal year, if changed since last report)





---




Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days.  Yes  x  No  ̈





The issuer had 3,694,061 shares of common stock, par value $0.01 per share, outstanding as of August 7, 2002.





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##### Table of Contents




WORONOCO BANCORP, INC.


FORM 10-Q





INDEX





PagePART I.

FINANCIAL INFORMATIONItem 1.

Financial Statements (unaudited)Consolidated Balance Sheets at June 30, 2002 and December 31, 2001.

1Consolidated Income Statements for the Three and Six Months Ended June 30, 2002 and 2001

2Consolidated Statements of Changes in Stockholders Equity for the Six Months Ended June 30, 2002 and 2001

3Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001

4Notes to Unaudited Consolidated Financial Statements

5Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

7Item 3.

Quantitative and Qualitative Disclosures About Market Risk

28PART II:

OTHER INFORMATIONItem 1.

Legal Proceedings

29Item 2.

Changes in Securities and Use of Proceeds

29Item 3.

Defaults Upon Senior Securities

29Item 4.

Submission of Matters to a Vote of Security Holders

29Item 5.

Other Information

29Item 6.

Exhibits and Reports on Form 8-K

30SIGNATURES



31




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PART I.    FINANCIAL INFORMATION





Item 1.Financial Statements (unaudited)





WORONOCO BANCORP, INC. AND SUBSIDIARIES





CONSOLIDATED BALANCE SHEETS


(In Thousands)





June 30, 2002


December 31, 2001UnauditedASSETSCash and due from banks

$
17,219


$
19,883Interest-bearing balances


1,787



7,326Federal funds sold


11,000



Total cash and cash equivalents


30,006



27,209Securities available for sale, at fair value


185,780



175,708Federal Home Loan Bank stock, at cost


13,795



13,750Loans, net of allowance for loan losses ($3,015 at June 30, 2002 and $2,701 at December 31, 2001)


457,973



427,409Other real estate owned, net






Premises and equipment, net


10,756



11,172Accrued interest receivable


3,834



3,036Goodwill and other intangible assets, net


1,930



1,923Net deferred tax asset


730



1,362Cash surrender value of life insurance


2,510



2,412Other assets


2,801



4,025Total assets

$
710,115


$
668,006LIABILITIES AND STOCKHOLDERS EQUITYDeposits

$
382,231


$
336,060Short-term borrowings


41,095



44,041Long-term debt


208,000



205,000Mortgagors escrow accounts


996



1,130Accrued expenses and other liabilities


4,710



11,926Total liabilities


637,032



598,157Commitments and contingenciesStockholders Equity:Preferred stock ($.01 par value; 2,000,000 shares authorized; no shares issued and outstanding)






Common stock ($.01 par value; 16,000,000 shares authorized; shares issued: 5,998,860 at June 30, 2002 and December
31, 2001; shares outstanding: 3,708,361 at June 30, 2002 and 3,737,268 at December 31, 2001)


60



60Additional paid-in capital


58,483



58,292Unearned compensation


(4,390
)


(4,834
)Retained earnings


43,227



41,441Accumulated other comprehensive income


2,940



1,497Treasury stock, at cost (2,290,499 shares at June 30, 2002 and 2,261,592 shares at December 31, 2001)



(27,237
)


(26,607
)Total stockholders equity


73,083



69,849Total liabilities and stockholders equity

$
710,115


$
668,006





See accompanying notes to unaudited consolidated financial statements




1




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##### Table of Contents

WORONOCO BANCORP, INC. AND SUBSIDIARIES





CONSOLIDATED INCOME STATEMENTS


(In Thousands Except Per Share Amounts)





UnauditedThree Months EndedJune 30,


Unaudited Six Months
EndedJune 30,2002


2001


2002

2001Interest and dividend income:Interest and fees on loans

$
7,496


$
7,372


$
14,750

$
14,813Interest and dividends on securities:Interest


2,227



2,226



4,402


4,645Dividends


791



825



1,508


1,645Interest on federal funds sold


43



27



73


188Other interest income


(1
)


63



15


182Total interest and dividend income


10,556



10,513



20,748


21,473Interest expense:Interest on deposits


2,239



2,809



4,252


5,779Interest on borrowings


3,107



2,990



6,227


6,565Total interest expense


5,346



5,799



10,479


12,344Net interest income


5,210



4,714



10,269


9,129Provision for loan losses


243



85



352


85Net interest income, after provision for loan losses


4,967



4,629



9,917


9,044Other income:Fee income


604



611



1,189


1,184Insurance commissions


159



113



293


244(Loss) gain on sales, disposition and impairment of securities, net


(33
)


228



121


343Gain on sales of loans, net













70Gain (loss) on derivative instruments and hedging activities


4



(311
)


2


(68
)Other income


17



50



30


97Total other income


751



691



1,635


1,870Other expenses:Salaries and employee benefits


1,803



2,092



4,233


4,098Occupancy and equipment


561



532



1,113


1,093Marketing


132



223



300


373Professional services


200



270



431


506Data processing


227



218



466


445Other general and administrative


684



751



1,396


1,471Total other expenses


3,607



4,086



7,939


7,986Income before income tax expense


2,111



1,234



3,613


2,928Income tax expense


644



427



1,070


1,045Net income before cumulative effect of change in accounting principle


1,467



807



2,543


1,883Cumulative effect of change in accounting principle, net of tax benefit of $92













(161
)Net income

$
1,467


$
807


$
2,543

$
1,722Earnings per share:Basic

$
0.44


$
0.23


$
0.75

$
0.48Diluted

$
0.40


$
0.22


$
0.70

$
0.45Weighted average shares outstanding:Basic


3,368,223



3,542,026



3,368,564


3,615,386Diluted


3,639,722



3,718,299



3,628,561


3,785,373





See accompanying notes to unaudited consolidated financial statements




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##### Table of Contents




WORONOCO BANCORP, INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY


Six Months Ended June 30, 2002 and 2001


(In Thousands)


(Unaudited)





Common Stock

Additional Paid-in Capital


Unearned Compensation


Retained Earnings


Accumulated Other Comprehensive Income

Treasury Stock


TotalBalance at December 31, 2001

$
60

$
58,292


$
(4,834
)

$
41,441


$
1,497

$
(26,607
)

$
69,849Comprehensive income:Net income













2,543










2,543Change in net unrealized gain on securities available for sale, net of reclassification adjustment and tax
effects

















1,369






1,369Net gain (loss) on derivative instruments

















74






74Total comprehensive income
























3,986Decrease in unearned compensation





198



444














642Adjustment for tax benefit related to vesting of stock awards and stock option exercises





10


















10Treasury stock reissued in connection with Company's stock-based incentive plan (10,393 shares)





(17
)













123



106Cash dividends declared













(757
)









(757
)Treasury stock purchased (39,300 shares)




















(753
)


(753
)Balance at June 30, 2002

$
60

$
58,483


$
(4,390
)

$
43,227


$
2,940

$
(27,237
)

$
73,083Balance at December 31, 2000

$
60

$
57,954


$
(5,742
)

$
38,311


$
365

$
(20,189
)

$
70,759Comprehensive income:Net income













1,722










1,722Change in net unrealized gain on securities available for sale, net of reclassification adjustment and tax
effects

















1,261






1,261Total comprehensive income
























2,983Decrease in unearned compensation





97



435














532Treasury stock reissued in connection with Company's stock-based incentive plan (500 shares)




















6



6Cash dividends declared













(500
)









(500
)Treasury stock purchased (227,446 shares)




















(3,348
)


(3,348
)Balance at June 30, 2001

$
60

$
58,051


$
(5,307
)

$
39,533


$
1,626

$
(23,531
)

$
70,432





See accompanying notes to unaudited consolidated financial statements




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WORONOCO BANCORP, INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF CASH FLOWS





