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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-KSB



(Mark One)



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



For the Fiscal Year Ended June 30, 2003



| ̈ |  | 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: 0-23945



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SERVICE BANCORP, INC.

(Name of Small Business Issuer in its Charter)



|Massachusetts                                                 |  | 04-3430806                         
|------------------------------------------------------------- |  | -----------------------------------
|(State or Other Jurisdiction ofIncorporation or Organization) |  | (I.R.S. EmployerIdentification No.)
|                                                              | 
|81 Main Street, Medway, Massachusetts                         |  | 02053                              
|(Address of Principal Executive Office)                       |  | (Zip Code)                         



1-800-339-4346

(Issuers Telephone Number, Including Area Code)



Securities Registered Pursuant to Section 12(b) of the Exchange Act:



None



Securities Registered Pursuant to Section 12(g) of the Exchange Act:



Common Stock, par value $0.01 per share

(Title of Class)



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Check whether the issuer (1) filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 ̈



Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any
amendments to this Form 10-KSB. ̈



The Issuers revenues for the fiscal year ended June 30, 2003 were $16.9 million.



The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the issuer, computed by reference to the price at which the common equity was sold as of September 9, 2003 ($22.05) was $13,584,013. The exclusion from such amount of the market value of the shares owned by any person shall not be
deemed an admission by the issuer that such person is an affiliate of the issuer pursuant to Rule 12b-2 of the Exchange Act. As of September 9, 2003, there were issued and outstanding 1,647,284 shares of the Registrants Common Stock, par value
$0.01 per share.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the Proxy Statement for the 2003 Annual
Meeting of Stockholders to be held on October 28, 2003 are incorporated by reference into Part III.



Transitional Small Business Disclosure Format    YES ̈NO    x



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TABLE OF CONTENTS



|           |  |                                                                                               
|---------- |  | ----------------------------------------------------------------------------------------------
|           |  | P A R T    I                                                                                  
|           |  |                                                                                               
|Item 1     |  | Description of Business                                                                       
|           |  |                                                                                               
|Item 2     |  | Description of Property                                                                       
|           |  |                                                                                               
|Item 3     |  | Legal Proceedings                                                                             
|           |  |                                                                                               
|Item 4     |  | Submission of Matters to a Vote of Security Holders                                           
|           |  |                                                                                               
|           |  | P A R T    II                                                                                 
|           |  |                                                                                               
|Item 5     |  | Market for Common Equity and Related Stockholder Matters                                      
|           |  |                                                                                               
|Item 6     |  | Managements Discussion and Analysis or Plan of Operation                                     
|           |  |                                                                                               
|Item 7     |  | Financial Statements                                                                          
|           |  |                                                                                               
|Item 8     |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure          
|           |  |                                                                                               
|Item 8A    |  | Controls and Procedures                                                                       
|           |  |                                                                                               
|           |  | P A R T    III                                                                                
|           |  |                                                                                               
|Item 9     |  | Directors and Executive Officers of the Registrant                                            
|           |  |                                                                                               
|Item 10    |  | Executive Compensation                                                                        
|           |  |                                                                                               
|Item 11    |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|           |  |                                                                                               
|Item 12    |  | Certain Relationships and Related Transactions                                                
|           |  |                                                                                               
|Item 13    |  | Exhibits and Reports on Form 8-K                                                              
|           | 
|Signatures |  | 69                                                                                            



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PART I



ITEM 1.    Description of Business.



Service Bancorp, Inc.



Service Bancorp, Inc.
(the Company) was organized as a Massachusetts corporation in 1998 at the direction of the Board of Directors of Strata Bank (the Bank) and the Board of Trustees of Service Bancorp, MHC (the Mutual Company) for
the purpose of acting as the holding company of the Bank. The Companys assets consist primarily of the outstanding capital stock of the Bank and interest-bearing deposits of $1.8 million, representing a portion of the net proceeds from the
Companys stock offering completed October 7, 1998. At June 30, 2003, 907,694 shares of the Companys common stock, par value $0.01 per share, were held by the Mutual Company and 737,590 shares of common stock were held by others. The
Companys principal business is overseeing and directing the business of the Bank and investing the net stock offering proceeds retained by it.



In this document, the Company is being discussed on a consolidated basis with its wholly-owned subsidiary, the Bank. References to the Company may signify
the Bank, depending on the context of the reference.



At June
30, 2003, the Company had total assets of $299.9 million, total deposits of $239.9 million and total equity of $23.5 million.



The Companys office is located at 81 Main Street, Medway, Massachusetts 02053. Its telephone number is 1-800-339-4346.



Strata Bank



The Bank was organized in 1871 as a Massachusetts-chartered mutual savings bank and was reorganized into the stock form of
ownership in August 1997 as part of the Banks original mutual holding company reorganization. No common stock was offered for sale to depositors or other persons at the time of the reorganization in 1997. The Banks deposits are insured
by the Bank Insurance Fund, as administered by the Federal Deposit Insurance Corporation (FDIC), up to the maximum amount permitted by law, and by the Depositors Insurance Fund in excess of the maximum FDIC insurance. The Bank is a
community-oriented savings bank engaged primarily in the business of offering FDIC-insured deposits to customers through its branch offices and using those deposits, together with funds generated from operations and borrowings, to make one- to
four-family residential mortgage loans, commercial real estate loans, commercial business loans, construction loans and consumer loans, and to invest in mortgage-backed and other securities.



The Bank has two wholly owned subsidiaries, Medway Security Corporation and
Franklin Village Security Corporation. Both subsidiaries are Massachusetts securities corporations, which were formed to hold investment securities.



The Banks main office is located at 81 Main Street, Medway, Massachusetts 02053. Its telephone number is 1-800-339-4346.



Service Bancorp, MHC



The Mutual Company was formed in August 1997 as part of the Banks conversion from mutual to stock form. The Mutual
Company is a Massachusetts-chartered mutual holding company with the powers set forth in its Charter and By-laws and under Massachusetts law. The Mutual Company owns 55.2% of the voting stock of the Company. The Board of Trustees of the Mutual
Company directs the voting of the shares of the Companys common stock held by the Mutual Company. The Mutual Company is subject to regulation and supervision by the Federal Reserve Bank (FRB) and the Massachusetts Division of
Banks. The Mutual Company does not



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engage in any business activity other than to hold the Companys common stock and to invest any liquid assets of the Mutual Company.



The Mutual Companys offices are located at 81 Main Street, Medway,
Massachusetts 02053, and its telephone number is 1-800-339-4346.



Market
Area



The Bank operates eight full-service banking offices
in the Massachusetts towns of Medway, Franklin, Medfield, Millis and Bellingham, all of which are located in Norfolk County, Milford, located in Worcester County, and Hopkinton, located in Middlesex County. In addition, the Bank has two
limited-service banking locations at senior assisted living facilities in Franklin and Worcester. The Banks deposits are gathered from the general public primarily in these towns and surrounding communities. The Banks lending activities
are concentrated primarily in these counties and nearby surrounding markets in the greater Boston metropolitan area. Consistent with large metropolitan areas in general, the economy in the Banks market area is based on a mixture of service,
manufacturing, wholesale/retail trade, and state and local government. Maintaining operations in a large metropolitan area serves as a benefit to the Bank in periods of economic growth, while at the same time fosters significant competition for the
financial services provided by the Bank. Future growth opportunities for the Bank depend in part on national economic factors, the future growth in the Banks market area, and the intensity of the competitive environment for financial
institutions.



Norfolk County has experienced a significant
population growth since the mid-1990s, with the county showing a higher growth rate than the Commonwealth of Massachusetts as a whole. Population growth has been supported by the outward expansion of the greater Boston metropolitan area, with
Norfolk Countys proximity to Boston and more affordable housing attracting a number of individuals wishing to maintain jobs in greater Boston. Within Norfolk County, the town of Franklin in particular has experienced considerable growth in
recent years in population and employment, and is one of the fastest growing towns in Massachusetts. The increased demand for housing resulting from this growth has had a positive impact on real estate values and on loan demand in the area in recent
years.



Competition



The Bank faces significant competition both in making loans and in
attracting deposits. The Banks service area of Norfolk, Worcester and Middlesex Counties has a high density of financial institutions, many of which are branches of significantly larger institutions that have greater financial resources than
the Bank, and all of which are competitors of the Bank to varying degrees. The Banks competition for loans comes principally from commercial banks, savings banks, savings and loan associations, mortgage banking companies, credit unions,
insurance companies and other financial service companies. Its most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations and credit unions. The Bank faces additional competition
for deposits from non-depository competitors, such as the mutual fund industry, securities and brokerage firms and insurance companies.



Lending Activities



Loan Portfolio Composition.    The types of loans that the Bank may originate are subject to federal and state laws and
regulations. Interest rates charged by the Bank on loans are affected primarily by the demand for such loans, the supply of money available for lending purposes and the rates offered by competitors. These factors are, in turn, affected by national,
regional and local economic conditions, the levels of federal government spending and revenue, monetary policies of the Federal Reserve Board, and tax policies.



The Banks loan portfolio consists primarily of first mortgage loans secured by one- to four-family residential real estate and commercial real
estate located in the Banks primary lending area. The Bank also



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provides financing for construction projects, home equity and second mortgage loans and other consumer loans, and commercial business loans.



Loan Originations.    Substantially all of the
Banks consumer and commercial loan origination activity is conducted by loan officers throughout the Banks branch network and through the commercial lending division. The Bank relies on referrals from existing customers, attorneys,
accountants and other real estate professionals to generate business within its lending area. Existing borrowers are an important source of business since many of its commercial real estate and commercial business loan customers have more than one
loan outstanding with the Bank. Construction loans are generated primarily from builders who have an established relationship with the Bank. Consumer loans are largely generated through existing customers and walk-in customers. Loan generation is
further supported by advertising and networks built through the community activities of Bank employees.



The Banks ability to originate residential real estate loans depends on the strength of the economy, trends in interest rates, customer demands and
competition. The Bank has a contractual relationship with Marathon Mortgage Company (Marathon) of Hopkinton, Massachusetts, an independent mortgage loan origination company. The arrangement is a working agreement whereby the Bank and
Marathon combine efforts to service the residential mortgage lending needs in the towns that branches of the Bank are located and surrounding communities. This arrangement supplements the Banks mortgage loan origination and refinance
activities and allows the Bank to offer an expanded product line. The Bank pays a fee to Marathon for each residential mortgage loan originated by Marathon that is retained in the Banks portfolio. The combined efforts of the Bank and Marathon
are marketed under a division of the Bank known as the Strata Mortgage Center. The Strata Mortgage Center, which includes a staff of Marathon loan originators, is an additional source of new residential real estate loan originations for
the Bank. In addition, the Bank has the opportunity to purchase loans directly from Marathon.



Loan Sales and Servicing.    While the Bank has not originated for sale large commercial real estate and commercial business loans, the Bank may originate such loans for sale in the future
to accommodate customers seeking larger loans without assuming credit risks that exceed policy guidelines. In addition, one- to four-family residential loans are generally underwritten to conform to secondary market guidelines. While the Bank has
the ability to sell in the secondary market, there were no loan sales during the years ended June 30, 2003 and 2002. Such sales might be considered in the future.



Loan Purchases.    To supplement originations of one- to four-family residential mortgage loans,
the Bank has purchased adjustable-rate one- to four-family mortgage loans secured by residential properties in the New England area originated by other New England-based financial institutions and mortgage companies. All purchased loans are priced
at market rates and must meet the underwriting standards applied to loans originated by the Bank. Such loan purchases totaled $12.9 million and $19.1 million for the years ended June 30, 2003 and 2002, respectively. The Bank has purchased only whole
loans and participates in loans originated by others.



One-
to Four-Family Mortgage Lending.    The Bank currently offers both fixed-rate and adjustable-rate mortgage loans secured by one- to four-family residences located in the Banks primary lending area, with maturities
ranging from fifteen to thirty years. One- to four-family mortgage loan customers are obtained through advertisements, referrals from personnel at the Banks eight full-service operating offices and through the originators at Strata Mortgage
Center. At June 30, 2003, the Banks one- to four-family mortgage loans totaled $96.8 million, or 53.5% of gross loans.



The Bank currently offers the following adjustable-rate mortgage loan programs: a one-year adjustable-rate loan that reprices annually and a three-year
adjustable-rate loan that reprices every third year. The Bank also offers, 5-1, 7-1, and 10-1 loans where the interest rate is fixed for the first five, seven and ten years, respectively, and is adjusted on an
annual basis thereafter. The interest rates on the adjustable-rate loans are indexed to the comparable-term U.S. Treasury securities rate, with the initial rate of interest being dependent upon the length of the repricing term (i.e. a higher rate is
charged for loans with an initial three-year repricing



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term). The one-year adjustable-rate loan and the 5-1, 7-1 and 10-1 adjustable-rate loans are subject to interest rate caps of 2% for each adjustment period
up to a maximum of 6% over the life of the loans. The three-year adjustable-rate loan is subject to a 3% cap for each adjustment period up to a maximum of 6% over the life of the loan.



The volume and type of adjustable-rate loans originated by the Bank are affected by market factors such as interest rates,
consumer preferences and the availability of funds. While the origination of adjustable-rate loans helps reduce the Banks exposure to increases in interest rates, credit risk can increase if borrowers are unable to make the larger payments
that result from upward interest rate adjustments. Periodic and lifetime caps on interest rate increases help to reduce the risks associated with adjustable-rate loans but also limit the Banks sensitivity to interest rate risk.



One- to four-family residential mortgage loans are generally underwritten in
accordance with the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Association (FHLMC) guidelines, with some exceptions on adjustable-rate loans originated for retention in the Banks
loan portfolio. Loans are originated in amounts up to 95% (97% for first-time home buyers) of the lower of the appraised value or the selling price of the property securing the loan. The Bank offers a blended mortgage that enables borrowers to
obtain a conventional mortgage for up to 80% of the propertys appraised value with a second mortgage available at elevated rates for up to 10% of the appraised value. Loans over 80% of appraised value are required to either obtain a blended
mortgage product or obtain outside private mortgage insurance.



Commercial Real Estate Mortgage Lending.    Origination of loans secured by commercial real estate is the Banks most significant area of lending activity after one- to four-family residential mortgage
lending. The loans are generally secured by office and manufacturing buildings, office warehouses, apartments and retail stores primarily located in the Banks market area. At June 30, 2003, commercial real estate mortgage loans totaled $41.5
million, or 23.0% of gross loans.



Pursuant to the Banks
underwriting policies, a number of factors are considered before a commercial real estate loan is made. The qualifications and financial condition of the borrower, including credit history, profitability and expertise, as well as the value and
condition of the underlying property, are evaluated. When evaluating the qualifications of the borrower for a multi-family mortgage loan, the Bank considers the financial resources of the borrower, the borrowers experience in owning or
managing similar property, and the borrowers payment history with the Bank and other financial institutions. Factors considered in evaluating the underlying property include the net operating income of the mortgaged premises before debt
service and depreciation, the debt service coverage ratio (the ratio of net operating income to debt service) and the ratio of the loan amount to the appraised value.



According to the Banks policy, multi-family mortgage loans may be made in an amount up to 80% of the appraised value
(as determined by the Bank or a qualified independent appraiser) or the sales price of the underlying property, whichever is lower, provided the debt service coverage ratio is not less than 120%. The appraisal process takes into consideration
geographic location, comparable sales, vacancy rates, if applicable, operating expenses and historic, current and projected economic conditions. Appraisals are obtained from independent licensed and certified fee appraisers for all loan requests
over $250,000, as required under the Banks commercial real estate policy.



Commercial real estate loans are offered both as adjustable-rate and fixed-rate loans. Typical terms for loans provide for a five-year repricing term, with up to a 25-year amortization. The adjustable-rate is
generally tied to either the Prime Rate as published in the Wall Street Journal or the applicable U.S. Treasury security index. The Bank from time to time will partially fund fixed-rate loans through fixed-rate borrowings from the Federal Home Loan
Bank of Boston (FHLB) obtained for periods that approximate the fixed-rate terms of the loans originated.



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A number of the Banks commercial real estate borrowers have done business with the Bank for many
years and have more than one loan outstanding. The Bank generally originates commercial real estate loans of $150,000 to $750,000, a range the Bank views as being too small for larger commercial banks. The Bank will consider all requests regardless
of size. Should the terms of a request exceed the Banks legal lending limits, the Bank will consider participating a portion of the relationship with another financial institution.



Loans secured by commercial real estate generally involve larger principal amounts and a greater degree of risk than one- to
four-family residential mortgage loans. Because payments of loans secured by commercial real estate are often dependent on successful operation or management of the properties, repayment of such loans may, to a greater extent, be subject to adverse
conditions in the real estate market or the economy.



The Bank
intends to continue to emphasize its commercial real estate lending activities in its primary lending area depending on the demand for such loans and trends in the real estate market and the economy.



Construction Lending.    The Bank provides funding
for construction projects involving residential properties within its primary lending area. These loans may be for the construction of new properties or the rehabilitation of existing properties. The Bank underwrites construction-permanent loans for
owner-occupied one- to four-family property according to its own internal guidelines for adjustable-rate and fixed-rate mortgages. For this type of construction loan, the Bank will lend up to 90% of the lesser of appraised value upon completion of
construction or the cost of construction, provided private mortgage insurance coverage is obtained for any loan with a loan-to-value or loan-to-cost ratio in excess of 80%. For loans on one- to four-family properties being constructed for sale, the
Bank lends up to 80% of the lesser of completed value or project cost on pre-sold projects and up to 70% for speculative projects. Typically, loan proceeds are disbursed in increments as construction progresses as determined by property inspections
and title rundowns.



At June 30, 2003, total construction loan
commitments outstanding amounted to $18.3 million. The Bank had funded all but $6.3 million of this amount.



Construction financing is generally considered to involve a higher degree of risk than long-term financing on improved, occupied real estate. Risk of loss
on a construction loan is largely dependent upon the accuracy of the initial estimate of construction costs, the estimated time to sell or rent the completed property at an adequate price or rate of occupancy, and market conditions. If the estimates
and projections prove to be inaccurate, the Bank may be confronted with a project which, upon completion, has a value that is insufficient to assure full loan repayment.



Home Equity Lending.    The Bank offers home equity lines of credit and fixed-term loans secured
by one- to four-family owner-occupied properties in its primary lending area. Loans are offered in amounts up to 80% of the value of the property, less the first lien. Values are determined by a recent tax bill from the town where the property is
located showing the assessed value of the property or by an appraisal from a preferred provider. Fixed-term home equity loans are written at fixed rates, and are amortized for terms of up to 12 years, while home equity lines of credit are written
with adjustable rates, and may be extended for up to 20 years (with a 10- year draw period and a 10-year repayment period). At June 30, 2003, the Bank had $15.4 million in home equity and second mortgage loans, or 8.5% of gross loans.



Commercial Loans.    The Bank originates both
secured and unsecured commercial business loans to businesses located primarily in the Banks primary lending area. Commercial business loans are typically originated as both fixed-rate loans and adjustable-rate loans set at a percentage above
the Prime Rate as published in the Wall Street Journal. Fixed-rate loans generally are originated for terms of seven years or less. At June 30, 2003, commercial business loans totaled $13.5 million, or 7.5% of gross loans.



Consumer Loans.    The Banks origination of
consumer loans, other than home equity loans, has been fairly limited. This consumer loan portfolio includes direct automobile loans and various other types of installment



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loans, including loans secured by deposits, as well as a modest amount of revolving credit balances. Consumer lending is expected to remain a limited part of
the Banks overall lending program. At June 30, 2003, consumer loans other than home equity and second mortgage loans totaled $1.5 million, or 0.9% of gross loans.



Investment Securities Activities



The investment policy of the Bank is reviewed and approved by the Board of Directors on an annual basis. The Bank views its investment portfolio as an
alternative earning asset vehicle into which to deploy excess funds as well as to assist in interest-rate risk management. Compliance with the Banks investment policy is the responsibility of the President and Chief Financial Officer.
Investment purchases are initiated in accordance with specific guidelines and criteria specified in the investment policy. No sales of investment securities can be made without the prior permission of the President. All investment transactions are
reported to and reviewed by the Board of Directors on a monthly basis.



The Banks current policy generally favors investment in U.S. Government and federal agency securities, corporate debt obligations and corporate equities. The policy permits investment in mortgage-backed and mortgage-related securities
but does not allow the use of interest rate swaps, options and futures. The Banks current investment strategy has emphasized the purchase of federal agency obligations and corporate debt obligations, most of which mature within ten years and
federal agency mortgage-backed securities. Statement of Financial Accounting Standards (SFAS) No. 115 requires the Bank to designate its securities as held to maturity, available for sale or trading depending on the Banks ability
to hold and intent regarding its investments. The Bank does not currently maintain a trading portfolio of securities.



U.S. Government and Federal Agency Obligations.    The federal agency securities portfolio consists primarily of medium-term
(maturities of 3 to 10 years) securities. The Banks current investment strategy, however, is to maintain investments in such instruments for liquidity purposes, as collateral for borrowings, and for prepayment protection. Some of the
Banks agency debentures are callable on a semi-annual basis or have one-time call features following a holding period of twelve months. The Bank generally does not purchase structured notes and there were no structured notes in the Banks
portfolio at June 30, 2003.



Mortgage-Backed
Securities.    Mortgage-backed securities are generally purchased by the Bank as a means to deploy excess liquidity at more favorable yields than other investment alternatives. In addition, mortgage-backed securities generate
positive interest rate spreads with minimal administrative expense and lower the Banks overall credit risk due to the guarantees on such securities provided by the Government National Mortgage Association (GNMA), FNMA and FHLMC.



Mortgage-backed securities are created by pooling individual
mortgages and bear an interest rate that is less than the interest rate on the underlying mortgages. Mortgage-backed securities typically represent a participation interest in a pool of single family or multi-family mortgages, although the Bank
generally purchases only mortgage-backed securities backed by single family mortgage loans. The issuers of such securities (generally federal agencies and U.S. Government sponsored enterprises, including FNMA, FHLMC and GNMA) pool and resell the
participation interests in the form of securities to investors and guarantee the payment of principal and interest to these investors. Investments in mortgage-backed securities involve a risk that actual prepayments on the underlying mortgage loans
will be greater than estimated over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby affecting the net yield on such securities. There is
also reinvestment risk associated with the cash flows from such securities or in the event such securities are redeemed by the issuer. Finally, the market value of such securities may be adversely affected by changes in interest rates.



Corporate Obligations.    The Banks
policy generally requires that investment in corporate debt obligations be limited to corporate bonds with an A rating or better by at least one nationally recognized rating service at the time of purchase.



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Marketable Equity Securities.    The Banks marketable equity securities
consist of investments in common stocks. The Bank generally purchases marketable equity securities as growth and income investments in major Standard & Poors 500 companies that can provide the opportunity for revenue that is taxed on a
more favorable basis than operating income. There can be no assurance that investment in marketable equity securities will achieve appreciation in value and, therefore, such investments involve higher risk.



Federal Home Loan Bank Stock.    The Bank is a
member of the FHLB. As part of a borrowing arrangement with the FHLB, the Bank is required to invest in the stock of the FHLB in an amount determined on the basis of the Banks residential mortgage loans and borrowings from the FHLB. The stock
is redeemable at par and earns dividends declared at the discretion of the FHLB.



Deposit Activities



The Bank offers a variety
of deposit accounts with a range of interest rates and terms. The Banks deposit accounts consist of non-interest-bearing checking accounts and interest-bearing NOW accounts, savings accounts and money market deposit accounts (referred to in
the aggregate as transaction accounts) and certificate of deposit accounts. The Bank offers Individual Retirement Accounts (IRAs) and other qualified plan accounts.



The flow of deposits is influenced significantly by general economic
conditions, changes in money market rates, prevailing interest rates and the relative attractiveness of competing deposit and investment alternatives. The Banks deposits are obtained predominantly from the communities surrounding its branch
offices. The Bank relies primarily on competitive pricing of its deposit products and customer service and long-standing relationships with customers to attract and retain these deposits. In addition, the Bank has actively marketed its core deposit
products to elderly customers in the Banks market area through the organization of travel clubs designed to promote savings by the Banks senior citizen customers. Finally, the Bank has emphasized the acquisition of customers dissatisfied
with the less personalized and more costly services provided by merged financial institutions. However, market interest rates and rates offered by competing financial institutions significantly affect the Banks ability to attract and retain
deposits. The Bank uses traditional means of advertising its deposit products, including broadcast and print media, and generally does not solicit deposits from outside its market area. The Bank does not use brokers to obtain deposits.



Financial Services Activities



The Financial Services Center at Strata Bank provides a wide variety of
alternative investment and insurance products. These non-deposit investment products are offered through the Banks alliance with Linsco/Private Ledger (LPL). LPL is a registered broker/dealer and member NASD/SIPC. LPL is one of the
nations largest independent brokerages with investment professionals in locations across the country.



REGULATION



General



The Bank is a Massachusetts-chartered stock savings bank and its deposit
accounts are insured up to applicable limits by the Bank Insurance Fund (BIF) of the FDIC and by the Depositors Insurance Fund. The Bank is subject to extensive regulation by the Massachusetts Division of Banks (the Division)
as its chartering agency, and by the FDIC, as its deposit insurer. The Bank is required to file reports with, and is periodically examined by, the FDIC and the Division concerning its activities and financial condition and must obtain regulatory
approvals prior to entering into certain transactions, including, but not limited to, mergers with or acquisitions of other savings institutions. The Bank is a member of the Federal Home Loan Bank (FHLB) of Boston and is subject to
certain limited regulation by the Board of Governors of the FRB. As bank holding companies, the Mutual Company and the Company are subject to regulation by the FRB and the Division and required to file reports with such regulatory bodies. Any change
in such regulations, whether by the Division, the



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FDIC, or the FRB could have a material adverse impact on the Bank, the Company, or the Mutual Company. Certain of the regulatory requirements applicable to
the Bank, the Company and the Mutual Company are referred to below or elsewhere herein.



Massachusetts Bank Regulation



As a
Massachusetts-chartered savings bank, the Bank is subject to supervision, regulation and examination by the Division and 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 of earnings, and payment of dividends. In addition, the Bank is subject to Massachusetts consumer protection and civil rights laws and regulations. The
Divisions approval is required for a Massachusetts bank to establish or close branches, merge with other banks, organize a holding company, issue stock and undertake certain other activities.



Parity Regulation.    Massachusetts regulation on
parity with national banks establishes procedures allowing state-chartered banks to exercise additional or more flexible parallel powers granted to national banks under federal law which are otherwise not permitted under state law. Under the parity
regulation, a bank which is either adequately capitalized or well capitalized, which has not been informed in writing by the Commissioner or an applicable federal bank regulatory agency that it has been designated to be in
troubled condition, and which has received as least a satisfactory CRA rating (as defined below) during its most recent examination by the Commissioner or other applicable federal banking regulatory agency, may engage in
certain activities in which Massachusetts chartered banks ordinarily may not engage. Such activities include, but are not limited to, the establishment of temporary branch offices, investment in corporate affiliates and subsidiaries, engagement in
lease financing transactions, investment in community development and public welfare projects, and the provision of tax planning and preparation, payroll and financial planning services, among others. The procedures and requirements for engaging in
such activities range from an application process or expedited review and notice process to no application or notice whatsoever. The applicable procedures and requirements vary according to the nature of the activity to be engaged in and the
capitalization of the bank. As of the date of this document, the Bank was well capitalized, had received a CRA rating of satisfactory and was not in troubled condition and was therefore eligible to engage in
certain of the above-referenced activities, subject to the applicable procedures and requirements of Massachusetts regulation.



Regulatory Enforcement Authority.    Any Massachusetts bank that does not operate in accordance with the regulations, policies
and directives of the Commissioner may be subject to sanctions for non-compliance, including seizure of the property and business of the bank and suspension or revocation of its charter. The Commissioner may under certain circumstances suspend or
remove officers or directors who have violated the law, conducted the Banks business in a manner which is unsafe, unsound or contrary to the depositors interests, or been negligent in the performance of their duties. In addition, upon
finding that a bank has engaged in an unfair or deceptive act or practice, the Commissioner may issue an order to cease and desist and impose a fine on the bank concerned. Finally, Massachusetts consumer protection and civil rights statutes
applicable to the Bank permit private individual and class action law suits and provide for the rescission of consumer transactions, including loans, and the recovery of statutory and punitive damages and attorneys fees in the case of certain
violations.



Depositors Insurance
Fund.    All Massachusetts-chartered savings banks are required to be members of the Depositors Insurance Fund (DIF), a corporation that insures savings bank deposits not covered by federal deposit insurance. The
DIF is authorized to charge savings banks an annual assessment of up to 1/16th of 1% of a savings banks
deposits.



Insurance of Accounts and Regulation by the FDIC



The Bank is a member of the BIF, which is administered by
the FDIC. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the U.S. Government. As insurer,



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the FDIC charges deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may
prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a risk to the insurance fund. The FDIC also has the authority to initiate enforcement actions against savings banks, after giving
the Commissioner an opportunity to take such action, and may terminate deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition.



The FDIC has authority under federal law to appoint a conservator or receiver
for an insured bank under certain circumstances. The FDIC is required, with certain exceptions, to appoint a receiver or conservator for an insured state bank if that bank was critically undercapitalized on average during the calendar
quarter beginning 270 days after the date on which the bank became critically undercapitalized. For this purpose, critically undercapitalized means having a ratio of tangible capital to total assets of less than 2%. The FDIC
may also appoint a conservator or receiver for a state bank on the basis of the institutions financial condition or upon the occurrence of certain events, including: (i) insolvency (whereby the assets of the bank are less than its liabilities
to depositors and others); (ii) substantial dissipation of assets or earnings through violations of law or unsafe or unsound practices; (iii) existence of an unsafe or unsound condition to transact business; (iv) likelihood that the bank will be
unable to meet the demands of its depositors or to pay its obligations in the normal course of business; and (v) insufficient capital, or the incurring or likely incurring of losses that will deplete substantially all of the institutions
capital with no reasonable prospect of replenishment of capital without federal assistance.



Regulatory Capital Requirements



FDIC-insured savings banks are subject to risk-based capital guidelines that establish a framework for making regulatory capital requirements more sensitive to the risk profiles of each institution. The Bank is required to maintain certain
levels of regulatory capital in relation to risk-weighted assets. The ratio of such regulatory capital to risk-weighted assets is referred to as the Banks risk-based capital ratio. Risk-based capital ratios are determined by
allocating assets and specified off-balance sheet items to four risk-weighted categories ranging from 0% to 100%, with higher levels of capital being required for the categories perceived as representing greater risk.



These guidelines divide a savings banks capital into two tiers. The
first tier (Tier I) includes common equity, retained earnings, certain non-cumulative perpetual preferred stock (excluding auction rate issues) and minority interests in equity accounts of consolidated subsidiaries, less goodwill and
other intangible assets (except mortgage servicing rights and purchased credit card relationships subject to certain limitations). Supplementary or Tier II capital includes, among other items, cumulative perpetual and long-term limited-life
preferred stock, mandatory convertible securities, certain hybrid capital instruments, term subordinated debt and the allowance for loan and lease losses, subject to certain limitations, less required deductions. Savings banks are required to
maintain a total risk-based capital ratio equal to at least 8% of risk-weighted assets, of which at least 4% must be Tier I capital.



In addition, the FDIC has established regulations prescribing a minimum Tier I leverage capital ratio (Tier I capital to adjusted total assets as
specified in the regulations). These regulations provide for a minimum Tier I leverage ratio of 3% for banks that meet certain specified criteria, including that they have the highest examination rating and are not experiencing or anticipating
significant growth. All other banks are required to maintain a Tier I leverage ratio of 3% plus an additional cushion of at least 100 to 200 basis points. The FDIC may, however, set higher leverage and risk-based capital requirements on individual
institutions when particular circumstances warrant. Savings banks experiencing or anticipating significant growth are expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.



The federal banking agencies, including the FDIC have also adopted
regulations to require an assessment of an institutions exposure to declines in the economic value of a banks capital due to changes in interest rates when assessing the banks capital adequacy. Under such a risk assessment,
examiners will evaluate a banks



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capital for interest rate risk on a case-by-case basis, with consideration of both quantitative and qualitative factors. Institutions with significant
interest rate risk may be required to hold additional capital. The agencies also issued a joint policy statement providing guidance on interest rate risk management, including a discussion of the critical factors effecting the agencies
evaluation of interest rate risk in connection with capital adequacy.



Standards for Safety and Soundness



The
federal banking agencies have adopted a final regulation and Interagency Guidelines Prescribing Standards for Safety and Soundness (Guidelines) to implement the safety and soundness standards required under federal law. The Guidelines
set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The standards set forth in the Guidelines address internal
controls and information systems; internal audit program; credit underwriting; loan documentation; interest rate risk exposure; asset growth; and compensation, fees and benefits. The agencies also adopted additions to the Guidelines which require
institutions to examine asset quality and earnings standards. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the
agency an acceptable plan to achieve compliance with the standard, as required by federal law. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.



Limitations on Dividends and Other Capital Distributions



The FDIC has the authority to use its enforcement powers to prohibit a
savings bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable
capital requirements on a pro forma basis. Massachusetts law also restricts the Bank from declaring a dividend which would reduce its capital below (i) the amount required to be maintained by state and federal law and regulations, or (ii) the amount
of the Banks liquidation account established in connection with the Reorganization.



Prompt Corrective Action



The federal banking agencies have promulgated regulations to implement the system of prompt corrective action required by federal law. Under the regulations, a bank shall be deemed to be (i) well capitalized if it has total
risk-based capital of 10.0% or more, has a Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not subject to any written capital order or directive; (ii) adequately capitalized if
it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of well
capitalized; (iii) undercapitalized if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under
certain circumstances); (iv) significantly undercapitalized if it has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is less than
3.0%; and (v) critically undercapitalized if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Federal law and regulations also specify circumstances under which a federal banking agency may reclassify
a well capitalized institution as adequately capitalized and may require an adequately capitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may
not reclassify a significantly undercapitalized institution as critically undercapitalized).



Undercapitalized banks are subject to growth, capital distribution (including dividend) and other limitations and are required to submit a
capital restoration plan. A banks compliance with such plan is required to be guaranteed by any company that controls the undercapitalized institution. If an undercapitalized bank fails to submit an acceptable plan, it is treated
as if it is significantly undercapitalized. Significantly undercapitalized banks are subject to one or more of a number of additional restrictions, including an order by the FDIC to sell sufficient voting stock to become
adequately capitalized, requirements to reduce total assets and



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cease receipt of deposits from correspondent banks or to dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of
executive officers and capital distributions by a parent holding company.



Based on the foregoing, the Bank is currently classified as a well capitalized savings institution.



Activities and Investments of Insured State-Chartered Banks



Section 24 of the Federal Deposit Insurance Act (FDIA) generally limits the activities and equity investments of FDIC-insured, state-chartered
banks to those that are permissible for national banks, notwithstanding state laws. Under regulations dealing with equity investments, an insured state bank generally may not, directly or indirectly, acquire or retain any equity investment of a
type, or in an amount, that is not permissible for a national bank. In 1999, the FDIC substantially revised its regulations implementing Section 24 of the FDIA to ease the ability of FDIC-insured state-chartered banks to engage in certain activities
not permissible for national banks, and to expedite FDIC review of bank applications and notice to engage in such activities.



Federal law and FDIC regulations permit certain exceptions to the foregoing limitations. For example, certain state-chartered banks, such as the Bank, may
continue to invest, up to certain limits, in common or preferred stock listed on a national securities exchange or in the shares of registered investment companies if: (i) the Bank held such types of investments during the period from September 30,
1990 through November 26, 1991; (ii) the state in which the Bank is chartered permitted such investments as of September 30, 1991; and (iii) the Bank obtains approval from the FDIC to make or retain such investments. As of June 30, 2003, the Bank
had marketable equity securities with a cost of $1.0 million pursuant to this exception.



Transactions with Affiliates and Insiders of the Bank



Under current federal law, transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act (FRA). An affiliate of a savings bank is
generally any company or entity that controls, is controlled by, or is under common control with the savings bank, other than a subsidiary. In a holding company context, at a minimum, the parent holding company of a savings bank and any companies
which are controlled by such parent holding company are affiliates of the savings bank. Generally, Section 23A limits the extent to which the savings bank or its subsidiaries may engage in covered transactions with any one affiliate to
an amount equal to 10% of such savings banks capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. The term covered
transaction includes the making of loans or other extensions of credit to an affiliate; the purchase of assets from an affiliate; the purchase of, or an investment in, the securities of an affiliate; the acceptance of securities of an
affiliate as collateral for a loan or extension of credit to any person; or issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. Section 23A also establishes specific collateral requirements for loans or extensions of
credit to, or guarantees, acceptances or letters of credit issued on behalf of an affiliate. Section 23B requires that covered transactions and a broad list of other specified transactions be on terms substantially the same, or no less favorable, to
the savings bank or its subsidiary as similar transactions with nonaffiliates.



Effective April 1, 2003, the FRB has rescinded its interpretations of Sections 23A and 23B of the FRA and has replaced these interpretations with Regulation W. In addition, Regulation W makes various changes to
existing law regarding Sections 23A and 23B, including expanding the definition of what constitutes an affiliate subject to Sections 23A and 23B and exempting certain subsidiaries of state-chartered banks from the restrictions of Sections 23A and
23B.



Under Regulation W, all transactions entered into on or
before December 12, 2002 which either became subject to Sections 23A and 23B solely because of Regulation W, and all transactions covered by Sections 23A and 23B, the treatment of which will change solely because of Regulation W, will become subject
to



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Regulation W on July 1, 2003. All other covered affiliate transactions became subject to Regulation W on April 1, 2003. Management does not expect that
the changes made by Regulation W will have a material adverse effect on our business.



The Banks authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and
22(h) of the FRA and the FRBs Regulation O. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less
stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of
credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Banks capital. In addition, extensions of credit in excess of certain limits must be approved by the Banks board of
directors.



Bank Holding Company Regulation



General.    Bank holding companies are subject to
comprehensive regulation and regular examinations by the FRB and the Division. The FRB also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease
and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. As a
savings bank, the Bank may elect to have the Company and the Mutual Company regulated as savings and loan holding companies by the Office of Thrift Supervision (OTS). Regulation as a savings and loan holding company would require
application to, and prior approval of, the OTS.