Six Months Ended June 30,2002


2001(In thousands)Cash flows from operating activities:Net income

$
2,543


$
1,722Adjustments to reconcile net income to net cash (used) provided by operating activities:Provision for loan losses


352



85Net amortization (accretion) of investments


221



(1
)Depreciation and amortization


546



485Amortization of goodwill and other intangible assets


25



39Employee stock ownership plan expense


395



289Stock-based incentive plan expense


247



243Gain on sales, disposition and impairment of securities, net


(121
)


(343
)Gain on sale of other real estate owned






(4
)Gain on sales of loans, net






(70
)Proceeds from sale of loans held for sale






14,383Changes in operating assets and liabilities:Accrued interest receivable


(798
)


249Accrued expenses and other liabilities


(7,206
)


750Other, net


1,139



1,431Net cash (used) provided by operating activities


(2,657
)


19,258Cash flows from investing activities:Proceeds from sales of securities available for sale


3,001



2,631Purchases of securities available for sale


(27,290
)


(3,734
)Principal payments on mortgage-backed securities


16,147



12,574Purchases of Federal Home Loan Bank stock


(45
)


Loans originations and principal collections, net


(30,919
)


(18,364
)Additions to premises and equipment


(130
)


(484
)Proceeds from sales of foreclosed real estate


3



65Net cash used in investing activities


(39,233
)


(7,312
)Cash flows from financing activities:Net increase in deposits


46,171



2,307Net decrease in short-term borrowings


(2,946
)


(82,516
)Proceeds from issuance of long-term debt


3,000



70,000Net decrease in mortgagors escrow accounts


(134
)


(62
)Cash dividends paid


(757
)


(500
)Treasury stock purchased


(753
)


(3,348
)Reissuance of treasury stock in connection with stock option exercises


106



6Net cash provided (used) by financing activities


44,687



(14,113
)Net increase (decrease) in cash and cash equivalents


2,797



(2,167
)Cash and cash equivalents at beginning of period


27,209



25,368Cash and cash equivalents at end of period

$
30,006


$
23,201Supplemental cash flow information:Interest paid on deposits

$
4,900


$
3,283Interest paid on borrowings


6,205



3,193Income taxes paid


1,598



1,079Transfer from loans to other real estate owned


3



225





See accompanying notes to unaudited consolidated financial statements




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##### Table of Contents

WORONOCO BANCORP, INC. AND SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


At and for the Six Months Ended June 30, 2002





1.    Unaudited Consolidated Financial Statements





The Unaudited Consolidated Financial Statements of Woronoco Bancorp, Inc. and its subsidiaries (the Company) included herein are unaudited. In the opinion of
management, all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the financial condition, results of operations and cash flows, as of and for the periods covered herein, have been made. Certain
information and note disclosures normally included in the Consolidated Financial Statements have been omitted as they are included in the most recent Securities and Exchange Commission Form 10-K and accompanying Notes to the Consolidated Financial
Statements (the Form 10-K) filed by the Company for the year ended December 31, 2001. Management believes that the disclosures contained herein are adequate to make a fair presentation.





These unaudited consolidated financial statements should be read in conjunction with the Form 10-K.





The results for the three and six month interim periods covered hereby are not necessarily indicative of the operating results for a full
year.





2.    New Accounting Pronouncements





The Company adopted the provisions of Statements of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective January 1, 2002. SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. With the adoption of SFAS No. 142, goodwill is
no longer subject to amortization over its estimated useful life. As a result of the adoption of this statement, the Company no longer recognizes goodwill amortization of $6,458 each month. SFAS No. 142 also subjects goodwill to at least an annual
assessment for impairment by applying a fair value based test. The Company completed a fair value assessment in June and determined that the remaining goodwill balance is not impaired. Additionally, under SFAS No. 142, acquired intangible assets
should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the intent to do so. In
connection with the acquisition of Keyes & Mattson Insurance Agency in November 2001, the Company recognized intangible assets totaling $150,000. These assets are being amortized over five years.




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##### Table of Contents




3.    Earnings Per Share





Basic earnings per share represents net income divided by the weighted-average number of common shares outstanding during the period.
Diluted earnings per share reflects additional common shares that would have been outstanding if potential dilutive shares, such as stock options, had been issued. However, options will have a dilutive effect only when the average market price of
the common stock exceeds the exercise price of the options.





The following table sets forth the calculation of
basic and diluted earnings per share for the periods indicated (dollars in thousands except per share amounts).





Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


2001Unaudited


UnauditedNet income

$
1,467


$
807


$
2,543


$
1,722Weighted average shares outstanding:Weighted average shares outstanding


5,998,860



5,998,860



5,998,860



5,998,860Less: unearned ESOP shares


(345,964
)


(389,816
)


(351,119
)


(394,842
)Less: treasury shares


(2,284,673
)


(2,067,018
)


(2,279,177
)


(1,988,632
)Basic


3,368,223



3,542,026



3,368,564



3,615,386Effect of dilutive stock options


271,499



176,273



259,997



169,987Diluted


3,639,722



3,718,299



3,628,561



3,785,373Net income per share:Basic

$
0.44


$
0.23


$
0.75


$
0.48Diluted

$
0.40


$
0.22


$
0.70


$
0.45





4.    Dividends





On July 17, 2002, the Company declared a cash dividend of $0.12 per share payable on August 29, 2002 to shareholders of record as of the
close of business on August 7, 2002.





5.    Loan commitments





Outstanding loan commitments totaled $25.9 million at June 30, 2002 compared to $27.0 million at December 31, 2001. At June 30, 2002 and
December 31, 2001, the Company had no commitments to purchase loans.




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##### Table of Contents




|Item |  | 2.Managements Discussion and Analysis of Financial Condition and Results of Operations.
|---- |  | ----------------------------------------------------------------------------------------




The following analysis discusses changes in the financial condition and results of operations of the Company at and for the three and six months ended June 30, 2002 and 2001, and should be read in
conjunction with the Companys Unaudited Consolidated Financial Statements and the notes thereto, appearing in Part I, Item 1 of this document. This report refers to operating earnings, which is a non-GAAP measure. However, the
Company believes that it is useful to assist investors in gaining an understanding of the trends and results of operations for the Companys core business. This non-GAAP measure should be viewed in addition to the Companys GAAP results
and not in lieu of GAAP results.





Forward-Looking Statements





This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this
statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identified by use of the words
believe, expect, intend, anticipate, estimate, project or similar expressions. The Companys ability to predict results or the actual effect of future plans or strategies
is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company include, but are not limited to: changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal
policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial
services in the Companys market area and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.





Except as required by applicable law and regulation, the Company does not undertakeand specifically
disclaims any obligationto publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or
unanticipated events.




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##### Table of Contents




Comparison of Financial Condition at June 30, 2002 and December 31, 2001





Total assets expanded $42.1 million, or 6.3%, to $710.1 million at June 30, 2002 compared to $668.0 million at December 31, 2001 fueled by
purchases of U.S. government agency securities totaling $20.6 million and growth in net loans of $30.6 million, partially offset by mortgage-backed securities principal payments aggregating $16.1 million. Total net loans rose 7.2% to $458.0 million
at June 30, 2002 from $427.4 million at December 31, 2001 reflecting loan origination and refinancing volumes of $85.3 million, offset by prepayments and amortization of the existing portfolio. Loan growth was strongest in the one- to four-family
and commercial real estate portfolios reflecting the favorable interest rate environment, a solid housing market and a stable economy. Fed funds sold balances were $11.0 million at June 30, 2002 compared to zero at December 31, 2001 as excess funds
generated from principal payments on mortgage-backed securities were shifted from interest-bearing balances at the FHLB for an enhanced rate. Interest-bearing balances declined $5.5 million to $1.8 million at June 30, 2002, primarily reflecting the
transfer of balances in FHLB accounts to the fed funds market, partially offset by deposits of principal payments on mortgage-backed securities received during the six months ended June 30, 2002.