The
Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (GLBA) was signed into law on November 12, 1999 and became effective March 11, 2000. This federal legislation is intended to modernize the financial services industry by
establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. As a result of the legislation, bank holding companies are permitted to engage in a
wider variety of financial activities than permitted under prior law, particularly with respect to insurance and securities activities. In addition, in a change from prior law, bank holding companies are in a position to be owned, controlled or
acquired by any company engaged in financially-related activities. To the extent that it permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. This additional
consolidation could result in a growing number of larger financial institutions that offer a wider variety of financial services than the Company might be able to offer. This could adversely impact the Companys ability to retain and attract
customers that prefer to obtain all of their financial services from one provider and, ultimately, the Companys profitability.



The Company is subject to capital adequacy guidelines for bank holding companies (on a consolidated basis) which are substantially similar to those of the
FDIC for the Bank. The Companys stockholders equity exceeds these requirements.



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



A bank holding
company must obtain Massachusetts Board of Bank Incorporation and FRB approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own
or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another
bank holding company.



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The Bank Holding Company Act of 1956, as amended (BHCA) prohibits a bank holding company from
acquiring substantially all of the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, or merging or consolidating with any bank
holding companies without the prior approval of the FRB. The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not
a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve
certain non-bank activities which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. In making such determinations, the FRB is required to weigh
the expected benefit to the public against the possible adverse effects. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 generally authorizes bank holding companies to acquire banks located in any states, possibly subject to
certain state-imposed age and deposit concentration limits, and also generally authorizes interstate mergers and to a lesser extent interstate branching.



Dividends.    The FRB has issued a policy statement expressing their view that a bank holding company should pay cash dividends
on common stock only to the extent that its net income available to common stockholders over the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the organizations capital needs,
asset quality and overall financial condition. The FRB may prohibit a bank holding company from paying any dividends if its bank subsidiary is classified as undercapitalized.



The FRB has imposed certain restrictions regarding the waiving of dividend payments by the Company to the Mutual Company. To
date, the Mutual Company has not waived any dividends paid by the Company. If, in the future, the Mutual Company sought to waive dividends paid by the Company and obtained the approval of the FRB to do so, the cumulative amount of waived dividends
would not be available for payment by the Company to minority stockholders and would be maintained in a restricted capital account. While such account would not have to be reflected in the Companys financial statements, it would not be
available for distribution to minority stockholders if the Mutual Company decided to convert to stock form in the future.



Limitations on Certain Capital Transactions.    Under the Divisions regulations, the Company is prohibited from
repurchasing any shares of its stock within three years of its date of issuance unless the repurchase is limited to (i) stock repurchases at amounts designated by the Commissioner where compelling and valid business reasons are established to the
satisfaction of the Commissioner and (ii) stock repurchases in amounts up to the shares covered by qualified employee stock benefit plans.



Bank holding companies are required to give the FRB prior written notice of any purchase or redemption of their outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to 10% or more of their consolidated net worth. The FRB may disapprove
such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, FRB order, or any condition imposed by, or written agreement with, the FRB. This notification
requirement does not apply to any company that meets the well-capitalized standard for commercial banks, has a safety and soundness examination rating of at least a 2 and is not subject to any unresolved supervisory issues.



Customer Information Security



The FDIC and other bank regulatory agencies have adopted final guidelines
for establishing standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (Information Security Guidelines). Among other things, the Information Security Guidelines require each
financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program



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designed to ensure the security and confidentiality of customer information, to protect against any anticipated threats or hazards to the security or
integrity of such information; and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.



Privacy



The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers
to nonaffiliated third parties. In general, the statute requires us to explain to consumers our policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, we are prohibited from
disclosing such information except as provided in our polices and procedures.



Federal Securities Law



The common stock of
the Company is registered with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 (the Exchange Act). The Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the SEC under the Exchange Act.



Federal Reserve System



The FRB requires all
depository institutions to maintain noninterest-bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At June 30, 2003, the Bank was in compliance with these reserve
requirements. Savings banks are authorized to borrow from the Federal Reserve Bank discount window, but FRB regulations require savings banks to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before
borrowing from the Federal Reserve Bank.



USA Patriot Act



The USA Patriot Act of 2001 (the Patriot Act), designed to deny
terrorists and others the ability to obtain anonymous access to the United States financial system, has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act,
together with the implementing regulations of various federal regulatory agencies, mandates or will require financial institutions to implement additional policies and procedures with respect to, or additional measures designed to address, any or
all of the following matters, among others: money laundering; suspicious activities and currency transaction reporting; and currency crimes. The Patriot Act and various implementing regulations also permit information sharing for counter-terrorist
purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB (and other federal banking agencies) to evaluate the effectiveness of an
applicant in combating anti-money laundering activities when considering applications filed under Section 3 of the BHCA or the Bank Merger Act. Management believes that we are currently in compliance with all currently effective requirements
prescribed by the Patriot Act and all applicable final implementing regulations.



The Sarbanes-Oxley Act



On July 30, 2002,
President George W. Bush signed into law the Sarbanes-Oxley Act of 2002 (S-O Act). The S-O Act implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in
corporate America and better protect investors from the type of corporate wrongdoings that occurred in Enron, WorldCom and similar companies. The S-O Acts principal legislation includes:



| |  |  | the creation of an independent accounting oversight board;
| | - |  | ----------------------------------------------------------



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| |  |  | auditor independence provisions which restrict non-audit services that accountants may provide to their audit clients;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuers securities by directors and senior officers in the twelve month period
following initial publication of any financial statements that later require restatement;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an increase in the oversight of, and enhancement of certain requirements relating to audit committees of public companies and how they interact with the companys independent
auditors;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | requirement that companies disclose whether at least one member of the committee is a financial expert (as such term will be defined by the SEC) and if not, why not;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension
blackout periods;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | mandatory disclosure by analysts of potential conflicts of interest; and
| | - |  | ------------------------------------------------------------------------



| |  |  | a range of enhanced penalties for fraud and other violations.
| | - |  | -------------------------------------------------------------



Although we anticipate that we will incur additional expense in complying with the provisions of the S-O Act and the resulting regulations, management
does not expect that such compliance will have a material impact on our results of operations or financial condition.



Community Reinvestment Act



Under the Community Reinvestment Act, as amended (the CRA), as implemented by FDIC regulations, a savings bank has a continuing and
affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for
financial institutions nor does it limit an institutions discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC, in connection
with its examination of a savings institution, to assess the institutions record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution, including
applications to acquire branches and other financial institutions. The CRA requires the FDIC to provide a written evaluation of an institutions CRA performance utilizing a four-tiered descriptive rating system. The Banks latest CRA
rating was satisfactory.



Massachusetts has its own
statutory counterpart to the Community Reinvestment Act which is also applicable to the Bank. The Massachusetts version is generally similar to the Community Reinvestment Act but utilizes a five-tiered descriptive rating system. Massachusetts law
requires the Commissioner to consider, but not be limited to, a banks record of performance under Massachusetts law in considering any application by the bank to establish a branch or other deposit-taking facility, to relocate an office, or to
merge or consolidate with or acquire the assets and assume the liabilities of any other banking institution. The Banks most recent rating under the Massachusetts law was satisfactory.



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Federal Home Loan Bank System



The Bank is a member of the FHLB of Boston, which is one of 12 regional FHLBs that administers the home financing credit
function of savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to
members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from
the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB.



As a member, the Bank is required to purchase and maintain stock in the FHLB of Boston. At June 30, 2003, the Bank owned $1.9 million of FHLB stock. In past years, the Bank has received dividends on its FHLB stock.
The dividend yield from FHLB stock was 3.41% for the year ended June 30, 2003. No assurance can be given that such dividends will continue in the future at such levels.



Under federal law, the FHLBs are required to provide funds for the resolution of troubled savings institutions and to
contribute to low and moderately priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects.



These contributions have affected adversely the level of FHLB dividends paid
and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Banks FHLB stock may result in a corresponding reduction in the Banks
capital.



Environmental Issues



The Bank encounters certain environmental risks in its lending activities.
Under federal and state environmental laws, lenders may become liable for costs of cleaning up hazardous materials found on property securing their loans. In addition, the existence of hazardous materials may make it unattractive for a lender to
foreclose on such properties. Although environmental risks are usually associated with loans secured by commercial real estate, risks also may be substantial for loans secured by residential real estate if environmental contamination makes the
property unsuitable for use. This could also have a negative effect on nearby property values. The Bank attempts to control its risk by requiring appropriate environmental assessments as part of its underwriting of all non-residential real estate
mortgage loans over $250,000.



The Bank believes its procedures
regarding the assessment of environmental risk are adequate and, as of June 30, 2003, the Bank was unaware of any environmental issues which would subject it to any material liability. However, no assurance can be given that the values of properties
securing loans in the Banks portfolio will not be adversely affected by unforeseen environmental risks.



Employees



As of June
30, 2003, the Bank had 92 full-time equivalent employees. The employees are not represented by a collective bargaining unit, and the Bank considers its relationship with its employees to be good.



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ITEM 2.    Description of Property.



The following table sets forth certain information regarding the Companys offices at June 30, 2003.



|Location                                            |  | YearOpened |  | Leased/Owned |  | LeaseExpirationDates |  | RenewalOptionsThrough
|--------------------------------------------------- |  | ---------- |  | ------------ |  | -------------------- |  | ---------------------
|81 Main Street Medway, Massachusetts                |  | 1871       |  | Owned        |  |                     |  |                     
|                                                    |  |            |  |             
|1098 Main Street Millis, Massachusetts              |  | 1962       |  | Owned        |  |                     |  |                     
|                                                    |  |            |  |             
|18 North Meadow Road Medfield, Massachusetts        |  | 1990       |  | Leased       |  | 2008                 |  | 2018                 
|                                                    |  |            |  |             
|1000 Franklin Village Drive Franklin, Massachusetts |  | 1993       |  | Leased       |  | 2005-2008            |  | 2015-2018            
|                                                    |  |            |  |             
|281A East Central Street Franklin, Massachusetts    |  | 1997       |  | Leased       |  | 2007                 |  | 2012                 
|                                                    |  |            |  |             
|555 Plantation Street* Worcester, Massachusetts     |  | 2000       |  |             |  |                     |  |                     
|                                                    |  |            |  |             
|267 Hartford Avenue Bellingham, Massachusetts       |  | 1999       |  | Owned        |  |                     |  |                     
|                                                    |  |            |  |             
|59 Main Street Hopkinton, Massachusetts             |  | 1999       |  | Leased       |  | 2004                 |  | 2014                 
|                                                    |  |            |  |             
|140 South Main Street Milford, Massachusetts        |  | 2000       |  | Leased       |  | 2009                 |  | 2019                 
|                                                    |  |            |  |             
|4 Forge Hill Road* Franklin, Massachusetts          |  | 1999       |  |             |  |                     |  |                     

---

|* |  | Limited service branch at Senior Living Center
|- |  | ----------------------------------------------



ITEM 3.    Legal Proceedings.



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



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



No matters were submitted to a vote of stockholders during the fourth quarter of the 2003 fiscal year.



17



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##### Table of Contents

PART II



ITEM 5.    Market for Common Equity and Related Stockholder Matters.



COMMON STOCK AND RELATED MATTERS



The Companys Common Stock is listed on the Over-the-Counter Bulletin Board under the symbol SERC. As of September 9, 2003, the Company
had eight registered market makers, 418 stockholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms), and 1,647,284 shares outstanding. As of such date, Service Bancorp, MHC (the
Mutual Company), the Companys mutual holding company, held 907,694 shares of common stock and 739,590 shares of common stock were held by others.



The following table sets forth market price and dividend information for the Common Stock for the past two fiscal years. The
Over-the-Counter Market quotes reflect inter-dealer prices without retail markup, markdown or commission and may not represent actual transactions.



|Fiscal Year Ended June 30,
2003 |  | High |       | Low |   | CashDividendsDeclared
|------------------------------- |  | ---- | ----- | --- | - | ---------------------
|First Quarter                   |  | $    | 16.50 |     | $ | 14.30                
|Second Quarter                  |  | $    | 16.95 |     | $ | 15.05                
|Third Quarter                   |  | $    | 23.25 |     | $ | 15.45                
|Fourth Quarter                  |  | $    | 22.85 |     | $ | 18.15                
|                                |  |      |      
|Fiscal Year Ended June 30,
2002 |  | High |       | Low |   | CashDividendsDeclared
|First Quarter                   |  | $    | 13.75 |     | $ | 11.00                
|Second Quarter                  |  | $    | 13.90 |     | $ | 12.65                
|Third Quarter                   |  | $    | 14.45 |     | $ | 13.05                
|Fourth Quarter                  |  | $    | 16.80 |     | $ | 13.30                



Payment of dividends
on the Companys common stock is subject to determination and declaration by the Board of Directors and depends upon a number of factors, including capital requirements, regulatory limitations on the payment of dividends, the Companys
results of operations and financial condition, tax considerations and general economic conditions. No assurance can be given that dividends will be declared or, if declared, what the amount of dividends will be, or whether such dividends, once
declared, will continue.



18



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##### Table of Contents

Equity Compensation Plan Information



The following table provides information as of the end of the fiscal year ended June 30, 2003 regarding shares of Common
Stock of the Company that may be issued under the Companys existing equity compensation plans, including the Companys 1999 Stock Option Plan and the Companys 1999 Recognition and Retention Plan.



|                                                           |  | Equity Compensation Plan Information                                                        
|---------------------------------------------------------- |  | --------------------------------------------------------------------------------------------
|Plan category                                              |  | Number of securities tobe issued upon exerciseof outstanding options,warrants and rights (1)
|                                                           |  | (a)                                                                                         
|Equity compensation plans approved by security holders(2)  |  | 70,294                                                                                      
|Equity compensation plans not approved by security holders |  | N/A                                                                                         
|                                                           |  |                                                                                             
|Total                                                      |  | 70,294                                                                                      
|                                                           |  |                                                                                             

---

|(1) |  | Does not include any restricted stock as such shares are already reflected in the Companys outstanding shares.
|--- |  | ---------------------------------------------------------------------------------------------------------------

|(2) |  | Consists of the 1999 Stock Option Plan and the 1999 Recognition and Retention Plan.
|--- |  | -----------------------------------------------------------------------------------



ITEM 6.    Managements Discussion and Analysis or Plan of Operation



Forward-Looking Statements



In addition to historical information, this document contains forward-looking statements. For this purpose, any statements contained herein that are not
statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words believe, anticipates, plans, expects and similar expressions are intended to
identify forward-looking statements. There are a number of important factors that could cause the Companys actual results to differ materially from those contemplated by such forward-looking statements. These important factors include, without
limitation, competitive conditions in the Banks marketplace generally, the Banks continued ability to originate quality loans, fluctuation in interest rates including fluctuations which may effect the Banks interest rate spread,
real estate conditions in the Banks lending areas, changes in the securities or financial markets, changes in loan defaults and charge-off rates, general and local economic conditions, the Banks continued ability to attract and retain
deposits, the Companys ability to control costs, new accounting pronouncements, and changing regulatory requirements. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements
which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.



FINANCIAL CONDITION AT JUNE 30, 2003



Total assets increased by $22.8 million, or 8.3%, from $277.1 million at June 30, 2002 to $299.9 million at June 30, 2003. The increase was primarily
attributable to growth of $29.1 million, or 19.3%, in net loans since June 30, 2002 and a $12.8 million, or 81.7%, increase in short term investments. These increases were partially offset by an $18.5 million decrease in investment securities.
Funding for the asset growth was also provided by an increase in deposits of $19.7 million, or 9.0%, from $220.2 million to $239.9 million.



19



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##### Table of Contents

Loans



Net loans increased $29.1 million, or 19.3%, from June 30, 2002 to $179.9 million at June 30, 2003. For the year ended June 30, 2003, the Bank, through
its Strata Mortgage Center division, originated $47.6 million in residential real estate loans compared with $38.4 million in originations last year. In addition, the Bank purchased $12.9 million of residential loans directly from Marathon Mortgage
Company during the year. Due to the lower market interest rates this year and the resulting increase in residential loan refinance activity, principal payments on residential loans increased from $40.4 million last year to $46.6 million this year.
With this activity, the Banks residential mortgages increased a net $13.3 million, or 15.9%, since June 30, 2002. Net deferred loan costs and premium also increased since last year to $801,000 at June 30, 2003, largely due to costs associated
with residential loan originations and purchases through Marathon Mortgage Company.



Commercial loans continued to be an area of strong growth for the Bank due to additions to the staff of commercial lenders and healthy demand for commercial loans in the Banks market area. The Bank originated
$42.5 million for all commercial, commercial real estate and construction loans for the year ended June 30, 2003, which is an $11.2 million volume increase over the year ended June 30, 2002. After loan paydowns, total commercial, commercial real
estate and construction loans increased by $11.0 million, or 19.7%, since June 30, 2002. Home equity and second mortgage loans increased 53.1% since June 30, 2002 to $15.4 million at June 30, 2003. The strong growth was due to the expansion of the
Banks product offerings for new home equity loans and aggressive promotions for these products.



The following information relates to the composition of the Banks loan portfolio in dollar amounts and in percentages (before deferred fees and
premiums, and allowances for loan losses) as of the dates indicated.



|                                           |  | June 30,               |        
|------------------------------------------ |  | ---------------------- | -------
|                                           |  | 2003                   |        
|                                           |  | Amount                 |        
|                                           |  | (Dollars in Thousands) |        
|Real estate loans:                         |  |                        |        
|One-to four family                         |  | $                      | 96,830 
|Commercial and multi-family                |  |                        | 41,522 
|Construction                               |  |                        | 12,059 
|                                           |  |                        |        
|Total real estate loans                    |  |                        | 150,411
|                                           |  |                        |        
|Other loans:                               |  |                        |        
|Consumer loans:                            |  |                        |        
|Passbook secured                           |  |                        | 494    
|Home equity and second mortgages           |  |                        | 15,377 
|Other                                      |  |                        | 1,054  
|                                           |  |                        |        
|Total consumer loans                       |  |                        | 16,925 
|Commercial business loans                  |  |                        | 13,530 
|                                           |  |                        |        
|Total other loans                          |  |                        | 30,455 
|                                           |  |                        |        
|Total gross loans                          |  |                        | 180,866
|                                           |  |                        |        
|Net deferred loan costs (fees) and premium |  |                        | 801    
|Allowance for loan losses                  |  |                        | (1,745 
|                                           |  |                        |        
|Total loans, net                           |  | $                      | 179,922
|                                           |  |                        |        



20



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##### Table of Contents

Loan Maturity and Repricing.    The following table sets forth certain
information as of June 30, 2003, regarding the dollar amount of loans maturing in the Banks portfolio based on their contractual terms to maturity. Demand loans having no stated schedule of repayments and no stated maturity, and overdrafts are
reported as due in one year or less. Adjustable and floating rate loans are included in the period in which interest rates are next scheduled to adjust rather than the period in which they contractually mature, and fixed-rate loans are included in
the period in which the final contractual repayment is due. This table does not include prepayments.



|                            |  | At June 30, 2003
|--------------------------- |  | ----------------
|                            |  | WithinOne Year  
|Real estate loans:          |  |                 
|One- to four-family         |  | $               
|Commercial and multi-family |  |                 
|Construction                |  |                 
|                            |  |                 
|Total real estate loans     |  |                 
|Other loans:                |  |                 
|Consumer                    |  |                 
|Commercial business         |  |                 
|                            |  |                 
|Total loans                 |  | $               
|                            |  |                 



The following table
sets forth at June 30, 2003, the dollar amount of gross loans, net of unadvanced funds on loans, contractually due or scheduled to reprice after June 30, 2004, and whether such loans have fixed interest rates or adjustable interest rates. This table
does not include prepayments.



|                            |  | Due or Repricing After June 30,2004
|--------------------------- |  | -----------------------------------
|                            |  | Fixed                              
|                            |  | (Dollars in Thousands)             
|Real estate loans:          |  |                                    
|One- to four-family         |  | $                                  
|Commercial and multi-family |  |                                    
|Construction                |  |                                    
|                            |  |                                    
|Total real estate loans     |  |                                    
|Other loans:                |  |                                    
|Consumer loans              |  |                                    
|Commercial business         |  |                                    
|                            |  |                                    
|Total loans                 |  | $                                  
|                            |  |                                    



Investments



Total investment securities (amortized cost) decreased $20.8 million, or
23.2%, from June 30, 2002 to June 30, 2003. The decrease was mostly due to amortization and prepayments on mortgage-backed securities and calls on federal agency securities exceeding new purchases. Investment securities have been a less attractive
investment due to the current low interest rate environment and its effect on securities yield. The Companys continued objective is to prudently increase its loan portfolio, primarily in residential and commercial loans.