Balance sheet growth was primarily funded by deposits, which rose $46.1 million, or 13.7%, to $382.2 million at June 30, 2002 compared to $336.1 million at December
31, 2001. Accrued expenses and other liabilities fell $7.2 million to $4.7 million at June 30, 2002, principally attributable to the settlement of several investment security purchases in January 2002, which were accounted for a on trade-date basis
in December 2001. Total stockholders equity was $73.1 million at June 30, 2002, an increase of $3.2 million, or 4.6%, compared to $69.8 million at December 31, 2001, primarily due to net income of $2.5 million, an increase of $1.4 million in
the net unrealized gain on available for sale securities and a reduction of $642,000 in unearned compensation, partially offset by cash dividends of $757,000 and repurchases of 39,300 shares of stock at a cost of $753,000.




8




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##### Table of Contents




Investments





At June 30, 2002, the Companys securities portfolio totaled $185.8 million, or 26.2% of assets, all of which was categorized as available-for-sale. The following
table sets forth information regarding the amortized cost and market values of the Companys investment securities.





June 30, 2002

December 31, 2001Amortized Cost

Fair Value

Amortized Cost

Fair Value(In Thousands)Available for sale securities:Equity securities:Preferred stocks

$
4,515

$
4,407

$
4,116

$
4,147Common stocks


12,657


11,896


12,490


12,289Trust preferred stocks


19,610


20,546


19,600


19,586Total equity securities


36,782


36,849


36,206


36,022Debt securities:Mortgage-backed:Freddie Mac


15,436


16,180


19,689


20,323Fannie Mae


50,951


54,003


58,771


61,299Ginnie Mae


23,192


23,516


27,015


26,868REMICS


5,175


5,346


5,438


5,405Total mortgage-backed securities


94,754


99,045


110,913


113,895Other:U.S. agency


28,450


28,707


7,944


8,393Municipal bonds


21,460


21,179


18,340


17,398Total other debt securities


49,910


49,886


26,284


25,791Total debt securities


144,664


148,931


137,197


139,686Total available-for-sale securities

$
181,446

$
185,780

$
173,403

$
175,708





Securities available for sale balances increased $10.1 million, or
5.7%, primarily due to purchases of agency and municipal securities totaling $20.6 million and $3.1 million, respectively, and a $2.0 million increase in the unrealized gain on available for sale securities. The Company purchased government agency
securities with original maturities of two to three years in anticipation of accelerated cash flows from the mortgage-backed securities porfolio. Management believes these securities will enhance net interest income as a result of positive interest
rate spreads, position the balance sheet for expected future rate increases and improve liquidity. These securities can also be used as collateral for certain borrowings. The Company also invested in additional municipal bonds to capitalize on
several positive features of these instruments including the favorable income tax treatment, attractive yields and spreads, call protection for six to ten years, significant insurance coverage and excellent credit ratings. The increase in the
unrealized gain on available for sale securities mainly reflects lower market interest rates. The investment purchases, and the increase in the unrealized gain on available for sale securities, were offset to some extent by mortgage-backed security
principal payments of $16.1 million.




9




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##### Table of Contents




Lending Activities





At June 30, 2002, the Companys gross loan portfolio was $475.9 million, or 67.0%, of total assets. The following table sets forth the composition of the
Companys loan portfolio in dollar amounts and as a percentage of the respective portfolio.





June 30, 2002


December 31, 2001Amount


Percent of Total


Amount


Percent of Total(Dollars In Thousands)Real estate loansOne- to four-family

$
267,571


56.23
%

$
245,990


55.62
%Multi-family


33,547


7.05
%


33,821


7.65
%Commercial


47,037


9.88
%


36,221


8.19
%Construction and development


18,558


3.90
%


16,145


3.65
%Total real estate loans


366,713


77.06
%


332,177


75.11
%Consumer loansHome equity loans


84,620


17.78
%


84,117


19.02
%Automobile


9,948


2.09
%


12,174


2.75
%Other


2,908


0.61
%


3,382


0.76
%Total consumer loans


97,476


20.48
%


99,673


22.53
%Commercial loans


11,690


2.46
%


10,447


2.36
%Total loans


475,879


100.00
%


442,297


100.00
%Less:Unadvanced loan funds(1)


(15,685
)





(13,070
)Deferred loan origination costs


794






883Allowance for loan losses


(3,015
)





(2,701
)Net loans

$
457,973





$
427,409


---

|(1) |  | Includes committed but unadvanced loan amounts.
|--- |  | -----------------------------------------------




Loan originations totaled $85.3 million for the first six months of 2002, contributing to growth in gross loans of $33.6 million, or 7.6%. The continued strength in the Companys level of loan
closings was due to several factors including promotional and sales activities, a strong housing market, a favorable interest rate environment and a stable local economy. Other factors affecting the Companys outstanding gross loan balances
were advances on commercial construction lines and prepayments and amortization of the existing portfolio.




10




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##### Table of Contents




Non-performing Assets





The following table sets forth information regarding nonaccrual loans, real estate owned and restructured loans.





June 30, 2002


December 31, 2001(Dollars in Thousands)Nonaccruing loans:Real estate:One- to four-family

$
1,052


$
243Commercial


106



Home equity loans






11Other consumer


4



290Commercial loans


12



12Total


1,174



556Other real estate owned, net(1)






Total non-performing assets


1,174



556Troubled debt restructurings






Troubled debt restructurings and total non-performing assets

$
1,174


$
556Total non-performing loans and troubled debt restructurings as a percentage of total loans(2)(3)


0.25
%


0.13
%Total non-performing assets and troubled debt restructurings as a percentage of total assets(3)


0.17
%


0.08
%


---

|(1) |  | Other real estate owned balances are shown net of related allowances.
|--- |  | ---------------------------------------------------------------------

|(2) |  | Total loans includes loans, less unadvanced loan funds, plus net deferred loan costs.
|--- |  | -------------------------------------------------------------------------------------

|(3) |  | Non-performing assets consist of nonperforming loans and other real estate owned, net. Non-performing loans consist of nonaccruing loans and all loans 90 days
or more past due and other loans which have been identified by the Company as presenting uncertainty with respect to the collectibility of interest or principal.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




The Company experienced an increase of $809,000 in one- to four- family residential real estate non-accrual loans during the six months ended June 30, 2002 from December
31, 2001 as several loans became past due for ninety days or more. These loans are fully secured by real estate. Other consumer non-accrual loans declined $286,000 to $4,000 at June 30, 2002, as the Company used the proceeds from the liquidation of
stock collateral to payoff in full two consumer non-accrual loans totaling $290,000.




11




---

##### Table of Contents




Allowance for Loan Losses





Management prepares a loan loss sufficiency analysis on a quarterly basis based upon the loan portfolio composition, asset classifications, loan-to-value ratios,
impairments in the loan portfolio, historical loan loss experience and other relevant factors. This analysis is compared to actual losses, peer group data and economic trends and conditions. The allowance for loan losses is maintained through the
provision for loan losses, which is charged to operations.





The allowance for loan losses is maintained at an
amount that management considers adequate to cover estimated losses in its loan portfolio based on managements on-going evaluation of the risks inherent in its loan portfolio, consideration of trends in delinquency and impaired loans,
charge-offs and recoveries, volume of loans, changes in risk selection, credit concentrations, national and regional economies and the real estate market in the Companys primary lending area. The Company believes that the current allowance for
loan losses accurately reflects the level of risk in the current loan portfolio. The Companys loan loss allowance determinations also incorporate factors and analyses which consider the principal loss associated with the loan. This evaluation
is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.





The Companys methodology for assessing the adequacy of the loan loss allowance consists of a review of the components, which includes a specific allowance for identified problem and impaired loans and a general
allowance for current performing loans. All loans are considered in the evaluation, whether on an individual or group basis. Changes in the balances of problem and impaired loans affect the specific reserve, while changes in volume and
concentrations of current performing loans affects the general reserve and the allocation of the allowance of the loan losses among loan types.