At June 30, 2003, $51.3 million, or 74.5%, of the Banks securities were
designated as available for sale and $17.6 million, or 25.5%, were designated as held to maturity compared with $55.3 million, or 61.7%, and $34.4 million, or 38.3%, at June 30, 2002, respectively. The net unrealized gain on securities classified as
available for



21



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##### Table of Contents

sale was $2.3 million at June 30, 2003 compared with a net unrealized gain of $30,000 at June 30, 2002. The improvement reflects the lower interest rate
environment this year and its favorable effect on bond prices.



At June 30, 2003 short-term investments, which consist primarily of overnight fund investments, totaled $28.4 million. This level of overnight funds is maintained for liquidity purposes, particularly at end of month periods due to the
volatility in certain of the Banks deposits. In addition, excess funds are expected to be utilized to fund the origination and purchase of new loans.



The following table sets forth certain information regarding the amortized cost and fair values of the Banks securities and other investments, at
the dates indicated.



|                                          |  | June 30,              
|----------------------------------------- |  | ----------------------
|                                          |  | 2003                  
|                                          |  | AmortizedCost         
|                                          |  | (Dollars in Thousands)
|Securities:                               |  |                       
|Securities available for sale:            |  |                       
|Federal agency securities                 |  | $                     
|Federal agency mortgage-backed securities |  |                       
|Other debt securities                     |  |                       
|                                          |  |                       
|Total debt securities                     |  |                       
|Marketable equity securities              |  |                       
|                                          |  |                       
|Total securities available for sale       |  |                       
|                                          |  |                       
|Securities held to maturity:              |  |                       
|Federal agency mortgage-backed securities |  |                       
|Other debt securities                     |  |                       
|                                          |  |                       
|Total securities held to maturity         |  |                       
|                                          |  |                       
|Total securities                          |  | $                     
|                                          |  |                       
|Other investments:                        |  |                       
|Bank liquidity fund                       |  | $                     
|Federal funds sold                        |  |                       
|Certificates of deposit                   |  |                       
|FHLB stock                                |  |                       
|                                          |  |                       
|Total other investments                   |  | $                     
|                                          |  |                       



22



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##### Table of Contents

The table below sets forth certain information regarding the amortized cost, weighted average yields and
contractual maturities of the Banks securities portfolio as of June 30, 2003. Mortgage-backed securities are shown at or based on their final maturity but are expected to have shorter average lives.



|                                    |  | One Year or Less       |     |                      | More than One Yearto Five Years |   |               | More than Five Yearsto Ten Years |                      |  | More than Ten Years |               |  | Total                |      
|----------------------------------- |  | ---------------------- | --- | -------------------- | ------------------------------- | - | ------------- | -------------------------------- | -------------------- |  | ------------------- | ------------- |  | -------------------- | -----
|                                    |  | AmortizedCost          |     | WeightedAverageYield |                                 |   | AmortizedCost |                                  | WeightedAverageYield |  |                     | AmortizedCost |  | WeightedAverageYield |      
|                                    |  | (Dollars in Thousands) |    
|Securities available for sale:      |  |                        |     |                      |                                 |   |               |                                  |                      |  |                     |               |  |                      |      
|Debt securities:                    |  |                        |     |                      |                                 |   |               |                                  |                      |  |                     |               |  |                      |      
|Agency securities                   |  | $                      | 500 |                      | 7.61                            | % |               | $                                | 7,000                |  | 3.66                | %             |  | $                    | 5,030
|Mortgage-backed securities          |  |                        |    |                      |                                |   |               |                                  | 1,040                |  | 5.50                |               |  |                      |     
|Other debt securities               |  |                        | 139 |                      | 7.00                            |   |               |                                  | 18,356               |  | 6.51                |               |  |                      | 4,532
|                                    |  |                        |     |                      |                                 |   |               |                                  |                      |  |                     |               |  |                      |      
|Total debt securities               |  |                        | 639 |                      | 7.48                            |   |               | $                                | 26,396               |  | 5.71                |               |  |                      | 9,562
|Marketable equity securities        |  |                        |    |                      |                                 |   |               |                                  |                     |  |                     |               |  |                      |     
|                                    |  |                        |     |                      |                                 |   |               |                                  |                      |  |                     |               |  |                      |      
|Total securities available for sale |  | $                      | 639 |                      | 7.48                            | % |               | $                                | 26,396               |  | 5.71                | %             |  | $                    | 9,562
|                                    |  |                        |     |                      |                                 |   |               |                                  |                      |  |                     |               |  |                      |      
|Securities held to maturity:        |  |                        |     |                      |                                 |   |               |                                  |                      |  |                     |               |  |                      |      
|Debt securities:                    |  |                        |     |                      |                                 |   |               |                                  |                      |  |                     |               |  |                      |      
|Other debt securities               |  | $                      | 396 |                      | 6.85                            | % |               | $                                | 4,355                |  | 7.29                | %             |  | $                    |     
|Mortgage-backed securities          |  |                        | 24  |                      | 6.50                            |   |               |                                  | 24                   |  | 7.00                |               |  |                      | 2,028
|                                    |  |                        |     |                      |                                 |   |               |                                  |                      |  |                     |               |  |                      |      
|Total securities held to maturity   |  | $                      | 420 |                      | 6.83                            | % |               | $                                | 4,379                |  | 7.29                | %             |  | $                    | 2,028
|                                    |  |                        |     |                      |                                 |   |               |                                  |                      |  |                     |               |  |                      |      



Liquidity and Capital Resources



The Companys primary sources of funds are deposits,
repayments and prepayments and interest on loans, proceeds from sales of loans and securities, maturities and interest on debt securities, and cash flows from operations are the primary sources of the Banks funds for use in lending, investing
and other general purposes. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by interest rate trends, economic conditions and
competition. The Bank also utilizes borrowed funds from the FHLB to fund its loans and investment purchases in connection with its management of the interest rate sensitivity of its assets and liabilities.



The Companys most liquid assets are cash and due from banks, short-term
investments, mortgage-backed securities, federal agency obligations, and other debt securities. The levels of these assets are dependent on the Companys operating, financing, lending and investment activities during any given period. At June
30, 2003, cash and due from banks, short-term investments, and securities maturing within one year amounted to $38.2 million, or 12.7%, of total assets. Additional funds amounting to $71.0 million will be available during the next year from the
prepayment of loans and mortgage-backed securities. The Bank also has the capacity to borrow an additional $36.5 million from the FHLB.



At June 30, 2003, the Company had commitments to originate loans, unused outstanding lines of credit, and undisbursed proceeds of loans totaling $42.8
million. The Company anticipates that it will have sufficient funds available to meet its current loan commitments. Refer to Note 12 of the Notes to Consolidated Financial Statements of this Form 10-KSB for a further discussion on commitments.
Certificates of deposit maturing within one year from June 30, 2003 amounted to $56.4 million. The Company expects that substantially all of the maturing certificate accounts will be retained by the Company at maturity.



Stockholders equity increased from $20.4 million, or 7.35% of total
assets at June 30, 2002 to $23.5 million, or 7.84% of total assets at June 30, 2003. The increase resulted primarily from retained earnings and the



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##### Table of Contents

improvement in the unrealized gain, net of tax, on securities, which is reported as other comprehensive income. At June 30, 2003, the Company exceeded all of
its regulatory requirements with Tier 1 capital of $21.9 million and a Tier 1 capital to average assets ratio of 7.77%, which was above the required level of $11.3 million or 4.00%. The Tier 1 capital to risk-weighted assets ratio was 10.53%, which
was above the required level of $8.3 million or 4.00%. In addition, with total capital of $23.6 million, the total capital to risk-weighted assets ratio was 11.37%, which was above the required level of $16.6 million, or 8.00%.



Deposits



Deposits increased $19.7 million, or 9.0%, from June 30, 2002 to $239.9 million at June 30, 2003. Core or non-certificate
deposits increased $28.1 million, or 23.2%, to $149.1 million, which provided the opportunity through less aggressive pricing, to reduce higher cost term certificates by $8.3 million, or 8.4%, to $90.8 million, between periods. Approximately 66.6%
of the decrease occurred in certificates of deposit with balances in excess of $100,000 which are typically a more volatile funding source compared with certificates under $100,000. Of the $90.8 million of certificates of deposit accounts at June
30, 2003, $56.4 million, or 62.1% were scheduled to mature within one year. While this percentage is significant, based on its monitoring of historical trends in deposit flows and its current pricing strategy for deposits, management believes the
Bank will retain a large portion of its certificate of deposit accounts upon maturity.



The following table indicates the amount of the Banks certificates of deposit by time remaining until maturity as of June 30, 2003.



|                                            |  | Maturity               |       
|------------------------------------------- |  | ---------------------- | ------
|                                            |  | 3 Monthsor Less        |       
|                                            |  | (Dollars in Thousands) |       
|Certificates of deposit less than $100,000  |  | $                      | 15,052
|Weighted average rate                       |  |                        | 2.57  
|Certificates of deposit of $100,000 or more |  |                        | 5,068 
|Weighted average rate                       |  |                        | 2.70  
|Total certificates of deposit               |  | $                      | 20,120



Borrowings



The Bank utilizes advances from the FHLB primarily in connection with its
management of the interest rate sensitivity of its assets and liabilities. The advances are collateralized primarily by certain of the Banks mortgage loans and secondarily by the Banks investment in the stock of the FHLB. The maximum
amount that the FHLB will advance to member institutions, including the Bank, fluctuates from time to time in accordance with the policies of the FHLB. At June 30, 2003, the Bank had $35.2 million in outstanding advances from the FHLB and had the
capacity to increase that amount by $36.5 million to $71.7 million. The Bank expects to continue to utilize borrowings from the FHLB as part of its management of the interest sensitivity of its assets and liabilities.



Interest Rate Risk



An important risk factor affecting the financial condition and operating results of the Company is interest rate risk. This
risk is managed by periodic evaluation of the interest rate risk inherent in certain balance sheet accounts, determination of the level of risk considered appropriate given the Companys capital and liquidity requirements, business strategy,
performance objectives and operating environment, and maintenance of such risks within guidelines approved by the Board of Directors. Through such management, the Company seeks to reduce the vulnerability of its operations to changes in interest
rates. The Companys Asset/Liability Committee, comprised of senior management, is responsible for managing interest rate risk and reviewing with the Board of Directors on a quarterly basis the Companys activities and strategies, the
effect of those strategies on the



24



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##### Table of Contents

Companys operating results, the Companys interest rate risk position, and the effect changes in interest rates would have on the Companys
net interest income. The extent of movement of interest rates is an uncertainty that could have a negative impact on the earnings of the Company.



The principal strategies used by the Company to manage interest rate risk include (1) emphasizing the origination and retention of both adjustable-rate
and fixed-rate loans, (2) originating shorter-term fixed-rate commercial real estate loans, (3) investing in debt securities with maturities with shorter call dates of 2 to 5 years, and (4) maintaining a high concentration of less
interest-rate-sensitive and lower-costing core deposits.



Gap Analysis.    The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are interest rate sensitive and by monitoring a banks interest
rate sensitivity gap. An asset or liability is deemed to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference
between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest bearing-liabilities maturing or repricing within that same time period. At June 30, 2003, the Companys cumulative
one-year gap position, the difference between the amount of interest-earning assets maturing or repricing within one year and interest-bearing liabilities maturing or repricing within one year, was a negative 3.0%. A gap is considered positive when
the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets.
Accordingly, during a period of rising interest rates, an institution with a negative gap position generally would not be in as favorable a position, compared to an institution with a positive gap, to invest in higher yielding assets. The resulting
yield on the institutions assets generally would increase at a slower rate than the increase in its cost of interest-bearing liabilities. Conversely, during a period of falling interest rates, an institution with a negative gap would tend to
experience a repricing of its assets at a slower rate than its interest-bearing liabilities which, consequently, would generally result in its net interest income growing at a faster rate than an institution with a positive gap position.



The following table sets forth the amortized cost of interest-earning
assets and interest-bearing liabilities outstanding at June 30, 2003, which are anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future time periods shown. Except as stated below, the amount of assets
and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of the repricing term or the contractual maturity of the asset or liability. The table sets forth an approximation of the
projected repricing of assets and liabilities at June 30, 2003, on the basis of contractual maturities, anticipated prepayments and scheduled rate adjustments within a three month period and subsequent selected time intervals. The loan amounts in
the table reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate and fixed-rate loans, and as a result of contractual rate adjustments on
adjustable-rate loans. Mortgage-backed securities are categorized according to their expected lives based on prepayment estimates. The agency and corporate debt obligations have maturities ranging from 3 to 15 years, a principal portion of which
have call features of between 6 months to 3 years. The GAP table generally presents the full contractual maturity of these obligations, notwithstanding the call features.



25



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##### Table of Contents

|                                                                                              |  | Amounts maturing or repricing at June 30, 2003
|--------------------------------------------------------------------------------------------- |  | ----------------------------------------------
|                                                                                              |  | LessThan 3Months                              
|                                                                                              |  | (Dollars in Thousands)                        
|Interest-earning assets:(1)                                                                   |  |                                               
|Loans(2)                                                                                      |  | $                                             
|Securities and FHLB stock                                                                     |  |                                               
|Short-term investments                                                                        |  |                                               
|                                                                                              |  |                                               
|Total interest-earning assets                                                                 |  |                                               
|                                                                                              |  |                                               
|Interest-bearing liabilities:                                                                 |  |                                               
|Savings deposits(4)                                                                           |  |                                               
|Money market deposits(4)                                                                      |  |                                               
|NOW deposits(5)                                                                               |  |                                               
|Certificate accounts                                                                          |  |                                               
|FHLB advances                                                                                 |  |                                               
|                                                                                              |  |                                               
|Total interest-bearing liabilities                                                            |  |                                               
|                                                                                              |  |                                               
|Interest sensitivity gap(3)                                                                   |  | $                                             
|                                                                                              |  |                                               
|Cumulative interest sensitivity gap                                                           |  | $                                             
|                                                                                              |  |                                               
|Cumulative interest sensitivity gap as a percentage of total assets                           |  |                                               
|Cumulative interest sensitivity gap as a percentage of total interest-earning assets          |  |                                               
|Cumulative interest-earning assets as a percentage of cumulative interest-bearing liabilities |  |                                               

---

|(1) |  | Interest-earning assets are included in the period in which the balances are expected to be redeployed and/or repriced as a result of anticipated prepayments, scheduled rate
adjustments and contractual maturities.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | For the purposes of the gap analysis, the allowance for loan losses and net deferred loan costs and premium have been excluded.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Interest sensitivity gap represents the difference between interest-earning assets and interest-bearing liabilities.
|--- |  | --------------------------------------------------------------------------------------------------------------------

|(4) |  | Regular savings and money market account balances have 50% included in the over 5 year timeframe; the rest is spread evenly within the four intervals up to and including the
one-to-three year period.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | NOW account balances have 25% included in the over 5 year timeframe; the rest is spread evenly within the four intervals up to and including the one-to-three year period.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Certain shortcomings are inherent in the method
of analysis presented in the GAP table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets such as adjustable-rate loans, have
features which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of changes in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those
assumed in calculating the table. Finally, the ability of many borrowers to service their adjustable-rate loans may decrease in the event of an interest rate increase.



Management of Credit Risk



Management considers credit risk to be an important risk factor affecting the financial condition and operating results of the Company. The potential for
loss associated with this risk factor is managed through a combination of policies approved by the Companys Board of Directors, the monitoring of compliance with these policies, and the periodic reporting and evaluation of loans with problem
characteristics. Policies relate to the maximum amount that can be granted to a single borrower and such borrowers related interests, the aggregate amount of loans outstanding by type in relation to total assets and capital, loan
concentrations, loan-to-collateral-value ratios, approval limits and other underwriting criteria. Policies also exist with respect to the rating of loans, when loans should be placed in a non-performing status, and the factors that should be
considered in establishing the Companys allowance for loan losses.



26



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Loan Approval Procedures and Authority.    The Board of Directors annually
approves the lending policies and loan approval limits for the Bank as well as the independent appraisers used by the Bank. Loans may be approved by loan officers, management, the Loan Committee or the Board of Directors, depending on the type and
size of the loan and the borrowers aggregate loan balances with the Bank. Where the borrowers aggregate loan balances with the Bank are $250,000 and below, individual loan officers (depending on lending limits) may approve loans, and
where the borrowers aggregate loan balances with the Bank are between $250,001 and $750,000, the loan request must be approved by the Loan Committee. The Loan Committee is made up of the Chief Executive Officer, Senior Lending Officer,
Commercial Loan officers, Commercial Loan Operations Manager and heads of Branch Administration and Residential and Consumer Lending. Where the borrowers aggregate borrowings with the Bank exceed $750,000, the loan request must be approved by
the Board of Directors.



The Bank requires an environmental
site assessment to be performed by an independent professional for all non-residential mortgage loans over $250,000. For all commercial real estate loans, the Bank must properly evaluate environmental risks. It is also the Banks policy to
require title and hazard insurance on all mortgage loans. In addition, the Bank may require borrowers to make payments to a mortgage escrow account for the payment of property taxes. Any exceptions to the Banks loan policies must be made in
accordance with the limitations set out in each policy. Typically, the exception authority ranges from the Vice-President of Branch Administration to the Board of Directors, depending on the size and type of loan involved.



Delinquent Loans, Other Real Estate Owned and Classified Assets



Delinquent Loans.    The Senior Lending Officer
reviews the status of all delinquent loans on an on going basis. The actions taken by the Bank with respect to delinquencies vary depending upon the nature of the loan and the period of delinquency. Notices are generated by the Banks service
bureau when a loan is fifteen days past due. Collection letters are used in addition to and as a supplement to telephone calls. Where allowed, late charges are assessed once a loan becomes past due the required number of days.



On loans secured by one- to four-family residences, the Bank attempts to work
out a payment schedule with the borrower in order to avoid foreclosure. If a satisfactory payment plan is not arranged, the Bank typically refers the loan to legal counsel and foreclosure procedures are initiated after the 120th day of delinquency.
At any time prior to a sale of the property at foreclosure, foreclosure proceedings will be terminated if the borrower and the Bank are able to work out a satisfactory payment plan. On loans secured by commercial real estate properties, the Bank
also seeks to reach a satisfactory payment plan so as to avoid foreclosure. If a satisfactory payment plan is not arranged, the Bank typically refers the loan to legal counsel for foreclosure after the loan becomes 120 days past due. Prior to any
foreclosure, the Bank requires an updated appraisal of the property.