The specific allowance incorporates the results of measuring impairment for specifically identified non-homogenous problem loans in accordance with SFAS No. 114. In accordance with SFAS No. 114, the
specific allowance reduces the carrying amount of the impaired loans to their estimated fair value. A loan is recognized as impaired when, based on current information and events, it is probable that the Company will be unable to collect all
interest and principal payments due according to the contractual terms of the loan agreement. A loan is not deemed to be impaired if there is a short delay in receipt of payment or if, during a longer period of delay, the Company expects to collect
all amounts due including interest accrued at the contractual rate during the period of delay. Impairment can be measured based on present value of the expected future principal and interest cash flows discounted at the loans effective
interest rate or the Company may measure impairment based on a loans observable market price or the fair market value of the collateral, if the loan is collateral dependent. Larger groups of smaller-balance homogeneous loans that are
collectively evaluated for impairment, such as residential real estate mortgages, home equity loans and consumer and installment loans, are not included within the scope of SFAS No. 114.





The general allowance is calculated by applying reserve percentages to outstanding loans by type, excluding loans for which a specific allowance has been determined. As
part of this analysis, each quarter management prepares an allowance for loan losses summary worksheet in which the loan portfolio is categorized by risk characteristics such as loan type and loan grade. Changes in the mix of loans and the internal
loan grades affect the amount of the formula allowance. Reserve percentages are assigned to each category based on the Companys assessment of each categorys inherent risk. In determining the reserve percentages to apply to each loan
category, management considers historical losses, peer group comparisons, industry data and loss percentages used by banking regulators for similarly graded loans. Reserve percentages may be adjusted for qualitative factors that, in
managements judgement, affect the collectibility of the portfolio as of the evaluation date. Classified loan loss factors are derived from loss percentages utilized by banking regulators for similarly




12




---

##### Table of Contents

graded loans. Reserve percentages of 5%, 15% and 50% are applied to the outstanding balance of loans internally classified as special mention,
substandard and doubtful, respectively.





Performing loan loss reserve percentages are based on actual losses for
the previous three years adjusted for qualitative factors, such as new loan products, credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, loan volumes and concentrations
and specific industry conditions within portfolio segments that exist at the balance sheet date. The reserve percentages are applied to outstanding loans by loan type.





The Companys methodologies include several factors that are intended to reduce the difference between estimated and actual losses. The reserve percentages that are
used to establish the allowance for current performing loans are designed to be self-correcting by taking into account changes in loan classification, loan concentrations and loan volumes and by permitting adjustments based on managements
judgements of qualitative factors as of the evaluation date. Similarly, by basing the current performing loan reserve percentages on loss experience over the prior three years, the methodology is designed to take the Companys recent loss
experience into account.





The Companys allowance methodology has been applied on a consistent basis. Based
on this methodology, it believes that it has established and maintained the allowance for loan losses at adequate levels. However, future adjustments to the allowance for loan losses may be necessary if economic, real estate, loan growth and
portfolio diversification and other conditions differ substantially from the current operating environment, resulting in estimated and actual losses differing substantially.





The Company determines the classification of its assets and the amount of its valuation allowances. These determinations can be reviewed by the Federal Deposit Insurance
Corporation (FDIC) and the Commissioner of Banks for the Massachusetts Department of Banking, which can order the establishment of additional allocated or general loss allowances. The FDIC, in conjunction with the other federal banking
agencies, recently adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment
of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify,
monitor and address asset quality problems; that management has analyzed all significant factors that affect the collectibility of the portfolio in a reasonable manner; and that management has established acceptable allowance evaluation processes
that meet the objectives set forth in the policy statement. While the Company believes that it has established an adequate allowance for loan losses, there can be no assurance that regulators, in reviewing the Companys loan portfolio, will not
request the Company to materially increase its allowance for loan losses, thereby negatively affecting the Companys financial condition and earnings.




13




---

##### Table of Contents




The following table sets forth activity in the allowance for loan losses for the
periods set forth.





At or for the Six Months Ended
June 30,2002


2001(Dollars in Thousands)Allowance for loan losses, beginning of period

$
2,701


$
2,590Charged-off loans:Real estate






Consumer


60



52Total charged-off loans


60



52Recoveries on loans previously charged-off:Real estate


7



9Commercial


3



Consumer


12



14Total recoveries


22



23Net loans charged-off


38



29Provision for loan losses


352



85Allowance for loan losses, end of period

$
3,015


$
2,646Net loans charged-off to average interest-earning loans


0.02
%


0.01
%Allowance for loan losses to total loans(1)


0.65
%


0.64
%Allowance for loan losses to non-performing loans and troubled debt restructurings(2)


256.81
%


1242.25
%Net loans charged-off to allowance for loan losses


2.52
%


2.19
%Recoveries to charge-offs


36.67
%


44.23
%


---

|(1) |  | Total loans includes loans, less unadvanced loan funds, plus deferred loan costs (fees), net.
|--- |  | ---------------------------------------------------------------------------------------------

|(2) |  | Nonperforming loans consist of nonaccruing loans and all loans 90 days or more past due and other loans which have been identified by the Company as presenting
uncertainty with respect to the collectibility of interest or principal.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14




---

##### Table of Contents




Deposits





The following table sets forth the distribution of deposit accounts for the periods indicated.





June 30, 2002


December 31, 2001Balance

Percent of Total Deposits


Balance

Percent of Total Deposits(Dollars In Thousands)Demand deposits

$
22,821

5.97
%

$
20,077

5.97
%Savings


78,572

20.56
%


71,490

21.27
%Money market


39,938

10.45
%


34,289

10.20
%NOW


65,677

17.18
%


63,426

18.87
%Brokered deposits


52,603

13.76
%


29,630

8.82
%Certificates of deposit


122,620

32.08
%


117,148

34.87
%Total deposits

$
382,231

100.00
%

$
336,060

100.00
%





Core deposits, which excludes brokered deposits and certificates of
deposit, increased $17.7 million, or 9.4%, to $207.0 million at June 30, 2002 from $189.3 million at December 31, 2001. The strong growth in core deposit balances reflects aggressive marketing efforts. Brokered deposits grew $23.0 million to $52.6
million at June 30, 2002 resulting from the issuance of new certificates of deposit. The Company utilizes brokered certificates of deposit to support asset growth when such instruments bear an attractive rate as compared to alternative funding
sources.




15




---

##### Table of Contents




Comparison of Operating Results for the Three Months Ended June 30, 2002 and 2001





General





The Company reported net income of $1.5 million, or $0.40 per diluted share, for the quarter ended June 30, 2002 compared to net income of $807,000, or $0.22 per diluted share, for the same period in
2001. The results for the second quarter of 2002 include the impact of a $644,000 gain from the termination of the Companys defined benefit pension plan, write-downs of certain equity securities totaling $171,000 and the related net tax
expense of $163,000. During the second quarter of 2001, the Company recognized a loss of $311,000 from the application of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and an associated tax benefit of
$108,000. Excluding these items, operating earnings increased $147,000, or 14.6%, to $1.2 million for the second quarter of 2002 compared to $1.0 million for the same period last year. Diluted operating earnings per share grew 19.0% to $0.32 for the
three months ended June 30, 2002 from $0.27 for the second quarter of 2001. The most significant factors influencing operating earnings in the second quarter of 2002 were growth in average interest-earning assets and core deposits, net interest
margin expansion and higher other expenses and provisions for loan losses.





Analysis of Net Interest Income





Net interest income represents the difference between income on interest-earning assets and expense on
interest-bearing liabilities. Net interest income depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.





The following table sets forth, for the periods indicated, average balances, interest income and expense and yields earned or rates paid on the major categories of assets
and liabilities. The average yields and costs are derived by dividing interest income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. The yields and costs are
annualized. Average balances are derived from average daily balances. The yields and costs include fees which are considered adjustments to yields. Loan interest and yield data does not include any accrued interest from nonaccruing loans.




16




---

##### Table of Contents




For the Three Months Ended June 30,2002


2001Average Balance

Interest


Average Yield/ Rate


Average Balance

Interest

Average Yield/ Rate(Dollars in Thousands)Interest-earning assets:(1)Investments:Mortgage-backed securities

$
102,301

$
1,676


6.55
%

$
136,601

$
2,226

6.52
%U.S. Government and agency securities


28,400


301


4.24
%







Equity securities


50,858


791


6.22
%


49,235


825

6.70
%State and municipal securities(2)


20,769


379


7.30
%





Loans:(3)Residential real estate loans


289,452


4,797


6.63
%


256,991


4,672

7.27
%Commercial real estate loans


51,839


1,034


7.98
%


32,456


739

9.11
%Consumer loans


96,520


1,478


6.14
%


99,057


1,844

7.47
%Commercial loans


11,040


187


6.70
%


6,132


117

7.55
%Loans, net


448,851


7,496


6.68
%


394,636


7,372

7.47
%Other


11,903


42


1.40
%


9,906


90

3.59
%Total interest-earning assets


663,082


10,685


6.45
%


590,378


10,513

7.12
%Noninterest-earning assets


38,845









38,507Total assets

$
701,927








$
628,885Interest-bearing liabilities:Deposits:Money market accounts

$
38,910

$
208


2.14
%

$
28,905

$
207

2.87
%Savings accounts(4)


78,097


281


1.44
%


70,066


331

1.89
%NOW accounts


65,090


189


1.16
%


58,393


257

1.77
%Certificates of deposit(5)


175,080


1,561


3.58
%


161,074


2,014

5.02
%Total interest-bearing deposits


357,177


2,239


2.51
%


318,438


2,809

3.54
%Borrowings


246,591


3,107


4.98
%


217,280


2,990

5.44
%Total interest-bearing liabilities


603,768


5,346


3.55
%


535,718


5,799

4.34
%Demand deposits


21,665









18,226Other noninterest-bearing liabilities


4,199









4,412Total liabilities


629,632









558,356Total stockholders equity


72,295









70,529Total liabilities and stockholders equity

$
701,927








$
628,885Net interest-earning assets

$
59,314








$
54,660Tax equivalent net interest income/interest rate spread(6)





5,339


2.90
%





4,714

2.78
%Tax equivalent net interest margin as a percentage of interest-earning assets(7)








3.22
%







3.19
%Ratio of interest-earning assets to interest-bearing liabilities








109.82
%







110.20
%Less: tax equivalent adjustment(2)





(129
)








Net interest income as reported on income statement




$
5,210








$
4,714


---

|(1) |  | Includes related assets available-for-sale and unamortized discounts and premiums.
|--- |  | ----------------------------------------------------------------------------------

|(2) |  | State and municipal securities income and net interest income are presented on a tax equivalent basis using a tax rate of 34%. The tax equivalent adjustment is
deducted from tax equivalent net interest income to agree to the amount reported in the income statement.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Amount is net of deferred loan origination fees, unadvanced loan funds, allowance for loan losses and includes nonaccrual loans. The Company records interest
income on nonaccruing loans on a cash basis.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Savings accounts include mortgagors escrow deposits.
|--- |  | -----------------------------------------------------

|(5) |  | Certificates of deposit include brokered deposits.
|--- |  | --------------------------------------------------

|(6) |  | Tax equivalent net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) |  | Tax equivalent net interest margin represents tax equivalent net interest income divided by average interest-earning assets.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------



17




---

##### Table of Contents




The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Companys interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i)
changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined
impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.





Three Months Ended June 30, 2002 compared to 2001Increase (Decrease) Due
toVolume


Rate


NetInterest-earning assets:Mortgage-backed securities

$
(562
)

$
12


$
(550
)U.S. Government and agency securities


301







301Equity securities


26



(60
)


(34
)State and municipal securities(1)


379







379Loans:Residential real estate loans


559



(434
)


125Commercial real estate loans


396



(101
)


295Consumer loans


(46
)


(320
)


(366
)Commercial loans


84



(14
)


70Total loans


993



(869
)


124Other


15



(63
)


(48
)Total interest-earning assets

$
1,152


$
(980
)

$
172Interest-bearing liabilities:Deposits:Money market accounts

$
61


$
(60
)

$
1Savings accounts(2)


35



(85
)


(50
)NOW accounts


27



(95
)


(68
)Certificates of deposit(3)


163



(616
)


(453
)Total deposits


286



(856
)


(570
)Borrowings


382



(265
)


117Total interest-bearing liabilities


668



(1,121
)


(453
)Increase in net interest income(4)

$
484


$
141


$
625


---

|(1) |  | The changes in state and municipal income are reflected on a tax equivalent basis.
|--- |  | ----------------------------------------------------------------------------------

|(2) |  | Includes interest on mortgagors escrow deposits.
|--- |  | -------------------------------------------------

|(3) |  | Includes interest on brokered certificates of deposit.
|--- |  | ------------------------------------------------------

|(4) |  | The changes in net interest income are reflected on a tax equivalent basis and thus do not correspond to the income statement.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------



18




---

##### Table of Contents




Net interest income, on a tax equivalent basis, totaled $5.3 million for the
three months ended June 30, 2002, an increase of $625,000, or 13.3%, compared to $4.7 million for the same period in 2001, mainly driven by growth in average interest-earning assets and, to a lesser extent, improvement in the net interest margin.
Net interest margin, on a tax equivalent basis, expanded by 3 basis points to 3.22% for the second quarter of 2002 from the same period in 2001 resulting from the lower cost of funding interest-bearing liabilities and an increase in total average
lower-cost core deposits. These factors were offset by higher average borrowings to fund balance sheet growth and reduced yields on interest-earning assets.





Interest and dividend income, on a tax equivalent basis, rose $172,000, or 1.6%, to $10.7 million for the three months ended June 30, 2002 compared to the same period last year, mainly reflecting
growth in average interest-earning assets partially offset by a decrease in the yield on interest-earning assets. Average interest-earning assets totaled $663.1 million for the second quarter of 2002 compared to $590.4 million for the same period
last year, an increase of $72.7 million, or 12.3%. Average loans increased $54.2 million, or 13.7%, primarily due to strong loan origination and refinancing activity, somewhat mitigated by amortization and prepayments of the existing portfolio. The
increase in the average balances of agency and municipal securities totaling $49.2 million reflects purchases in the fourth quarter of 2001 and first quarter of 2002. Average mortgage-backed securities fell $34.3 million to $102.3 million for the
second quarter of 2002, primarily reflecting normal amortization and prepayments. The yield on interest-earning assets declined 67 basis points to 6.45% in the three months ended June 30, 2002, mainly as a result of the lower interest rate
environment which led to reduced yields on new assets as well as the repricing of a portion of the Companys existing assets.





Total interest expense declined $453,000, or 7.8%, to $5.3 million for the three months ended June 30, 2002 from the same period in 2001, resulting primarily from lower rates paid on interest-bearing liabilities, partially
offset by growth in average interest-bearing liabilities to fund balance sheet growth and share repurchases. Rates paid on interest-bearing liabilities fell 79 basis points to 3.55% for the second quarter of 2002, largely reflecting a significant
reduction in market interest rates. The lower interest rate environment led to a decrease in rates paid for new deposits and borrowings and the repricing of a portion of the Companys outstanding deposits and FHLB advances. Average
interest-bearing liabilities rose $68.1 million, or 12.7% to $603.8 million for the three months ended June 30, 2002 from $535.7 million for the same period in 2001 reflecting strong growth in core deposits, the issuance of brokered certificates of
deposits and increased dependence on FHLB advances.





Provision for Loan Losses





The provision for loan losses was $243,000 for the second quarter of 2002 compared to $85,000 for the same period in 2001.
Several factors contributed to this increase including stronger loan growth, changes to loan concentrations including increases in commercial and commercial mortgage loans and the reclassification of several loans to lower credit grades due to
delinquency.