Other Real Estate Owned.    Property acquired through foreclosure or acceptance of a deed in lieu of foreclosure is classified in the Banks financial statements as other real estate owned (OREO).
When a property is placed in OREO, the excess of the loan balance over the estimated fair value is charged to the allowance for loan losses. Estimated fair value usually represents the sales price a buyer would be willing to pay on the basis of
current market conditions, including normal loan terms from other financial institutions, less estimated costs to sell the property. Management inspects all OREO properties periodically. When a decline in estimated fair value of a property is deemed
to have taken place, management establishes an allowance for such decline by a charge to income. The adequacy of the allowance for OREO is evaluated by management and reviewed with the Loan Committee on a quarterly basis, taking into consideration
each property in the portfolio and current real estate market conditions. At June 30, 2003, there was no OREO property held by the Bank.



Classified Assets.    Consistent with regulatory guidelines, the Bank provides for the classification of loans and other assets
considered to be of lesser quality. Such ratings coincide with the Substandard, Doubtful and Loss classifications used by regulators in their examination of financial institutions. Generally, an asset is



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##### Table of Contents

considered Substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged.
Substandard assets include those characterized by the distinct possibility that the insured financial institution will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all the weaknesses inherent in assets
classified Substandard with the added characteristic that the weaknesses present make collection in full, on the basis of currently existing facts, highly questionable and improbable. Assets classified as Loss are those considered uncollectible and
of such little value that their continuance as assets without the establishment of a specific loss reserve and/or charge-off is not warranted. Assets which do not currently expose the insured financial institution to sufficient risk to warrant
classification in one of the aforementioned categories but otherwise possess weaknesses are designated Special Mention.



When the Bank classifies problem assets as either Substandard or Doubtful, it establishes allocated valuation allowances or loss reserves in
an amount deemed prudent by management. Allocated allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to
particular problem assets. When the Bank classifies problem assets as Loss, it is required either to establish a specific allowance for losses equal to 100% of the amount of assets so classified, or to charge-off such amount. For such
loans that are also classified as impaired, an allowance is established when the collateral value of the impaired loans is lower than the carrying value of that loan. The Banks determination as to the classification of its assets and the
amount of its valuation allowance is subject to review by its regulatory agencies, which can order the establishment of additional general or specific loss allowances. The Bank reviews its portfolio monthly to determine whether any assets require
classification in accordance with applicable regulations.



On
the basis of managements review of its assets as June 30, 2003, the Bank had classified a total of $297,000 of its loans and other assets as Substandard and $12,000 of its loans and other assets as Doubtful, and no loans were classified as
Loss.



Non-Performing Assets. The table below sets forth
the amounts and categories of non-performing assets in the Banks loan portfolio. Loans are placed on non-accrual status when the collection of principal and/or interest become doubtful. Foreclosed assets include assets acquired in settlement
of loans.



|                                             |  | June 30,               |     
|-------------------------------------------- |  | ---------------------- | ----
|                                             |  | 2003                   |     
|                                             |  | (Dollars in Thousands) |     
|Non-accruing loans:                          |  |                        |     
|One  to-four-family real estate             |  | $                      |    
|Commercial and multi-family real estate      |  |                        |    
|Consumer                                     |  |                        | 12  
|Commercial business                          |  |                        | 297 
|                                             |  |                        |     
|Total                                        |  |                        | 309 
|                                             |  |                        |     
|Accruing loans delinquent more than 90 days: |  |                        |     
|One-  to four-family real estate             |  |                        |    
|Commercial and multi-family real estate      |  |                        |    
|Consumer                                     |  |                        |    
|                                             |  |                        |     
|Total                                        |  |                        |    
|                                             |  |                        |     
|Foreclosed assets                            |  |                        |    
|                                             |  |                        |     
|Total non-performing assets                  |  | $                      | 309 
|                                             |  |                        |     
|Total as a percentage of total assets        |  |                        | 0.10



In addition, the Bank
had troubled debt restructurings (which involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates). The loan balances were



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$16,000, $59,000 and $345,000, at June 30, 2001, 2000 and 1999 respectively. There were no troubled debt restructurings at June 30, 2003 or 2002.



The gross interest income that would have been recorded for the year ended
June 30, 2003, if non-performing loans had been current in accordance with their original terms was $39,000. The amount of interest income on these loans that was recorded to interest income during the year was $1,000.



Allowance for Loan Losses



The allowance for loan losses is established through provisions for loan
losses based on managements on-going evaluation of the risks inherent in the Banks loan portfolio. The allowance for loan losses is maintained at an amount management considers adequate to cover estimated losses in its loan portfolio
which are deemed probable and estimable based on information currently known to management. While the Bank believes that, based on information currently available, that it has established adequate allowances for losses on loans, there can be no
assurance that the level of allowance will be sufficient to cover loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions
considered by the Bank in evaluating the adequacy of the current level of the allowance.



The allowance for loan losses consists of allocated, general and unallocated components.



The allocated component of the allowance relates to loans that are individually evaluated for impairment and classified as either substandard, doubtful or
loss in accordance with the Banks internal grading system. The Bank generally evaluates individually commercial, commercial real estate, construction and delinquent residential loans for impairment. A loan is considered impaired when, based on
current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining
impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis,
taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan-by-loan basis using the fair value of existing collateral and a specific allowance amount is allocated.



The general component of the allowance is determined using a formula-based approach applied to groups of loans that possess
similar risk characteristics. The level of allowance allocated to each group is then determined by management applying a loss factor that estimates the amount of probable loss inherent in each category. The assigned loss factor is based on an
assessment on the probability of loss due to the following risk factors: (i) historical loss experience; (ii) the risk characteristics of the types of loans in the portfolio; (iii) growth of the loan portfolio; (iv) geographic and large borrower
concentrations; (v) current regional economic and real estate market conditions that could affect the ability of borrowers to pay; (vi) the value of underlying collateral; and (vii) trends in loan delinquencies.



A portion of the allowance for loan losses is not allocated to any specific
category of the loan portfolio. This unallocated portion, which historically does not represent more than 15% of the aggregate allowance amount, takes into consideration the nature of the loan loss estimation process and the variability in the risk
factors discussed above. The evaluation of the inherent loss resulting from these factors involves a higher degree of uncertainty because they are not identified with specific problem loans or portfolio categories. When an evaluation of these
conditions signifies a change in the level of risk, the Bank adjusts the unallocated portion of the allowance. Although the unallocated portion of the reserve is provided to absorb losses in excess of the amounts allocated to specific lending
categories, both allocated and unallocated components are available to absorb losses in any loan category.



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##### Table of Contents

For the year ended June 30, 2003 the Banks provision for loan losses was $570,000 compared with
$330,000 for the year ended June 30, 2002. The increase was consistent with the growth in loans, including the commercial loan portfolios, which generally present a greater risk of loss than residential loans. In addition, during the year the Bank
after considering current economic conditions and risk factors such as the increasing unemployment rate, declining consumer confidence, forecasts that called for a jobless recovery, continued weakness in corporate spending and the threat
of terrorism and war, increased the amount of allowance for loan losses required to be allocated to certain categories of loans. The allowance for loan losses was $1.7 million at June 30, 2003, which as a percentage of total loans was .96% compared
with .83% at June 30, 2002.



The following table sets forth
activity in the Banks allowance for loan losses for the years indicated.



|                                                                                      |  | Year Ended June 30,    |      
|------------------------------------------------------------------------------------- |  | ---------------------- | -----
|                                                                                      |  | 2003                   |      
|                                                                                      |  | (Dollars in Thousands) |      
|Balance at beginning of year                                                          |  | $                      | 1,258
|Charge-offs:                                                                          |  |                        |      
|Commercial and multi-family real estate                                               |  |                        |     
|Consumer                                                                              |  |                        | 9    
|Commercial business                                                                   |  |                        | 102  
|                                                                                      |  |                        |      
|Total charge-offs                                                                     |  |                        | 111  
|                                                                                      |  |                        |      
|Recoveries:                                                                           |  |                        |      
|Consumer                                                                              |  |                        | 27   
|Commercial business                                                                   |  |                        | 1    
|                                                                                      |  |                        |      
|Total recoveries                                                                      |  |                        | 28   
|                                                                                      |  |                        |      
|Net charge-offs                                                                       |  |                        | 83   
|Provision for loan losses                                                             |  |                        | 570  
|                                                                                      |  |                        |      
|Balance at end of year                                                                |  | $                      | 1,745
|                                                                                      |  |                        |      
|Ratio of net charge-offs during the year to average loans outstanding during the year |  |                        | 0.05 
|Ratio of net charge-offs during the year to average non-performing assets             |  |                        | 21.75



The distribution of
the Banks allowance for losses on loans at the dates indicated is summarized as follows:



|                                        |  | June 30,                   |      
|--------------------------------------- |  | -------------------------- | -----
|                                        |  | 2003                       |      
|                                        |  | Amountof LoanLossAllowance |      
|                                        |  | (Dollars in Thousands)     |      
|One- to four-family real estate         |  | $                          | 339  
|Commercial and multi-family real estate |  |                            | 650  
|Construction                            |  |                            | 240  
|Home equity                             |  |                            | 85   
|Consumer loans                          |  |                            | 19   
|Commercial business                     |  |                            | 279  
|Unallocated                             |  |                            | 133  
|                                        |  |                            |      
|Total                                   |  | $                          | 1,745
|                                        |  |                            |      



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Impact of Inflation and Changing Prices



The Consolidated Financial Statements and Notes thereto presented herein have been prepared in accordance with accounting
principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money
over time due to inflation. The impact of inflation is reflected in the increased cost of the Companys operations. Unlike industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result,
interest rates have a greater impact on the Companys performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.



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COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED



JUNE 30, 2003 AND JUNE 30, 2002



The Companys results of operations depend primarily on its net interest
income, which is the difference between the income earned on the Companys loan and securities portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the
Companys provision for loan losses, gains and losses from sales of securities, fee income and non-interest expenses. The Companys non-interest expenses consist principally of compensation and employee benefits, occupancy, equipment and
data processing, and other operating expenses. Results of operations are also significantly affected by general economic and competitive conditions, changes in interest rates, as well as government policies and actions of regulatory authorities.
Future changes in applicable law, regulations or government policies may materially affect the Company.



Net income for the year ended June 30, 2003 was $1.6 million compared with $1.3 million for 2002, an increase of $326,000, or 25.1%. This years
growth in net income over last year was primarily attributable to an increase of $771,000, or 8.7% in net interest income. Partially offsetting this increase was lower non-interest income of $68,000 due to a net loss on securities compared with a
net gain last year. In addition, total non-interest expense was $55,000, or 0.7% higher and the provision for loan losses was $240,000 higher. The return on average stockholders equity improved to 7.47% for the year ended June 30, 2003 from
6.78% last year. The return on average assets was 0.59% and 0.50% for the years ended June 30, 2003 and 2002, respectively.



Net Interest Income



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



Net interest income increased $771,000, or 8.7%, due largely to growth of $19.4 million, or 8.0%, in average earning assets over last year. In
addition, the Banks interest rate spread (the difference between yields earned on earning assets and rates paid on deposits and borrowings) increased from 3.24% for the year ended June 30, 2002 to 3.35% for the year ended June 30, 2003. The
interest rate margin (net interest income divided by average earning assets) also increased slightly from 3.67% last year to 3.69% this year.



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##### Table of Contents

Average Balance Sheet.    The following table presents, for the periods
indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent
adjustments were made. All average balances are monthly average balances. Non-accruing loans have been included in the table.



|                                                                       |  | Year Ended June 30,    |        
|---------------------------------------------------------------------- |  | ---------------------- | -------
|                                                                       |  | 2003                   |        
|                                                                       |  | AverageBalance         |        
|                                                                       |  | (Dollars in Thousands) |        
|Interest-earning assets:                                               |  |                        |        
|Loans(1)                                                               |  | $                      | 169,464
|Securities(2)                                                          |  |                        | 80,804 
|Short-term investments                                                 |  |                        | 10,515 
|                                                                       |  |                        |        
|Total interest-earning assets                                          |  |                        | 260,783
|                                                                       |  |                        |        
|Non-interest-earning assets                                            |  |                        | 17,100 
|                                                                       |  |                        |        
|Total assets                                                           |  | $                      | 277,883
|                                                                       |  |                        |        
|Interest-bearing liabilities:                                          |  |                        |        
|Savings deposits                                                       |  | $                      | 42,131 
|Money market deposits                                                  |  |                        | 24,414 
|NOW accounts                                                           |  |                        | 28,608 
|Certificates of deposit                                                |  |                        | 96,038 
|FHLB borrowings                                                        |  |                        | 34,598 
|                                                                       |  |                        |        
|Total interest-bearing liabilities                                     |  |                        | 225,789
|                                                                       |  |                        |        
|Demand deposits                                                        |  |                        | 29,234 
|Other non-interest bearing liabilities                                 |  |                        | 1,088  
|Stockholders equity                                                   |  |                        | 21,772 
|                                                                       |  |                        |        
|Total liabilities and stockholders equity                             |  | $                      | 277,883
|                                                                       |  |                        |        
|Net interest income                                                    |  |                        |        
|                                                                       |  |                        |        
|Net interest rate spread                                               |  |                        |        
|                                                                       |  |                        |        
|Net earning assets                                                     |  | $                      | 34,994 
|                                                                       |  |                        |        
|Net yield on average interest-earning assets                           |  |                        |        
|                                                                       |  |                        |        
|Average interest-earning assetsto average interest-bearing liabilities |  |                        |        

---

|(1) |  | Calculated net of deferred loan costs and premium, loans in process and allowance for loan losses.
|--- |  | --------------------------------------------------------------------------------------------------

|(2) |  | Securities include securities available for sale and held to maturity, FHLB stock and certificates of deposit.
|--- |  | --------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Rate/Volume Analysis.    The following table presents the approximate dollar
amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and those due to the changes in interest
rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes
in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.



|                              |  | Years Ended June 30, 2003 vs. 2002 |      
|----------------------------- |  | ---------------------------------- | -----
|                              |  | Increase (Decrease)Due to          |      
|                              |  | Volume                             |      
|                              |  | (Dollars in Thousands)             |      
|Interest and dividend income: |  |                                    |      
|Loans                         |  | $                                  | 2,223
|Securities                    |  |                                    | (732 
|Short-term investments        |  |                                    | (14  
|                              |  |                                    |      
|Total                         |  |                                    | 1,477
|                              |  |                                    |      
|Interest expense:             |  |                                    |      
|Savings deposits              |  |                                    | 71   
|Money market deposits         |  |                                    | 91   
|NOW accounts                  |  |                                    | 25   
|Certificates of deposit       |  |                                    | (59  
|FHLB borrowings               |  |                                    | (22  
|                              |  |                                    |      
|Total                         |  |                                    | 106  
|                              |  |                                    |      
|Net interest income           |  | $                                  | 1,371
|                              |  |                                    |      



Interest and
Dividend Income.    Total interest and dividend income decreased by $696,000, or 4.3%, from $16.2 million for the year ended June 30, 2002 to $15.5 million for the comparable period in 2003. The average loan portfolio
increased $32.6 million, or 23.8%, which increased interest income, however, the average yield on loans decreased 97 basis points to 6.45%. This decrease in yield reflects the effect of loan repricings and new loan originations at this years
lower market interest rates. The increased level of residential loan refinance activity in the Banks existing portfolio contributed to the amount of new loan volume priced at this years lower rates, and the increase in amortization
expense on deferred loan costs and premium which reduces interest income. Yield on the securities portfolio was lower and declined 68 basis points compared to 2002 to 5.46%. Certain investments within the Banks portfolio that matured, were
prepaid or called were reinvested in lower yielding investments. The average securities portfolio balance decreased $12.7 million, or 13.6%, which contributed to the lower interest income.



Interest Expense.    Interest expense on deposits
decreased $1.4 million, or 25.9%, from $5.4 million for the year ended June 30, 2002, to $4.0 million for the same period in 2003. The decrease was attributable to the decline in the cost of interest-bearing deposits of 97 basis points to 2.11%. The
decline in interest cost on deposits was the result of rate reductions in new certificate deposit offerings and on savings deposit products during the year. The rate reductions by management were in consideration of the downward trend in market
interest rates and the Banks funding requirements.



Interest expense on borrowings decreased by $60,000, or 3.2%. Average borrowings from the FHLB during the year ended June 30, 2003 decreased $410,000, or 1.2%, compared to last year. The cost of funds on these borrowings decreased from
5.36% to 5.25% between these periods. Borrowings are generally used to manage liquidity and asset-liability management performance of the Bank.



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Provision for Loan Losses



The provision for loan losses increased by $240,000, from $330,000 for the year ended June 30, 2002 to $570,000 for the
comparable period in 2003. The increase was consistent with the growth in loans, including the commercial loan portfolios, which generally present a greater risk of loss than residential loans. In addition, during the year the Bank, after
considering current economic conditions and risk factors in its loan portfolio, increased the allowance for loan losses required to be allocated to certain categories of loans. The allowance for loan losses was $1.7 million at June 30, 2003 and $1.3
million at June 30, 2002, or .96% and .83% of total loans outstanding at each respective year-end. While management believes that, based on information currently available, the Bank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 level of the Banks allowance will be sufficient to cover future loan losses incurred by the Bank or that future adjustments to the allowance will not be necessary
if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance.



Non-Interest Income



Total non-interest income decreased $68,000 from last year to $1.4 million for the year ended June 30, 2003. The decrease was largely the result of net
securities losses this year of $19,000, which included impairment write-downs of $118,000 net of gains from the sale of securities of $99,000, while net securities gains were $47,000 last year due to $398,000 in net gains from the sale of securities
net of $351,000 in write-downs. Customer service fees and other income totaled $1.4 million for the year ended June 30, 2003 consistent with last year.



The Company reviews its available for sale investment securities with unrealized depreciation to assess whether a decline in fair value is temporary or
other-than-temporary. The Company judges whether the decline in value is from company-specific events, industry developments, general economic conditions or other reasons. Once the estimated reasons for the decline are identified, further judgments
are required as to whether those conditions are likely to reverse and, if so, whether that reversal is likely to result in a recovery of the fair value of the investment in the near term. As part of the Companys quarterly review of the
investment securities portfolio, it was determined that the decline in the fair value of certain equity investment securities was other-than-temporary. As a result, the Company recorded impairment charges totaling $118,000 and $351,000 for the years
ending June 30, 2003 and 2002, respectively.



Non-Interest Expense



Total non-interest expense increased $55,000, or less
than 1%, to $8.0 million for the year ended June 30, 2003 compared with last year. Fiscal year 2002 included $150,000 in charges related to the cancellation of a property lease. Excluding these charges, total non-interest expense increased $205,000,
or only 2.6%, over last year. Salaries and benefits increased $268,000, or 7.0%, as the result of the growth in operations and enhancements in employee benefit plans as well as increases in benefit costs such as health insurance. Occupancy expense
and equipment expense decreased from last year due to lower depreciation expense as older fixed assets reached their depreciation lives and the Companys recent successful efforts in controlling fixed asset expenditures. Occupancy expense also
decreased due to a reduction in leased space for administrative offices. Data processing expense increased $48,000, or 7.2%, consistent with business growth. Professional fees increased this year due to additional legal fees related to new and
changing regulations and higher fees paid to new outsourced professional service providers such as internal audit and credit review. The decrease in other general and administrative expense was mostly due to the aforementioned lease cancellation
charges recorded last year.



Income Taxes



The effective income tax rate was 31.8% and 34.2% for the fiscal years ended
June 30, 2003 and 2002, respectively. The effective tax rates reflect the utilization by the Bank of certain tax preference items such as bank-owned life insurance, dividends received deductions and security corporation subsidiaries to reduce the
statutory corporate tax rates.



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##### Table of Contents

COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED



JUNE 30, 2002 AND JUNE 30, 2001



Net income for the year ended June 30, 2002 was $1.3 million compared with
$1.0 million for 2001, an increase of $343,000, or 35.8%. The growth in net income during fiscal year 2002 over 2001 was primarily attributable to increases of $1.5 million, or 20.0%, and $181,000, or 14.8%, in net interest income and non-interest
income excluding gains, respectively. Partially offsetting these items was an increase of $542,000, or 7.3%, in total operating expenses and a decrease in net securities gains of $320,000.



Net Interest Income



Net interest income increased $1.5 million, or 20.0%, during the year ended June 30, 2002 due largely to growth of $34.9
million, or 16.9%, in average earning assets over the previous year. In addition, the Banks interest rate spread (the difference between yields earned on earning assets and rates paid on deposits and borrowings) increased from 3.04% for the
year ended June 30, 2001 to 3.24% for the year ended June 30, 2002. The increase in interest rate spread reflects the Banks ability to successfully control its cost of funds through adjusting new deposit rate offerings during the declining
interest rate environment in fiscal year 2002. The interest rate margin (net interest income divided by average earning assets) also increased from 3.57% for the year ended June 30, 2001 to 3.67% for the year ended June 30, 2002.



Rate/Volume Analysis.    The following table
presents the approximate dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and
those due to the changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and
(ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the
change due to rate.



|                              |  | Years Ended June 30, 2002 vs. 2001 |      
|----------------------------- |  | ---------------------------------- | -----
|                              |  | Increase (Decrease) Due to         |      
|                              |  | Volume                             |      
|                              |  | (Dollars in Thousands)             |      
|Interest and dividend income: |  |                                    |      
|Loans                         |  | $                                  | 1,941
|Securities                    |  |                                    | 518  
|Short-term investments        |  |                                    | 76   
|                              |  |                                    |      
|Total                         |  |                                    | 2,535
|                              |  |                                    |      
|Interest expense:             |  |                                    |      
|Savings deposits              |  |                                    | 106  
|Money market deposits         |  |                                    | 114  
|NOW accounts                  |  |                                    | 27   
|Certificates of deposit       |  |                                    | 419  
|FHLB borrowings               |  |                                    | 451  
|                              |  |                                    |      
|Total                         |  |                                    | 1,117
|                              |  |                                    |      
|Net interest income           |  | $                                  | 1,418
|                              |  |                                    |      



Interest and
Dividend Income.    Total interest and dividend income increased by $532,000, or 3.4%, from $15.6 million for the year ended June 30, 2001 to $16.2 million for the comparable period in 2002. This increase



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was attributable to a $25.3 million, or 22.7%, increase in average loans over 2001, which was partially offset by an 87 basis point decrease in the total
loan yield to 7.42%. The loan yield decrease reflects the effect of loan repricings and new loan originations during the year ended June 30, 2002 with market interest rates that were lower than the previous year.



The average securities portfolio which increased $7.9 million, or 9.3%, also
contributed to the increase in interest income. However, the average yield on securities decreased 76 basis points to 6.14%. This decrease in yield was directly attributable to the purchase of additional securities and the reinvestment of
prepayments, calls and maturities in lower yielding securities during a declining rate environment.



Interest Expense.    Interest expense on deposits decreased $1.2 million, or 18.7%, from $6.7 million for the year ended June
30, 2001, to $5.4 million for the same period in 2002. The decrease was attributable to the decline in the cost of interest-bearing deposits of 123 basis points to 3.08%. The decline in interest cost on deposits was the result of rate reductions in
new certificate deposit offerings and on savings deposit products during fiscal year 2002.



Interest expense on borrowings increased by $309,000, or 19.4%. The Bank increased its use of borrowings from the FHLB during the year ended June 30, 2002 as average balances increased $7.9 million, or 29.0%, while
the cost of funds on these borrowings decreased from 5.87% to 5.36% between these periods.



Provision for Loan Losses



The provision for loan losses increased by $112,000, from $218,000 for the year ended June 30, 2001 to $330,000 for the comparable period in 2002. Management maintains the allowance for loan losses at a level to properly match loan credit
risk, especially in the commercial loan portfolio. The ratio of non-accruing loans to total assets increased to 0.14% at June 30, 2002, as compared to 0.06%, at June 30, 2001. The allowance for loan losses was $1.3 million at June 30, 2002 and $1.0
million at June 30, 2001, or .83% and .79% of total loans outstanding at each respective year-end.



Non-Interest Income



Total non-interest income decreased $236,000, or 14.0%, from $1.7 million for the year ended June 30, 2001 to $1.4 million for the year ended June 30, 2002. Gains on securities were $47,000 in 2002, $320,000 lower than 2001. Gains on
securities in 2002 were net of a $351,000 impairment charge. Non-interest income was also lower in comparison with 2001, which included a one-time gain of $97,000 on a pension plan settlement. Customer service charges and other income increased a
total of $181,000, or 14.8%, over 2001 mostly as a result of increased deposit, loan and business service fees consistent with the growth in these areas. Fees generated from the Financial Service Center at Strata Bank (Securities offered through
Linsco/Private Ledger, Member NASD, SIPC), in its first year of operation also contributed to the increase in non-interest income.



Non-Interest Expense



Total operating expense increased $542,000, or 7.3%, from $7.4 million for the year ended June 30, 2001 to $8.0 million for the year ended June 30, 2002.
Salaries and benefits, occupancy and equipment, and data processing expenses increased $170,000 or 4.6%, $16,000, or 1.0%, and $94,000, or 16.3%, respectively, consistent with the growth in operations over the past year. Other general and
administrative expense included a one-time $150,000 charge related to a lease termination.



Income Taxes



The
effective income tax rate was 34.2% and 31.4% for the fiscal years ended June 30, 2002 and 2001, respectively. The effective tax rates reflect the utilization by the Bank of certain tax preference items such as



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##### Table of Contents

bank-owned life insurance, dividends received deduction and security corporation subsidiaries to reduce the statutory corporate tax rates. The increase in
the effective rate in 2002 was due mostly to the effect of a decrease in the dividends received deduction in 2002 due to lower dividend income caused by the sale of equity securities during the year, and the effect of a decrease in the percentage of
tax preference items to pre-tax income due to the increase in pre-tax income in 2002.



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##### Table of Contents

ITEM 7.    Financial Statements.



TABLE OF CONTENTS



|                                                           |  | Page
|---------------------------------------------------------- |  | ----
|                                                           | 
|Independent Auditors Report                               |  | 40  
|                                                           | 
|Consolidated Balance Sheets                                |  | 41  
|                                                           | 
|Consolidated Statements of Income                          |  | 42  
|                                                           | 
|Consolidated Statements of Changes in Stockholders Equity |  | 43  
|                                                           | 
|Consolidated Statements of Cash Flows                      |  | 44  
|                                                           | 
|Notes to Consolidated Financial Statements                 |  | 45  



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##### Table of Contents

INDEPENDENT AUDITORS REPORT



To the Board of Directors and Stockholders of

Service Bancorp, Inc.



We have audited the accompanying consolidated balance sheets of Service Bancorp, Inc. and subsidiary as of June 30, 2003 and 2002, and the related
consolidated statements of income, changes in stockholders equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
financial position of Service Bancorp, Inc. and subsidiary as of June 30, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United
States of America.



LOGO

Boston, Massachusetts

July 24,
2003



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##### Table of Contents

SERVICE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, Except per Share Amounts)



|                                                                                    |  | June 30, |        
|----------------------------------------------------------------------------------- |  | -------- | -------
|                                                                                    |  | 2003     |        
|ASSETS                                                                              |  |          |        
|Cash and due from banks                                                             |  | $        | 8,728  
|Short-term investments                                                              |  |          | 28,372 
|                                                                                    |  |          |        
|Total cash and cash equivalents                                                     |  |          | 37,100 
|                                                                                    |  |          |        
|Certificate of deposit                                                              |  |          |       
|Securities available for sale, at fair value                                        |  |          | 53,601 
|Securities held to maturity, at amortized cost                                      |  |          | 17,557 
|Federal Home Loan Bank stock, at cost                                               |  |          | 1,948  
|Loans                                                                               |  |          | 181,667
|Less allowance for loan losses                                                      |  |          | (1,745 
|                                                                                    |  |          |        
|Loans, net                                                                          |  |          | 179,922
|                                                                                    |  |          |        
|Banking premises and equipment, net                                                 |  |          | 3,608  
|Accrued interest receivable                                                         |  |          | 1,390  
|Bank-owned life insurance, at cash surrender value                                  |  |          | 4,316  
|Other assets                                                                        |  |          | 504    
|                                                                                    |  |          |        
|Total assets                                                                        |  | $        | 299,946
|                                                                                    |  |          |        
|LIABILITIES AND STOCKHOLDERS EQUITY                                                |  |          |        
|Deposits                                                                            |  | $        | 239,929
|Federal Home Loan Bank advances                                                     |  |          | 35,232 
|Other liabilities                                                                   |  |          | 1,274  
|                                                                                    |  |          |        
|Total liabilities                                                                   |  |          | 276,435
|                                                                                    |  |          |        
|Commitments and contingencies (Note 12)                                             |  |          |        
|Stockholders equity:                                                               |  |          |        
|Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued           |  |          |       
|Common stock, $.01 par value, 12,000,000 shares authorized, 1,712,630 shares issued |  |          | 17     
|Additional paid-in capital                                                          |  |          | 7,502  
|Retained earnings                                                                   |  |          | 15,516 
|Accumulated other comprehensive income                                              |  |          | 1,475  
|Treasury stock, at cost (67,346 and 64,506 shares, respectively)                    |  |          | (631   
|Unearned ESOP shares (24,345 and 30,784 shares, respectively)                       |  |          | (243   
|Unearned RRP shares (17,461 and 19,680 shares, respectively)                        |  |          | (125   
|                                                                                    |  |          |        
|Total stockholders equity                                                          |  |          | 23,511 
|                                                                                    |  |          |        
|Total liabilities and stockholders equity                                          |  | $        | 299,946
|                                                                                    |  |          |        



See accompanying notes
to consolidated financial statements.



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##### Table of Contents

SERVICE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Thousands, Except Per Share Amounts)



|                                                                                               |  | Years Ended June 30,
|---------------------------------------------------------------------------------------------- |  | --------------------
|                                                                                               |  | 2003                
|Interest and dividend income:                                                                  |  |                     
|Interest and fees on loans                                                                     |  | $                   
|Interest and dividends on securities, Federal Home Loan Bank stock and certificates of deposit |  |                     
|Interest on short-term investments                                                             |  |                     
|                                                                                               |  |                     
|Total interest and dividend income                                                             |  |                     
|                                                                                               |  |                     
|Interest expense:                                                                              |  |                     
|Interest on deposits                                                                           |  |                     
|Interest on Federal Home Loan Bank advances                                                    |  |                     
|                                                                                               |  |                     
|Total interest expense                                                                         |  |                     
|                                                                                               |  |                     
|Net interest income                                                                            |  |                     
|Provision for loan losses                                                                      |  |                     
|                                                                                               |  |                     
|Net interest income, after provision for loan losses                                           |  |                     
|                                                                                               |  |                     
|Non-interest income:                                                                           |  |                     
|Customer service fees                                                                          |  |                     
|Net (loss) gain on securities available for sale                                               |  |                     
|Other income                                                                                   |  |                     
|                                                                                               |  |                     
|Total non-interest income                                                                      |  |                     
|                                                                                               |  |                     
|Non-interest expense:                                                                          |  |                     
|Salaries and employee benefits                                                                 |  |                     
|Occupancy                                                                                      |  |                     
|Data processing                                                                                |  |                     
|Equipment                                                                                      |  |                     
|Professional fees                                                                              |  |                     
|Advertising                                                                                    |  |                     
|Other general and administrative                                                               |  |                     
|                                                                                               |  |                     
|Total non-interest expense                                                                     |  |                     
|                                                                                               |  |                     
|Income before income taxes                                                                     |  |                     
|Provision for income taxes                                                                     |  |                     
|                                                                                               |  |                     
|Net income                                                                                     |  | $                   
|                                                                                               |  |                     
|Weighted average shares outstanding (basic)                                                    |  |                     
|                                                                                               |  |                     
|Weighted average shares outstanding (diluted)                                                  |  |                     
|                                                                                               |  |                     
|Earnings per share (basic)                                                                     |  | $                   
|                                                                                               |  |                     
|Earnings per share (diluted)                                                                   |  | $                   
|                                                                                               |  |                     



See accompanying notes
to consolidated financial statements.



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SERVICE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY



Years Ended June 30, 2003 and 2002

(Dollars in Thousands)



|                                                                                                                  |  | CommonStock |    | AdditionalPaid-inCapital |   |       | RetainedEarnings |  | AccumulatedOtherComprehensiveIncome (Loss) |        |  | TreasuryStock |       |   | UnearnedESOPShares |   |      | UnearnedRRPShares |  |   | Total |  
|----------------------------------------------------------------------------------------------------------------- |  | ----------- | -- | ------------------------ | - | ----- | ---------------- |  | ------------------------------------------ | ------ |  | ------------- | ----- | - | ------------------ | - | ---- | ----------------- |  | - | ----- | -
|Balance at June 30, 2001                                                                                          |  | $           | 17 |                          | $ | 7,409 |                  |  | $                                          | 12,588 |  | $             | (514  | ) |                    | $ | (560 | )                 |  | $ | (372  | )
|                                                                                                                  |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Comprehensive income:                                                                                             |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Net income                                                                                                        |  |             |   |                          |   |      |                  |  |                                            | 1,301  |  |               |      |   |                    |   |     |                   |  |   |      |  
|Change in net unrealized gain/loss on securities available for sale, net of taxes and reclassification adjustment |  |             |   |                          |   |      |                  |  |                                            |       |  |               | 519   |   |                    |   |     |                   |  |   |      |  
|                                                                                                                  |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Total comprehensive income                                                                                        |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|                                                                                                                  |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Common stock held by ESOP released and committed to be released (6,439 shares)                                    |  |             |   |                          |   | 24    |                  |  |                                            |       |  |               |      |   |                    |   |     |                   |  |   | 64    |  
|Stock option exercises (4,000 shares)                                                                             |  |             |   |                          |   | (3    | )                |  |                                            |       |  |               |      |   |                    |   | 33   |                   |  |   |      |  
|Amortization of RRP stock (8,604 shares)                                                                          |  |             |   |                          |   |      |                  |  |                                            |       |  |               |      |   |                    |   |     |                   |  |   |      |  
|                                                                                                                  |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Balance at June 30, 2002                                                                                          |  |             | 17 |                          |   | 7,430 |                  |  |                                            | 13,889 |  |               | 5     |   |                    |   | (527 | )                 |  |   | (308  | )
|                                                                                                                  |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Comprehensive income:                                                                                             |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Net income                                                                                                        |  |             |   |                          |   |      |                  |  |                                            | 1,627  |  |               |      |   |                    |   |     |                   |  |   |      |  
|Change in net unrealized gain/loss on securities available for sale, net of taxes and reclassification adjustment |  |             |   |                          |   |      |                  |  |                                            |       |  |               | 1,470 |   |                    |   |     |                   |  |   |      |  
|                                                                                                                  |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Total comprehensive income                                                                                        |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|                                                                                                                  |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Common stock held by ESOP released and committed to be released (6,439 shares)                                    |  |             |   |                          |   | 47    |                  |  |                                            |       |  |               |      |   |                    |   |     |                   |  |   | 65    |  
|Purchase of treasury stock (8,840 shares)                                                                         |  |             |   |                          |   |      |                  |  |                                            |       |  |               |      |   |                    |   | (160 | )                 |  |   |      |  
|Stock option exercises (6,000 shares)                                                                             |  |             |   |                          |   | (11   | )                |  |                                            |       |  |               |      |   |                    |   | 56   |                   |  |   |      |  
|Income tax benefit on options exercised                                                                           |  |             |   |                          |   | 6     |                  |  |                                            |       |  |               |      |   |                    |   |     |                   |  |   |      |  
|Amortization of RRP stock (2,219 shares)                                                                          |  |             |   |                          |   | 30    |                  |  |                                            |       |  |               |      |   |                    |   |     |                   |  |   |      |  
|                                                                                                                  |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  
|Balance at June 30, 2003                                                                                          |  | $           | 17 |                          | $ | 7,502 |                  |  | $                                          | 15,516 |  | $             | 1,475 |   |                    | $ | (631 | )                 |  | $ | (243  | )
|                                                                                                                  |  |             |    |                          |   |       |                  |  |                                            |        |  |               |       |   |                    |   |      |                   |  |   |       |  



See accompanying notes
to consolidated financial statements.



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##### Table of Contents

SERVICE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)



|                                                                                  |  | Years Ended June 30, |        
|--------------------------------------------------------------------------------- |  | -------------------- | -------
|                                                                                  |  | 2003                 |        
|Cash flows from operating activities:                                             |  |                      |        
|Net income                                                                        |  | $                    | 1,627  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                      |        
|Provision for loan losses                                                         |  |                      | 570    
|Loss (gain) on securities available for sale, net                                 |  |                      | 19     
|Net amortization on securities                                                    |  |                      | 358    
|Depreciation and amortization expense                                             |  |                      | 498    
|Decrease (increase) in accrued interest receivable                                |  |                      | 367    
|Net amortization of deferred loan costs and premiums                              |  |                      | 446    
|Increase in cash surrender value of bank-owned life insurance                     |  |                      | (163   
|Deferred tax (benefit) provision                                                  |  |                      | (152   
|Other, net                                                                        |  |                      | (547   
|                                                                                  |  |                      |        
|Net cash provided by operating activities                                         |  |                      | 3,023  
|                                                                                  |  |                      |        
|Cash flows from investing activities:                                             |  |                      |        
|Maturity of certificate of deposit                                                |  |                      | 100    
|Activity in securities available for sale:                                        |  |                      |        
|Sales                                                                             |  |                      | 9,148  
|Maturities, prepayments and calls                                                 |  |                      | 21,594 
|Purchases                                                                         |  |                      | (25,560
|Activity in securities held to maturity:                                          |  |                      |        
|Maturities, prepayments and calls                                                 |  |                      | 16,637 
|Purchases                                                                         |  |                      |       
|Net increase in loans excluding loan purchases                                    |  |                      | (17,181
|Purchases of loans                                                                |  |                      | (12,910
|Purchase of banking premises and equipment                                        |  |                      | (200   
|Purchase of Federal Home Loan Bank stock                                          |  |                      |       
|Purchase of bank-owned life insurance                                             |  |                      | (1,400 
|                                                                                  |  |                      |        
|Net cash used by investing activities                                             |  |                      | (9,772 
|                                                                                  |  |                      |        
|Cash flows from financing activities:                                             |  |                      |        
|Net increase in deposits                                                          |  |                      | 19,736 
|Proceeds from Federal Home Loan Bank advances                                     |  |                      | 5,174  
|Repayment of Federal Home Loan Bank advances                                      |  |                      | (4,736 
|Purchases of treasury stock                                                       |  |                      | (160   
|Repayment of ESOP loan                                                            |  |                      | 65     
|Stock option exercises                                                            |  |                      | 45     
|                                                                                  |  |                      |        
|Net cash provided by financing activities                                         |  |                      | 20,124 
|                                                                                  |  |                      |        
|Net change in cash and cash equivalents                                           |  |                      | 13,375 
|Cash and cash equivalents at beginning of year                                    |  |                      | 23,725 
|                                                                                  |  |                      |        
|Cash and cash equivalents at end of year                                          |  | $                    | 37,100 
|                                                                                  |  |                      |        
|Supplementary information:                                                        |  |                      |        
|Interest paid on deposits                                                         |  | $                    | 4,039  
|Interest paid on Federal Home Loan Bank advances                                  |  |                      | 1,842  
|Income taxes paid, net of refunds                                                 |  |                      | 749    
|Decrease (increase) in net amounts due from broker on securities transactions     |  |                      | 1,424  



See accompanying notes
to consolidated financial statements.