The allowance for loan losses is maintained through provisions for loan losses. Management of the
Company assesses the adequacy of the allowance for loan losses based on known and inherent risks in the loan portfolio and upon managements continuing analysis of the factors underlying the quality of the loan portfolio. While management
believes that, based on information currently available, the Companys allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Companys level of allowance
for loan losses will be sufficient to cover loan losses inherent in the portfolio or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other
conditions used by management to determine the current level of the allowance for loan losses. Management may, in the future, increase its level of allowance for loan losses as a percentage of total loans and non-performing loans in the event it
increases the level of commercial real




19




---

##### Table of Contents

estate, multi-family, commercial, construction and development or consumer lending as a percentage of its total loan portfolio. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Companys allowance for loan losses. Such agencies may require the Company to provide additions to the allowance based upon judgments different from management.





Other Income





Excluding the effect of the write-downs of equity securities totaling $171,000 in the second quarter of 2002 and the FAS 133 loss of $311,000 recognized during the three months ended June 30, 2001, total other income
declined $80,000, or 8.0%, to $922,000 for the three months ended June 30, 2002 from $1.0 million in the second quarter of 2001. The reduction in other income was primarily due to lower gains on sales of securities and covered call option income.





Other Expenses





Excluding the $644,000 pension termination gain, other expenses increased $165,000, or 4.0%, to $4.3 million for the second quarter of 2002, compared to $4.1 million for
the 2001 period, mainly due to higher salary and benefit expenses, partially offset by lower marketing, professional services and other expenses. Total salary and benefits, exclusive of the $644,000 pension termination gain, grew $355,000, or 17.0%,
to $2.4 million for the second quarter of 2002 reflecting costs associated with increased staffing levels as a result of the acquisition of Keyes & Mattson Insurance Agency in November 2001, new employees hired to support the general growth of
the Company, higher employee stock ownership plan expenses related to an increase in the Companys average share price and standard wage increases. Marketing expenses fell $91,000 to $132,000 for the second quarter of 2002 as a result of
promotional activities during 2001 in connection with the opening of a new branch and the relocation of an existing facility. Professional services expenses declined $70,000, or 25.9%, reflecting costs incurred in 2001 in connection with insurance
acquisition activities as well as lower annual meeting and annual report expenses. Other expenses decreased $67,000, or 8.9%, mainly due to lower investor-related expenses, declining servicing expenses associated with the purchased loan portfolio as
a result of significant payoffs and the elimination of goodwill expense in 2002 as a result of the Companys adoption of SFAS No. 142 effective January 1, 2002.





Income Taxes





The
Companys income tax expense includes the effect of the 2002 net tax expense of $163,000 associated with the $644,000 pension termination gain and write-downs of securities totaling $171,000 and the benefit of $108,000 associated with the SFAS
No. 133 loss in 2001. Excluding these items, income tax expense decreased $54,000, or 10.1%, to $481,000 for the second quarter of 2002 compared to the same period in 2001. The decrease in income taxes was primarily attributable to a reduced
effective tax rate, partially offset by an increase in income before taxes. The Companys effective tax rate fell to 29.4% for the second quarter of 2002 from 34.6% in 2001 primarily as a result of the purchase of municipal securities, which
are exempt from federal taxes.




20




---

##### Table of Contents




Comparison of Operating Results for the Six Months Ended June 30, 2002 and 2001





General





For the six months ended June 30, 2002, the Company reported net income of $2.5 million, or $0.70 per diluted share, compared to net income of $1.7 million, or $0.45 per diluted share, for the same
period in 2001. Excluding the $644,000 pension termination gain, the write-downs of equity securities totaling $171,000 and the related net tax expense of $163,000, operating earnings for the first six months of 2002 were $2.2 million, or $0.62 per
diluted share. Excluding the SFAS No. 133 loss of $311,000 and the associated tax benefit of $108,000, the Companys operating earnings for the six months ended June 30, 2001 were $1.9 million, or $0.51 per diluted share. Several positive
factors contributed to the improvement of 16.0% in operating earnings and 21.6% in diluted operating earnings per share in the first six months of 2002, including lower rates paid on deposits and FHLB advances and growth in average earning assets
and core deposits.





Analysis of Net Interest Income





Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net
interest income depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.





The following table sets forth, for the periods indicated, average balances, interest income and expense and yields earned or rates paid on the major categories of assets and liabilities. The average
yields and costs are derived by dividing interest income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. The yields and costs are annualized. Average balances are
derived from average daily balances. The yields and costs include fees which are considered adjustments to yields. Loan interest and yield data does not include any accrued interest from nonaccruing loans.




21




---

##### Table of Contents




For the Six Months Ended June 30,2002


2001Average Balance

Interest


Average Yield/ Rate


Average Balance

Interest

Average Yield/ Rate(Dollars in Thousands)Interest-earning assets:(1)Investments:Mortgage-backed securities

$
105,942

$
3,433


6.48
%

$
139,732

$
4,645

6.65
%U.S. Government and agency securities


24,452


482


3.94
%







Equity securities


50,550


1,508


5.97
%


48,462


1,645

6.79
%State and municipal securities(2)


20,292


738


7.27
%





Loans:(3)Residential real estate loans


284,971


9,590


6.73
%


255,171


9,394

7.36
%Commercial real estate loans


47,481


1,824


7.68
%


32,576


1,411

8.66
%Consumer loans


96,878


2,964


6.17
%


99,105


3,774

7.68
%Commercial loans


10,809


372


6.85
%


5,674


234

8.20
%Loans, net


440,139


14,750


6.70
%


392,526


14,813

7.55
%Other


11,170


88


1.57
%


15,936


370

4.62
%Total interest-earning assets


652,545


20,999


6.44
%


596,656


21,473

7.20
%Noninterest-earning assets


38,882









36,083Total assets

$
691,427








$
632,739Interest-bearing liabilities:Deposits:Money market accounts

$
37,493

$
404


2.17
%

$
27,819

$
413

2.99
%Savings accounts(4)


76,201


551


1.46
%


68,582


645

1.90
%NOW accounts


63,807


373


1.18
%


53,920


473

1.77
%Certificates of deposit(5)


164,986


2,924


3.57
%


162,691


4,248

5.27
%Total interest-bearing deposits


342,487


4,252


2.50
%


313,012


5,779

3.72
%Borrowings


252,302


6,227


4.91
%


227,094


6,565

5.75
%Total interest-bearing liabilities


594,789


10,479


3.55
%


540,106


12,344

4.61
%Demand deposits


20,423









17,288Other noninterest-bearing liabilities


4,687









4,016Total liabilities


619,899









561,410Total stockholders equity


71,528









71,329Total liabilities and stockholders equity

$
691,427








$
632,739Net interest-earning assets

$
57,756








$
56,550Tax equivalent net interest income/interest rate spread(6)





10,520


2.89
%





9,129

2.59
%Tax equivalent net interest margin as a percentage of interest-earning assets(7)








3.22
%







3.06
%Ratio of interest earning assets to interest-bearing liabilities








109.71
%







110.47
%Less: tax equivalent adjustment(2)





(251
)








Net interest income as reported on income statement




$
10,269








$
9,129


---

|(1) |  | Includes related assets available-for-sale and unamortized discounts and premiums.
|--- |  | ----------------------------------------------------------------------------------

|(2) |  | State and municipal securities income and net interest income are presented on a tax equivalent basis using a tax rate of 34%. The tax equivalent adjustment is
deducted from tax equivalent net interest income to agree to the amount reported in the income statement.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Amount is net of deferred loan origination fees, unadvanced loan funds, allowance for loan losses and includes nonaccrual loans. The Company records interest
income on nonaccruing loans on a cash basis.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Savings accounts include mortgagors escrow deposits.
|--- |  | -----------------------------------------------------

|(5) |  | Certificates of deposit include brokered deposits.
|--- |  | --------------------------------------------------

|(6) |  | Tax equivalent net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) |  | Tax equivalent net interest margin represents tax equivalent net interest income divided by average interest-earning assets.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------



22




---

##### Table of Contents




The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Companys interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i)
changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined
impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.