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##### Table of Contents

SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Years Ended June 30, 2003 and 2002



1.    CORPORATE STRUCTURE



Service Bancorp, Inc. (the Company) is a Massachusetts corporation organized in August 1998 for the purpose of
owning all of the outstanding capital stock of Strata Bank (the Bank). The Company was organized as a wholly-owned subsidiary of Service Bancorp, MHC (MHC), which is a Massachusetts-chartered mutual holding company.



On October 7, 1998, the Company completed a public offering of
47% of the shares of its outstanding common stock in a public offering to eligible depositors, employees, and members of the general public (the Offering). The remaining 53% of the Companys shares of common stock were issued to
MHC. Prior to that date, the Company had no assets or liabilities. As of June 30, 2003 the MHC owned 55.2% of the Companys outstanding common stock.



2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Basis of presentation and consolidation



The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank, which includes the Banks
wholly-owned subsidiaries, Medway Securities Corp. and Franklin Village Security Corp., which engage in the purchase and sale of securities. All significant intercompany balances and transactions have been eliminated in consolidation.



Business and operating segments



The Company provides a variety of financial services to individuals and
small businesses through its offices in the Massachusetts counties of Norfolk, Middlesex and Worcester. Its primary deposit products are savings, checking and term certificate accounts and its primary lending products are mortgage, consumer and
commercial loans.



Management evaluates the Companys
performance and allocates resources based on a single segment concept. Accordingly, there are no separately identified operating segments for which discrete financial information is available. The Company does not derive revenues from, or have
assets located in, foreign countries, nor does it derive revenues from any single customer that represents 10% or more of the Companys total revenues.



Use of estimates



In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to
make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and other-than-temporary securities impairment losses.



Reclassifications



Certain amounts in the 2002 consolidated financial statements have been
reclassified to conform to the 2003 presentation.



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##### Table of Contents

SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Cash equivalents



Cash equivalents include amounts due from banks and short-term investments. Short-term investments consist primarily of
federal funds sold, money market funds and other interest-bearing deposits which mature on a daily basis.



Restrictions on cash and amounts due from banks



The Company is required to maintain average cash balances on hand or with the Federal Reserve Bank. At June 30, 2003 and 2002, these reserve balances
amounted to $2,653,000, and $2,971,000, respectively.



Certificate of deposit



The certificate
of deposit, which matured during fiscal year 2003, was carried at cost.



Securities



Debt securities that
management has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. All other securities are classified as available for sale and are carried at fair value,
with unrealized gains and losses excluded from earnings and reported in other comprehensive income/loss.



Amortization of premiums and accretion of discounts on debt securities are computed using the interest method. Declines in the fair value of securities
below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.



In estimating other-than-temporary impairment losses, management considers independent price quotations, projected target prices of investment analysts
within the short term and the financial condition of the issuer. Gains and losses on sales are recorded on the trade date and are computed using the specific identification method.



Loans



The Company grants mortgage, consumer and commercial loans to its customers. A substantial portion of the loan portfolio consists of mortgage loans in
Norfolk County, Middlesex County and Worcester County. The ability of the Companys debtors to honor their contracts is dependent, among other factors, upon the local economy and the local real estate market.



Loans, as reported, have been adjusted by the allowance for loan losses and
net deferred loan costs and premiums.



Income on loans,
including impaired loans, is recognized on the simple interest basis and is not accrued when in the judgment of management the collectibility of the loan principal or interest becomes doubtful. In 2003, loans delinquent 90 days or more are placed on
non-accrual status. Delinquent status is based on contractual terms of the loan.



Net deferred loan costs and premiums are amortized over the contractual lives of the related loans using the interest method.



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##### Table of Contents

SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



A loan is considered impaired when, based on current information and events, it is probable that the
Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value,
and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of
payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrowers prior payment
record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis using the fair value of existing collateral.



Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does
not separately identify individual consumer loans for impairment disclosures.



Allowance for loan losses



The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.



The allowance for loan losses is evaluated on a regular basis by management and is based upon managements periodic review of the collectibility of
the loans in light of known and inherent risks in the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any underlying collateral and prevailing economic conditions.
This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.



The allowance consists of allocated, general and unallocated components. The allocated component relates to loans that are classified as either doubtful,
substandard or loss. For such loans that are also classified as impaired, an allowance is established when the collateral value of the impaired loans is lower than the carrying value of that loan. The general component covers non-classified loans
and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect managements estimate of probable losses. The unallocated component of the allowance
reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating losses in the portfolio.



Banking premises and equipment



Land is carried at cost. Buildings, leasehold improvements and equipment are stated at cost less accumulated depreciation and amortization computed on the
straight-line method over the estimated useful lives of the assets or the expected terms of the leases, if shorter.



Income taxes



Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted accordingly through the provision for income taxes. The Banks base amount of its federal income
tax reserve for loan losses is a permanent difference for which there is no recognition of a deferred tax liability. However, the loan loss allowance maintained for financial reporting purposes is a temporary difference with allowable recognition of
a related deferred tax asset, if it is deemed realizable.



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Stock compensation plans



The Company measures the unearned compensation cost, reflected as a reduction of stockholders equity, for its
Recognition and Retention Plan (RRP) based on the fair value of the stock at the grant date. Compensation cost is recognized over the vesting period.



The Company measures compensation cost for its Stock Option Plan using the intrinsic value based method of accounting,
whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Companys Stock
Option Plan have no intrinsic value at the grant date and no compensation cost is recognized for them. The Company is required to make pro forma disclosures of net income and earnings per share as if compensation cost had been measured at the grant
date based on the fair value of the award and recognized over the service period, which is usually the vesting period. (See Note 11.)



Employee Stock Ownership Plan (ESOP)



Compensation expense is recognized based on the fair value of shares committed to be released to the ESOP. All shares held by the ESOP that are
released and committed to be released are deemed outstanding for purposes of earnings per share calculations. The value of unearned shares to be allocated to ESOP participants for future services not yet performed is reflected as a reduction of
stockholders equity.



Advertising Costs



Advertising costs are expensed as incurred.



Earnings per share



Basic earnings per share represents income available to common stockholders
divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares (common stock equivalents) that would have been outstanding if dilutive potential common shares had
been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options and unvested stock granted under the RRP and are determined
using the treasury stock method. Assumed conversion of the outstanding dilutive stock options and unvested RRP stock would increase the shares outstanding but would not require an adjustment to income as a result of the conversion. For the year
ended June 30, 2003, 25,582 average dilutive stock options and 3,948 average unvested shares of RRP stock were included in the diluted earnings per share computation. For the year ended June 30, 2002, 20,990 average dilutive stock options and 3,807
average unvested shares of RRP stock were included in the diluted earnings per share computation. For the year ended June 30,2003, there were no anti-dilutive common stock equivalents. For the year ended June 30, 2002, an average of 3,001 stock
options and an average 2,294 unvested shares of RRP stock were anti-dilutive and therefore excluded from the earnings per share calculation.



Comprehensive income/loss



Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets
and liabilities, such as unrealized gains and losses on securities, are reported as a separate component of the equity section of the consolidated balance sheet, such items, along with net income, are components of comprehensive income/loss.



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The components of other comprehensive income/loss and related tax effects are as follows:



|                                                                      |  | Years Ended June 30,   |      
|--------------------------------------------------------------------- |  | ---------------------- | -----
|                                                                      |  | 2003                   |      
|                                                                      |  | (Dollars in Thousands) |      
|Unrealized holding gains on securities available for sale             |  | $                      | 2,240
|Reclassification adjustment for net losses (gains) realized in income |  |                        | 19   
|                                                                      |  |                        |      
|Net unrealized gains                                                  |  |                        | 2,259
|Tax effect                                                            |  |                        | (789 
|                                                                      |  |                        |      
|Net-of-tax amount                                                     |  | $                      | 1,470
|                                                                      |  |                        |      



Recent
accounting pronouncements



In October 2002, the
Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 147, Acquisitions of Certain Financial Institutions. This Statement amends SFAS No. 72, SFAS No. 144 and
FASB Interpretation No. 9, and provides guidance on the application of the purchase method to acquisitions of financial institutions and includes guidance on the recognition and measurement of intangible assets associated with such acquisitions.
This Statement is generally effective for acquisitions occurring on or after October 1, 2002. This Statement did not have any effect on the Companys consolidated financial statements.



In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, and provides three alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123. The transition guidance and annual disclosure provisions of this Statement are effective for fiscal years ending after
December 15, 2002 and the interim period disclosure provisions are effective for interim periods beginning after December 31, 2002. This Statement did not have any effect on the Companys consolidated financial statements.



On April 30, 2003, the FASB issued SFAS No. 149, Amendment of Statement
133 on Derivative Instruments and Hedging Activities. This Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. This Statement is effective for contracts entered into or modified after June 30, 2003, except in certain circumstances, and for hedging relationships
designated after June 30, 2003. This Statement is not expected to have a material effect on the Companys consolidated financial statements.



On May 15, 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and
Equity. This Statement provides new rules on the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. Most of the guidance in SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 30, 2003. This Statement is not expected to have a material effect on the Companys consolidated financial
statements.



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



3.    SECURITIES



A summary of securities follows:



|                                          |  | June 30, 2003         
|----------------------------------------- |  | ----------------------
|                                          |  | AmortizedCost         
|                                          |  | (Dollars in Thousands)
|Securities Available for Sale             |  |                       
|Federal agency securities                 |  | $                     
|Federal agency mortgage-backed securities |  |                       
|Other debt securities                     |  |                       
|                                          |  |                       
|Total debt securities available for sale  |  |                       
|Marketable equity securities              |  |                       
|                                          |  |                       
|Total securities available for sale       |  | $                     
|                                          |  |                       
|Securities Held to Maturity               |  |                       
|Federal agency mortgage-backed securities |  | $                     
|Other debt securities                     |  |                       
|                                          |  |                       
|Total securities held to maturity         |  | $                     
|                                          |  |                       



|                                          |  | June 30, 2002         
|----------------------------------------- |  | ----------------------
|                                          |  | AmortizedCost         
|                                          |  | (Dollars in Thousands)
|Securities Available for Sale             |  |                       
|Federal agency securities                 |  | $                     
|Federal agency mortgage-backed securities |  |                       
|Other debt securities                     |  |                       
|                                          |  |                       
|Total debt securities available for sale  |  |                       
|Marketable equity securities              |  |                       
|                                          |  |                       
|Total securities available for sale       |  | $                     
|                                          |  |                       
|Securities Held to Maturity               |  |                       
|Federal agency mortgage-backed securities |  | $                     
|Other debt securities                     |  |                       
|                                          |  |                       
|Total securities held to maturity         |  | $                     
|                                          |  |                       



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The amortized cost and estimated fair value of debt securities by contractual maturity at June 30,
2003 follows. Expected maturities will differ from contractual maturities because the issuer may have the right to call or prepay obligations with or without call or prepayment penalties.



|                                          |  | Securities Availablefor Sale |        | Securities Held toMaturity
|----------------------------------------- |  | ---------------------------- | ------ | --------------------------
|                                          |  | AmortizedCost                |        | FairValue                 
|                                          |  | (Dollars in Thousands)      
|Within 1 year                             |  | $                            | 639    |                           
|Over 1 year to 5 years                    |  |                              | 25,356 |                           
|Over 5 years to 10 years                  |  |                              | 9,562  |                           
|Over 10 years                             |  |                              | 2,449  |                           
|                                          |  |                              | 38,006 |                           
|                                          |  |                              |        |                           
|                                          |  |                              |        |                           
|Federal agency mortgage-backed securities |  |                              | 12,292 |                           
|                                          |  |                              |        |                           
|Total debt securities                     |  | $                            | 50,298 |                           
|                                          |  |                              |        |                           



At June 30,2003, a
federal agency mortgage-backed security with an amortized cost and fair value of $1,040,000 and $1,047,000, respectively, was pledged to secure the Companys treasury tax and loan account.



Proceeds from the sale of securities available for sale, including amounts
due from brokers on unsettled sales, during fiscal 2003 and 2002 were $1.6 million and $33.6 million, respectively. Gross gains of $99,000 and $1,047,000, and gross losses of $0 and $649,000, were realized during fiscal 2003 and 2002, respectively.
In addition, for the years ended June 30, 2003 and 2002, the Company recognized impairment losses on securities amounting to $118,000 and $351,000, respectively.



The net unrealized loss of $10,000 and $21,000 related to securities transferred from available for sale to held to maturity
in prior years is included in accumulated other comprehensive income, net of tax, at June 30, 2003 and 2002, respectively.



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



4.    LOANS



A summary of the balances of loans follows:



|                                     |  | June 30,               |        
|------------------------------------ |  | ---------------------- | -------
|                                     |  | 2003                   |        
|                                     |  | (Dollars in Thousands) |        
|Real estate loans:                   |  |                        |        
|Residential                          |  | $                      | 96,830 
|Commercial and multi-family          |  |                        | 41,522 
|Construction                         |  |                        | 12,059 
|                                     |  |                        |        
|Total real estate loans              |  |                        | 150,411
|                                     |  |                        |        
|Commercial loans                     |  |                        | 13,530 
|                                     |  |                        |        
|Consumer loans:                      |  |                        |        
|Home equity                          |  |                        | 10,271 
|Second mortgages                     |  |                        | 5,106  
|Passbook secured                     |  |                        | 494    
|Other                                |  |                        | 1,054  
|                                     |  |                        |        
|Total consumer loans                 |  |                        | 16,925 
|                                     |  |                        |        
|Total gross loans                    |  |                        | 180,866
|Net deferred loan costs and premiums |  |                        | 801    
|Allowance for loan losses            |  |                        | (1,745 
|                                     |  |                        |        
|Total loans, net                     |  | $                      | 179,922
|                                     |  |                        |        



An analysis of the
allowance for loan losses follows:



|                             |  | Years Ended June 30,   |      
|---------------------------- |  | ---------------------- | -----
|                             |  | 2003                   |      
|                             |  | (Dollars in Thousands) |      
|Balance at beginning of year |  | $                      | 1,258
|Provision for loan losses    |  |                        | 570  
|Recoveries                   |  |                        | 28   
|Charge-offs                  |  |                        | (111 
|                             |  |                        |      
|Balance at end of year       |  | $                      | 1,745
|                             |  |                        |      



Impaired loans at June
30, 2003 and 2002 amounted to $297,000 and $647,000, respectively, none of which required a corresponding valuation allowance. No additional funds are committed to be advanced in connection with impaired loans. Non-accrual loans at June 30, 2003 and
2002 amounted to $309,000 and $384,000, respectively.



For the
years ended June 30, 2003 and 2002, the average recorded investment in impaired loans amounted to $399,000 and $366,000, respectively, and interest income recognized on impaired loans amounted to $12,000 and $27,000, respectively, substantially all
on a cash basis.



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



5.    BANKING PREMISES AND EQUIPMENT



A summary of the cost and accumulated depreciation and amortization of
banking premises and equipment follows:



|                                               |  | June 30,               |        |   |     
|---------------------------------------------- |  | ---------------------- | ------ | - | ----
|                                               |  | 2003                   |        |   | 2002
|                                               |  | (Dollars in Thousands) |        |   |     
|Banking premises:                              |  |                        |        |   |     
|Land                                           |  | $                      | 1,582  |   |     
|Building and leasehold improvements            |  |                        | 3,143  |   |     
|Equipment and furniture                        |  |                        | 2,589  |   |     
|                                               |  |                        |        |   |     
|                                               |  |                        | 7,314  |   |     
|Less accumulated depreciation and amortization |  |                        | (3,706 | ) |     
|                                               |  |                        |        |   |     
|                                               |  | $                      | 3,608  |   |     
|                                               |  |                        |        |   |     



Depreciation and
amortization expense for the years ended June 30, 2003 and 2002 amounted to $498,000 and $626,000, respectively.



6.    DEPOSITS



A summary of deposit balances by type follows:



|                                         |  | June 30,              
|---------------------------------------- |  | ----------------------
|                                         |  | 2003                  
|                                         |  | (Dollars in Thousands)
|Demand                                   |  | $                     
|NOW                                      |  |                       
|Money market deposits                    |  |                       
|Regular and other savings                |  |                       
|                                         |  |                       
|Total non-certificate accounts           |  |                       
|                                         |  |                       
|Term certificates of $100,000 or greater |  |                       
|Term certificates less than $100,000     |  |                       
|                                         |  |                       
|Total certificate accounts               |  |                       
|                                         |  |                       
|Total deposits                           |  | $                     
|                                         |  |                       



A summary of
certificate accounts by maturity follows:



|                        |  | June 30, 2003          |        |                     | June 30, 2002 |  
|----------------------- |  | ---------------------- | ------ | ------------------- | ------------- | -
|                        |  | Amount                 |        | WeightedAverageRate |               |  
|                        |  | (Dollars in Thousands) |       
|Within 1 year           |  | $                      | 56,378 |                     | 2.42          | %
|Over 1 year to 3 years  |  |                        | 31,155 |                     | 2.97          |  
|Over 3 years to 4 years |  |                        | 3,269  |                     | 3.64          |  
|                        |  |                        |        |                     |               |  
|                        |  | $                      | 90,802 |                     | 2.65          | %
|                        |  |                        |        |                     |               |  



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



7.    FEDERAL HOME LOAN BANK ADVANCES



A summary of Federal Home Loan Bank (FHLB) fixed-rate advances,
by maturity, follows:



|                          |  | June 30, 2003          |        |                     | June 30, 2002 |  
|------------------------- |  | ---------------------- | ------ | ------------------- | ------------- | -
|                          |  | Amount                 |        | WeightedAverageRate |               |  
|                          |  | (Dollars in Thousands) |       
|Within 1 year             |  | $                      | 2,000  |                     | 3.54          | %
|Over 1 year to 3 years    |  |                        | 6,000  |                     | 3.94          |  
|Over 3 years to 5 years   |  |                        | 7,000  |                     | 6.03          |  
|Over 5 years to 10 years  |  |                        | 19,500 |                     | 5.39          |  
|Over 10 years to 20 years |  |                        | 732    |                     | 6.74          |  
|                          |  |                        |        |                     |               |  
|                          |  | $                      | 35,232 |                     | 5.20          | %
|                          |  |                        |        |                     |               |  



A summary of FHLB
advances by the earlier of the maturity date or the date callable by the FHLB follows:



|                          |  | June 30, 2003          |        |                     | June 30, 2002 |  
|------------------------- |  | ---------------------- | ------ | ------------------- | ------------- | -
|                          |  | Amount                 |        | WeightedAverageRate |               |  
|                          |  | (Dollars in Thousands) |       
|Within 1 year             |  | $                      | 30,500 |                     | 5.40          | %
|Over 1 year to 3 years    |  |                        | 4,000  |                     | 3.36          |  
|Over 10 years to 20 years |  |                        | 732    |                     | 6.74          |  
|                          |  |                        |        |                     |               |  
|                          |  | $                      | 35,232 |                     | 5.20          | %
|                          |  |                        |        |                     |               |  



At June 30, 2003, the
Bank had the borrowing capacity with the FHLB to increase the amount of outstanding advances by $36.5 million to $71.7 million. At June 30, 2002, the Bank had borrowing capacity with the FHLB to increase the amount of outstanding advances by $25.7
million to $60.5 million. The Bank also has an available line of credit with the FHLB at an interest rate that adjusts daily. Borrowings under the line were limited to $4.0 million at June 30, 2003 and 2002. All borrowings from the FHLB are secured
by a blanket lien primarily on real estate loans in accordance with the FHLB agreement.