Six Months Ended June 30, 2002 compared to 2001Increase (Decrease) Due
toVolume


Rate


NetInterest-earning assets:Mortgage-backed securities

$
(1,098
)

$
(114
)

$
(1,212
)U.S. Government and agency securities


482







482Equity securities


69



(206
)


(137
)State and municipal securities(1)


738







738Loans:Residential real estate loans


1,043



(847
)


196Commercial real estate loans


587



(174
)


413Consumer loans


(83
)


(727
)


(810
)Commercial loans


182



(44
)


138Total loans


1,729



(1,792
)


(63
)Other


(88
)


(194
)


(282
)Total interest-earning assets

$
1,832


$
(2,306
)

$
(474
)Interest-bearing liabilities:Deposits:Money market accounts

$
122


$
(131
)

$
(9
)Savings accounts(2)


66



(160
)


(94
)NOW accounts


77



(177
)


(100
)Certificates of deposit(3)


59



(1,383
)


(1,324
)Total deposits


324



(1,851
)


(1,527
)Borrowings


683



(1,021
)


(338
)Total interest-bearing liabilities


1,007



(2,872
)


(1,865
)Increase in net interest income(4)

$
825


$
566


$
1,391


---

|(1) |  | The changes in state and municipal income are reflected on a tax equivalent basis.
|--- |  | ----------------------------------------------------------------------------------

|(2) |  | Includes interest on mortgagors escrow deposits.
|--- |  | -------------------------------------------------

|(3) |  | Includes interest on brokered certificates of deposit.
|--- |  | ------------------------------------------------------

|(4) |  | The changes in net interest income are reflected on a tax equivalent basis and thus do not correspond to the income statement.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------



23




---

##### Table of Contents




Net interest income, on a tax equivalent basis, totaled $10.5 million for the six
months ended June 30, 2002, an increase of $1.4 million, or 15.2%, compared to $9.1 million for the same period in 2001, mainly driven by net interest margin expansion and growth in average interest-earning assets. Net interest margin, on a tax
equivalent basis, improved by 16 basis points to 3.22% for the first six months of 2002 from the same period in 2001, reflecting lower funding costs and an increase in average lower-cost core deposits. These factors were offset to some extent by
higher average borrowings to fund balance sheet growth and reduced yields on interest-earning assets.





Interest
and dividend income, on a tax equivalent basis, declined $474,000, or 2.2%, to $21.0 million for the six months ended June 30, 2002, compared to the same period last year mainly reflecting a decrease in the yield on interest-earning assets partially
offset by growth in average interest-earning assets. The yield on interest-earning assets declined 76 basis points to 6.44% in the six months ended June 30, 2002, mainly as a result of the lower interest rate environment which led to reduced yields
on new assets, as well as the repricing of a portion of the Companys existing assets. Average interest-earning assets totaled $652.5 million for the first six months of 2002 compared to $596.7 million for the same period last year,
representing an increase of $55.8 million, or 9.4%. Average loans increased $47.6 million, or 12.1%, primarily due to strong loan origination and refinancing volumes partially offset by amortization and prepayments of the existing portfolio. The
increase in the average balances of agency and municipal securities totaling $44.7 million reflects purchases in the fourth quarter of 2001 and the first quarter of 2002. Average mortgage-backed securities fell $33.8 million to $105.9 million for
the second quarter of 2002 primarily reflecting normal amortization and prepayments.





Total interest expense
declined $1.9 million, or 15.1%, to $10.5 million for the six months ended June 30, 2002 from $12.3 million for the same period in 2001 resulting primarily from lower rates paid on interest-bearing liabilities, partially offset by growth in average
interest-bearing liabilities to fund balance sheet growth and share repurchases. Rates paid on interest-bearing liabilities fell 1.06% to 3.55% for the first six months of 2002, largely reflecting a significant reduction in market interest rates and
growth in lower-cost core deposits. The lower interest rate environment led to a decrease in rates paid for new deposits and borrowings and the repricing of a portion of the Companys outstanding deposits and FHLB advances. Average
interest-bearing liabilities rose $54.7 million, or 10.1% to $594.8 million for the six months ended June 30, 2002 from $540.1 million for the same period in 2001 reflecting strong growth in core deposits and increased dependence on FHLB advances.





Provision for Loan Losses





The Companys provision for loan losses increased $267,000 to $352,000 for the six months ended June 30, 2002 from $85,000 for the same period in 2001. This increase
was due to several factors including stronger loan growth, changes to loan concentrations including increases in commercial and commercial mortgage loans and the reclassification of several loans to lower credit grades due to delinquency.





The allowance for loan losses is maintained through provisions for loan losses. Management of the Company
assesses the adequacy of the allowance for loan losses based on known and inherent risks in the loan portfolio and upon managements continuing analysis of the factors underlying the quality of the loan portfolio. While management believes
that, based on information currently available, the Companys allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Companys level of allowance for loan
losses will be sufficient to cover loan losses inherent in the portfolio or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions
used by management to determine the current level of the allowance for loan losses. Management may in the future increase its level of allowance for loan losses as a percentage of total loans and non-performing loans in the event it increases the
level of commercial real




24




---

##### Table of Contents

estate, multi-family, commercial, construction and development or consumer lending as a percentage of its total loan portfolio. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Companys allowance for loan losses. Such agencies may require the Company to provide additions to the allowance based upon judgments different from management.





Other Income





Excluding the effect of the equity securities write-downs totaling $171,000 in the second quarter of 2002, total other income declined $64,000, or 3.4%, to $1.8 million for the six months ended June 30, 2002 from $1.9
million for the same period in 2001. The reduction in other income was primarily due to lower gains on sales of securities and loans and reduced covered call option income.





Other Expenses





Excluding the $644,000 pension termination gain, other expenses increased $597,000, or 7.5%, to $8.6 million for the first six months of 2002 compared to $8.0 million for the 2001 period, mainly due to higher salary and benefit
expenses, partially offset by lower marketing, professional services and other expenses. Total salary and benefits, exclusive of the $644,000 pension termination gain, grew $779,000, or 19.0%, to $4.9 million for the six months ended June 30, 2002,
reflecting costs associated with increased staffing levels as a result of the acquisition of Keyes & Mattson Insurance Agency in November 2001, new employees hired to support the general growth of the Company, higher employee stock ownership
plan expenses related to an increase in the Companys average share price and standard wage increases. Marketing expenses fell $73,000, or 19.6%, to $300,000 for the first six months of 2002 as a result of promotional activities during 2001 in
connection with the opening of a new branch and the relocation of an existing facility. Professional services expenses declined $75,000, or 14.8%, reflecting costs incurred in 2001 in connection with insurance acquisition activities as well as lower
annual meeting and annual report expenses. Other expenses decreased $75,000, or 5.1%, mainly due to lower investor-related expenses, declining servicing expenses associated with the purchased loan portfolio as a result of significant payoffs and the
elimination of goodwill expense in 2002 as a result of the Companys adoption of SFAS No. 142, effective January 1, 2002.





Income Taxes





Excluding the effect of the 2002 net tax expense of $163,000
associated with the $644,000 pension termination gain and write-downs of securities totaling $171,000, income tax expense decreased $138,000, or 13.2%, to $907,000 for the six months ended June 30, 2002 compared to the same period in 2001. The
decrease in income taxes was primarily attributable to a reduced effective tax rate, partially offset by an increase in income before taxes. The Companys effective tax rate fell to 29.6% for the six months ended June 30, 2002 from 35.7% in
2001, primarily as a result of the purchase of municipal securities, which are exempt from federal taxes.





Liquidity





Liquidity and funding strategies are the responsibility of the Asset/Liability Management Committee (the ALCO). The
ALCO is responsible for establishing liquidity targets and implementing strategies to meet desired goals. Liquidity is measured by the Banks ability to raise cash within 30 days at a reasonable cost and with a minimum of loss. The Banks
primary sources of funds are deposits, principal and interest payments on loans and investment securities and borrowings from the FHLB-Boston. While maturities and scheduled amortization of loans and securities are predictable sources of funds,
deposit outflows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.





The primary investing activities of the Bank are the origination of loans, primarily residential one-to four-family mortgage loans and consumer loans, mainly home equity loans and lines of credit, and, to a lesser extent,
multi-family and commercial real estate loans, construction and development loans, commercial




25




---

##### Table of Contents

business loans, and other types of consumer loans, as well as the purchase of mortgage-backed, agency, municipal and equity securities. During the six months ended June 30, 2002, the Banks
loan originations totaled $85.3 million. At June 30, 2002, the Banks investments in debt and equity securities totaled $185.8 million. During the six months ended June 30, 2002, total deposits increased $46.1 million, including the issuance of
$22.6 of brokered certificates of deposit. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by the Bank and its local competitors and other factors. The Bank closely monitors its liquidity
position on a daily basis. If the Bank requires funds beyond its ability to generate them internally, additional sources of funds are available through FHLB advances. At June 30, 2002, the Bank had $248.9 million of FHLB borrowings.





Outstanding loan commitments totaled $25.9 million at June 30, 2002. Management of the Bank anticipates that it will have
sufficient funds available to meet its current loan commitments. Certificates of deposit, which are scheduled to mature in one year or less from June 30, 2002, totaled $98.6 million. The Bank relies primarily on competitive rates, customer service,
and long-standing relationships with customers to retain deposits. From time to time, the Bank will also offer competitive special products to its customers to increase retention and to attract new deposits. Based upon the Banks experience
with deposit retention and current retention strategies, management believes that, although it is not possible to predict future terms and conditions upon renewal, a significant portion of such deposits will remain with the Bank.





The primary sources of funding for Woronoco Bancorp (the Corporation), the holding company for Woronoco Savings
Bank (the Bank), are dividend payments from the Bank, and, to a lesser extent, earnings on deposits of the Corporation. Dividend payments by the Bank have primarily been used to pay dividends and fund stock repurchase programs. The
Banks ability to pay dividends and other capital distributions to the Corporation is generally limited by the Massachusetts banking regulations and regulations of the Federal Deposit Insurance Corporation. Additionally, the Massachusetts
Banking Commissioner and Federal Deposit Insurance Corporation may prohibit the payment of dividends, which are otherwise permissible by regulation for safety and soundness reasons.





Regulatory Capital





The Bank is subject to various
regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Companys consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Banks assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.





Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk weighted assets and to average assets. Management believes, as of June 30, 2002, that the Bank met all capital
adequacy requirements to which it was subject. As of June 30, 2002, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To
be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes
have changed the Banks category.





The Companys and Banks actual capital amounts and ratios as of
June 30, 2002 and December 31, 2001 are also presented in the table.




26




---

##### Table of Contents




Actual


Minimum for Capital Adequacy Purposes


Minimum to be Well Capitalized Under Prompt Corrective Action ProvisionsAmount

Ratio


Amount

Ratio


Amount

Ratio(In Thousands)As of June 30, 2002:Total Capital to Risk Weighted AssetsCompany

$
70,747

15.5
%


N/A

N/A



N/A

N/ABank

$
58,873

13.0
%

$
36,342

8.0
%

$
45,427

10.0
%Tier 1 Capital to Risk Weighted AssetsCompany

$
67,732

14.9
%


N/A

N/A



N/A

N/ABank

$
55,858

12.3
%

$
18,171

4.0
%

$
27,256

6.0
%Tier 1 Capital to Average AssetsCompany

$
67,732

9.7
%


N/A

N/A



N/A

N/ABank

$
55,858

8.0
%

$
27,803

4.0
%

$
34,754

5.0
%As of December 31, 2001:Total Capital to Risk Weighted AssetsCompany

$
68,973

15.4
%


N/A

N/A



N/A

N/ABank

$
57,930

13.0
%

$
35,779

8.0
%

$
44,724

10.0
%Tier 1 Capital to Risk Weighted AssetsCompany

$
66,272

14.8
%


N/A

N/A



N/A

N/ABank

$
55,229

12.3
%

$
17,890

4.0
%

$
26,835

6.0
%Tier 1 Capital to Average AssetsCompany

$
66,272

10.2
%


N/A

N/A



N/A

N/ABank

$
55,229

8.5
%

$
26,016

4.0
%

$
32,520

5.0
%




27




---

##### Table of Contents




Item 3.    
Quantitative and Qualitative Disclosures About Market Risk





Information regarding
quantitative and qualitative disclosure about market risk is presented in the Securities and Exchange Commission Form 10-K filed by the Company for the year ended December 31, 2001. There have been no material changes in the Companys market
risk since December 31, 2001.







28




---

##### Table of Contents




PART II.    OTHER INFORMATION





Item 1.Legal Proceedings.





The Company is not involved in any pending legal
proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the financial condition and results of operations of the
Company.





Item 2.Changes in Securities and Use of Proceeds.





None.





Item 3.Defaults Upon Senior Securities.





None.





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





a.  An
annual meeting of shareholders of the Company was held on April 26, 2002 (the Annual Meeting).





b.  Not applicable.





c.  The items voted upon at the Annual Meeting and the
vote for each proposal were as follows:





1.  Election of directors for a three-year
term.





Director Nominees Elected For Three Year Term:

For

WithheldWilliam G. Aiken

2,866,200

66,833Joseph M. Houser, Jr.

2,865,908

67,125Norman H. Storey

2,852,854

80,179





2.  The ratification of the appointment
of Wolf & Company, P.C. as independent auditors of Woronoco Bancorp, Inc. for the fiscal year ending December 31, 2002.





For

Against

Abstain2,891,255

41,160

618





Item 5.Other Information.





None.




29




---

##### Table of Contents




Item 6.Exhibits and Reports on Form 8-K (§249.308 of this Chapter).





(a)Exhibits





3.1

Certificate of Incorporation of Woronoco Bancorp, Inc.(1)3.2

Amended Bylaws of Woronoco Bancorp, Inc.(2)4.0

Stock Certificate of Woronoco Bancorp, Inc.(1)10.1

Supplemental Retirement Plan Agreement between Woronoco Savings Bank and Cornelius D. Mahoney10.2

Supplemental Retirement Plan Agreement between Woronoco Savings Bank and Agostino J. Calheno10.3

Supplemental Retirement Plan Agreement between Woronoco Savings Bank and Debra L. Murphy10.4

Woronoco Savings Bank Directors Retirement Plan11.0

Statement Re: Computation of Per Share Earnings (Incorporated Herein By Reference to Part 1Earnings Per
Share)99.0

Certifications pursuant to 18 U.S.C. Section 1350


---

|(1) |  | Incorporated by reference into this document from the Exhibits filed with the Registration Statement on Form S-1, and any amendments thereto, Registration No.
333-67255.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Incorporated by reference into this document from the Exhibit filed with the Companys Form 10-Q on November 14, 2001.
|--- |  | ----------------------------------------------------------------------------------------------------------------------




(b)  Reports on Form 8-K





None




30




---

##### Table of Contents




SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.





Woronoco Bancorp, Inc.Dated: August 14, 2002



By:

/s/    CORNELIUS D. MAHONEYCornelius D. Mahoney Chairman
of the Board, President and Chief Executive Officer (principal executive officer)








Dated: August 14, 2002



By:

/s/    DEBRA L. MURPHYDebra L. Murphy Executive Vice
President andChief Financial Officer (principal financial and accounting officer)




31