8.    INCOME TAXES



Allocation of federal and state income taxes between current and deferred portions is follows:



|                                  |  | Years Ended June 30,  
|--------------------------------- |  | ----------------------
|                                  |  | 2003                  
|                                  |  | (Dollars in Thousands)
|Current tax provision:            |  |                       
|Federal                           |  | $                     
|State                             |  |                       
|                                  |  |                       
|Total current                     |  |                       
|                                  |  |                       
|Deferred tax provision (benefit): |  |                       
|Federal                           |  |                       
|State                             |  |                       
|                                  |  |                       
|Total deferred                    |  |                       
|                                  |  |                       
|                                  |  | $                     
|                                  |  |                       



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The reasons for the differences between the effective tax rate and the statutory federal income tax
rate are summarized as follows:



|                                        |  | Years Ended June 30, |  
|--------------------------------------- |  | -------------------- | -
|                                        |  | 2003                 |  
|Statutory rate                          |  | 34.0                 | %
|Increase (decrease) resulting from:     |  |                      |  
|State taxes, net of federal tax benefit |  | .2                   |  
|Cash surrender value of life insurance  |  | (2.2                 | )
|Dividends received deduction            |  | (0.3                 | )
|Other                                   |  | 0.1                  |  
|                                        |  |                      |  
|Effective tax rate                      |  | 31.8                 | %
|                                        |  |                      |  



The components of the
net deferred tax (liability) asset are as follows:



|                                   |  | June 30,               |       
|---------------------------------- |  | ---------------------- | ------
|                                   |  | 2003                   |       
|                                   |  | (Dollars in Thousands) |       
|Deferred tax asset:                |  |                        |       
|Federal                            |  | $                      | 804   
|State                              |  |                        | 274   
|                                   |  |                        |       
|                                   |  |                        | 1,078 
|                                   |  |                        |       
|Deferred tax liability:            |  |                        |       
|Federal                            |  |                        | (1,004
|State                              |  |                        | (117  
|                                   |  |                        |       
|                                   |  |                        | (1,121
|                                   |  |                        |       
|Net deferred tax (liability) asset |  | $                      | (43   
|                                   |  |                        |       



The tax effects of
each type of income and expense item that give rise to deferred tax assets (liabilities) are as follows:



|                                   |  | June 30,               |     
|---------------------------------- |  | ---------------------- | ----
|                                   |  | 2003                   |     
|                                   |  | (Dollars in Thousands) |     
|Allowance for loan losses          |  | $                      | 714 
|Net unrealized gain on securities  |  |                        | (793
|Employee benefit plans             |  |                        | 92  
|Net deferred loan costs            |  |                        | (314
|Depreciation and amortization      |  |                        | 210 
|Other                              |  |                        | 48  
|                                   |  |                        |     
|Net deferred tax (liability) asset |  | $                      | (43 
|                                   |  |                        |     



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



A summary of the change in the net deferred tax balance is as follows:



|                                                                        |  | Years Ended June 30,   |     
|----------------------------------------------------------------------- |  | ---------------------- | ----
|                                                                        |  | 2003                   |     
|                                                                        |  | (Dollars in Thousands) |     
|Net deferred tax asset balance at beginning of year                     |  | $                      | 594 
|Deferred tax benefit (provision)                                        |  |                        | 152 
|Change in deferred tax effect of net unrealized gain/loss on securities |  |                        | (789
|                                                                        |  |                        |     
|Net deferred tax (liability) asset balance at end of year               |  | $                      | (43 
|                                                                        |  |                        |     



There was no valuation
reserve required on deferred tax assets for the years ended June 30, 2003 and 2002.



The federal income tax reserve for loan losses at the Banks base year is $1.1 million. If any portion of the reserve is used for purposes other than to absorb loan losses, approximately 150% of the amount
actually used, limited to the amount of the reserve, would be subject to taxation in the fiscal year in which used. As the Bank intends to use the reserve solely to absorb loan losses, a deferred tax liability of $467,000 has not been provided.



9.    STOCKHOLDERS EQUITY



Minimum regulatory capital requirements



The Company (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Companys and the Banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that
involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Banks capital amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to the Company.



Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier 1
capital (as defined) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that the Company and the Bank meet all capital adequacy requirements to which they are subject.



As of June 30, 2003, 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 the Banks actual
capital amounts and ratios are also presented in the table.



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



|                                        |  | Actual                 |        |       | MinimumCapitalRequirement |   |        | Minimum To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|--------------------------------------- |  | ---------------------- | ------ | ----- | ------------------------- | - | ------ | --------------------------------------------------------------------- | ------
|                                        |  | Amount                 |        | Ratio |                           |   | Amount |                                                                       | Ratio 
|                                        |  | (Dollars in Thousands) |       
|June 30, 2003:                          |  |                        |        |       |                           |   |        |                                                                       |       
|Total capital to risk weighted assets:  |  |                        |        |       |                           |   |        |                                                                       |       
|Consolidated                            |  | $                      | 23,619 |       | 11.37                     | % |        | $                                                                     | 16,619
|Bank                                    |  |                        | 21,416 |       | 10.32                     |   |        |                                                                       | 16,619
|Tier 1 capital to risk weighted assets: |  |                        |        |       |                           |   |        |                                                                       |       
|Consolidated                            |  |                        | 21,874 |       | 10.53                     |   |        |                                                                       | 8,310 
|Bank                                    |  |                        | 19,761 |       | 9.48                      |   |        |                                                                       | 8,310 
|Tier 1 capital to average assets:       |  |                        |        |       |                           |   |        |                                                                       |       
|Consolidated                            |  |                        | 21,874 |       | 7.77                      |   |        |                                                                       | 11,265
|Bank                                    |  |                        | 19,671 |       | 6.99                      |   |        |                                                                       | 11,265
|                                        |  |                        |        |       |                           |  
|June 30, 2002:                          |  |                        |        |       |                           |   |        |                                                                       |       
|Total capital to risk weighted assets:  |  |                        |        |       |                           |   |        |                                                                       |       
|Consolidated                            |  | $                      | 21,352 |       | 12.00                     | % |        | $                                                                     | 14,241
|Bank                                    |  |                        | 18,101 |       | 10.17                     |   |        |                                                                       | 14,241
|Tier 1 capital to risk weighted assets: |  |                        |        |       |                           |   |        |                                                                       |       
|Consolidated                            |  |                        | 20,094 |       | 11.29                     |   |        |                                                                       | 7,120 
|Bank                                    |  |                        | 16,843 |       | 9.46                      |   |        |                                                                       | 7,120 
|Tier 1 capital to average assets:       |  |                        |        |       |                           |   |        |                                                                       |       
|Consolidated                            |  |                        | 20,094 |       | 7.50                      |   |        |                                                                       | 10,716
|Bank                                    |  |                        | 16,843 |       | 6.29                      |   |        |                                                                       | 10,716



Liquidation
account



At the time of the Offering, the Company
established a liquidation account in the amount of $4.6 million. In accordance with Massachusetts statute, the liquidation account will be maintained for the benefit of eligible account holders who continue to maintain their accounts in the Bank
after the Offering. The liquidation account will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holders interest in the
liquidation account. In the event of a complete liquidation, each eligible account holder will be entitled to receive a distribution in an amount equal to their current adjusted liquidation account balance, to the extent that funds are available.



Other capital restrictions



Federal and state banking regulations place certain restrictions on
dividends paid and loans or advances made by the Bank to the Company. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the Bank, and loans or advances are limited to 10% of the Banks
capital stock and surplus on a secured basis. In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Banks capital to be reduced below applicable minimum capital requirements.
Accordingly, at June 30, 2003, $16.6 million of the Companys equity in the Bank was restricted and funds available for loans or advances amounted to $2.1 million.



57



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##### Table of Contents

SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Stock Repurchase Plan



In February 2003, the Board of Directors of the Company approved a Stock Repurchase Plan under which the Company is
authorized to acquire up to 4% of the outstanding common stock, or up to approximately 65,925 shares of the issued and outstanding shares of its common stock in the open market or in private transactions. Under the Stock Repurchase Plan, shares may
be repurchased from time to time and in such amounts as market conditions warrant, and subject to regulatory considerations. As of June 30, 2003, 8,840 shares had been repurchased under the plan at an average price of $18.10.



10.    RETIREMENT BENEFIT AND INCENTIVE PLANS



401(k) plan



The Bank provides a savings plan which qualifies under Section 401(k) of the
Internal Revenue Code and provides for voluntary contributions by participating employees equal to the maximum amount allowed by federal regulations. The Bank makes matching contributions equal to 100% of each employees voluntary contribution,
up to 4% of the employees compensation. Total expense under the plan for the years ended June 30, 2003 and 2002 amounted to $88,000 and $81,000, respectively.



Supplemental retirement agreements



The Bank has supplemental retirement agreements with the directors of the Bank under the Directors Supplemental Retirement
Plan, which provide for compensation payments upon retirement, subject to certain limitations as set forth in the agreements. Retirement benefits are based on the performance of related life insurance policies purchased by the Bank and are accrued
on a current basis. Compensation expense applicable to these agreements amounted to $66,000 and $59,000 for the years ended June 30, 2003 and 2002, respectively.



The Bank entered into a supplemental retirement agreement with its President in March 2003, which provides supplemental
compensation payments upon retirement, subject to certain limitations as set forth in the agreement. The present value of future benefits is being accrued over the term of employment. Compensation expense applicable to the agreement amounted to
$18,000 for the year ended June 30, 2003.



Employee
incentive plan



The Bank has an Employee Incentive
Plan (EIP plan) whereby employees who meet certain eligibility requirements receive a bonus proportionate to their respective salary. The total available bonus pool is based on the Banks fiscal performance and the structure of the
EIP plan is reviewed annually by the Board of Directors. The EIP plan compensation expense for the years ended June 30, 2003 and 2002 was $164,000 and $181,000, respectively.



11.    STOCK COMPENSATION PLANS AND ESOP



Stock Option Plan



On September 1, 1999, the Board of Directors approved the 1999 Stock Option Plan (the Plan) which was approved by stockholders in 1999. Under
the Plan as in effect during the year ended June 30, 2003, the Company may grant options to its directors, officers and employees for up to 80,494 shares of common stock. Both incentive stock options and non-qualified stock options may be granted
under the Plan. The exercise price of each option equals the market price of the Companys stock on the date of grant and an options maximum term is ten years. Shares awarded vest in five equal annual installments and become fully vested
upon the recipients retirement.



58



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##### Table of Contents

SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Plan also permits the inclusion of limited rights, reload options and dividend equivalent rights.



Limited rights would permit the optionee to surrender an
option, or portion thereof, for cancellation and to receive cash or common stock equal to the excess, if any, of the then fair market value of the common stock subject to such option or portion thereof over the option exercise price. Limited rights
can only be exercised upon a change in control (as defined in the Plan) and, if the related options are exercised or terminated, the related rights are terminated. Limited rights with respect to 8,807 and 9,000 options were granted during fiscal
years 2003 and 2002, respectively, and 200 and 6,500 options were forfeited during fiscal years 2003 and 2002, respectively. Limited rights with respect to 6,000 and 3,000 options were terminated upon exercise of the related options during fiscal
years 2003 and 2002, respectively. Limited rights with respect to 38,294 and 35,687 options were outstanding at June 30, 2003 and 2002, respectively.



Reload options would permit the exchange of shares of stock in satisfaction of all or a portion of the exercise price of the original option grant. The
exercise price of the stock subject to the reload option will be determined at the time the original option is exercised. Dividend equivalent rights would permit the optionee to receive a cash benefit per share underlying the related vested stock
options outstanding in the amount of any extraordinary dividend (as defined in the Plan) declared by the Company. Reload options and dividend equivalent rights were granted with respect to all options granted during fiscal 2003 and 2002.



The Company measures compensation cost for the stock option plan using the
intrinsic value based method of accounting. Had compensation cost for the Companys stock option plan been determined using the fair value method based on the Black-Scholes option-pricing model at the grant dates, the Companys net income
and earnings per share would have been reduced to the following amounts:



|                                                                                                   |  | Years ended June 30,                           
|-------------------------------------------------------------------------------------------------- |  | -----------------------------------------------
|                                                                                                   |  | 2003                                           
|                                                                                                   |  | (Dollars in Thousands,Except Per Share Amounts)
|Net income, as reported                                                                            |  | $                                              
|Deduct: Total stockbased compensation expense determinedunder the fair value method, net of taxes |  |                                                
|                                                                                                   |  |                                                
|Pro forma net income                                                                               |  | $                                              
|                                                                                                   |  |                                                
|Earnings per share (basic):                                                                        |  |                                                
|As reported                                                                                        |  | $                                              
|                                                                                                   |  |                                                
|Pro forma                                                                                          |  | $                                              
|                                                                                                   |  |                                                
|Earnings per share (diluted):                                                                      |  |                                                
|As reported                                                                                        |  | $                                              
|                                                                                                   |  |                                                
|Pro forma                                                                                          |  | $                                              
|                                                                                                   |  |                                                



The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:



|                        |  | Years Ended June 30, |  
|----------------------- |  | -------------------- | -
|                        |  | 2003                 |  
|Dividend yield          |  |                     | %
|Expected life           |  | 10 years             |  
|Expected volatility     |  | 31                   | %
|Risk-free interest rate |  | 3.8                  | %



59



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##### Table of Contents

SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Stock option activity under the plan for the years ended June 30, 2003 and 2002 follows:



|                                                               |  | 2003    |        | 2002
|-------------------------------------------------------------- |  | ------- | ------ | ----
|                                                               |  | Options |        |     
|Outstanding at beginning of year                               |  |         | 55,687 |     
|Granted                                                        |  |         | 20,807 |     
|Forfeited                                                      |  |         | (200   | )   
|Exercised                                                      |  |         | (6,000 | )   
|                                                               |  |         |        |     
|Outstanding at end of year                                     |  |         | 70,294 |     
|                                                               |  |         |        |     
|Exercisable at end of year                                     |  |         | 26,672 |     
|                                                               |  |         |        |     
|Weighted average fair value of options granted during the year |  | $       | 7.41   |     
|                                                               |  |         |        |     



Information pertaining
to options outstanding and exercisable at June 30, 2003 is as follows:



|                           |  | Options Outstanding |  | Options Exercisable                    
|-------------------------- |  | ------------------- |  | ---------------------------------------
|Range of Exercise Prices   |  | NumberOutstanding   |  | WeightedAverageRemainingContractualLife
|$7.50-$9.75                |  | 41,987              |  | 6.5 years                              
|$13.70-$15.05              |  | 28,307              |  | 9.3                                    
|                           |  |                     |  |                                        
|Outstanding at end of year |  | 70,294              |  | 7.6 years                              
|                           |  |                     |  |                                        



Recognition and
Retention Plan



On September 1, 1999, the Board of
Directors approved the 1999 Recognition and Retention Plan (the RRP) for key employees and directors of the Company and the Bank and reserved 40,247 shares of common stock of the Company for issuance. During the years ended June 30, 2003
and 2002, 8,280 and 5,500 shares were awarded, respectively. There were 3,100 shares forfeited during the year ended June 20, 2002, while none were forfeited during the year ended June 30, 2003. Shares awarded vest in five equal annual installments
and become fully vested upon the recipients retirement. At June 30, 2003 and 2002, 18,835 and 12,127 shares, respectively, were vested. Compensation expense relating to the RRP amounted to $46,000 and $61,000 for the years ended June 30, 2003
and 2002, respectively. At June 30, 2003, all of the 40,247 shares of common stock of the Company, originally reserved for issuance under the RRP, had been granted and no shares remain available for issuance under the RRP.



Employee Stock Ownership Plan



Effective November 1, 1998, in connection with the Offering, the Bank
established an Employee Stock Ownership Plan (the ESOP) for the benefit of each employee that has reached the age of 21 and has completed at least 1,000 hours of service in the previous twelve-month period. The ESOP is funded by the
Banks contributions of cash (which generally will be invested in common stock) or common stock. Benefits may be paid in shares of common stock or in cash, subject to the employees right to demand shares.



The ESOP has a loan agreement with the Company whereby $644,000 was borrowed
for the purpose of purchasing shares of the Companys common stock. The loan provides for ten annual principal payments of



60



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



$64,000 commencing on the last business day of September 1999. The Bank made a $100,000 principal pre-payment on October 31, 1998.



The Bank has committed to make contributions to the ESOP sufficient to
support the debt service of the loan. The loan is secured by the shares purchased which are held in a suspense account for allocation among the members as the loans are paid. Total compensation expense applicable to the ESOP amounted to $112,000 and
$88,000 for the years ended June 30, 2003 and 2002, respectively.



Shares held by the ESOP include the following:



|                          |  | June 30,
|------------------------- |  | --------
|                          |  | 2003    
|Allocated                 |  | 28,127  
|Committed to be allocated |  | 4,293   
|Unallocated               |  | 24,345  
|                          |  |         
|                          |  | 56,765  
|                          |  |         



Any cash dividends
received on allocated shares would be allocated to members and cash dividends received on shares held in suspense would be applied to repay the outstanding debt of the ESOP. The fair value of unearned ESOP shares at June 30, 2003 and 2002 is
$536,000 and $477,000, respectively.



12.    COMMITMENTS
AND CONTINGENCIES



General



In the ordinary course of business, various legal claims arise from time to
time and, in the opinion of management, these claims will have no material effect on the Companys consolidated financial statements.



Employment agreement



The Company entered into a three-year employment agreement with its President effective September 2001. The agreement extends automatically for the
periods of one year commencing at the second anniversary of the effective date and on each subsequent anniversary thereafter, unless the Company or the President, subject to certain conditions, provide notice of the election to not extend the term.
The agreement provides for a specific salary and benefits continuation in the event the executive is terminated without cause. However, such employment may be terminated for cause, as defined, without incurring any continuing obligations. The
agreement also provides for a lump sum severance payment, subject to certain conditions, following a change in control as defined in the agreement.



Loan commitments



The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit, which involve elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated balance sheets. The Banks exposure to credit loss is
represented by the contractual amount of the instruments. The Bank uses the same credit policies in making commitments as it does for on-balance-sheet instruments.



61



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Financial instruments whose contract amount represents credit risk consist of:



|                                                |  | June 30,              
|----------------------------------------------- |  | ----------------------
|                                                |  | 2003                  
|                                                |  | (Dollars in Thousands)
|Commitments to grant loans                      |  | $                     
|Unadvanced funds on home equity lines-of-credit |  |                       
|Unadvanced funds on commercial lines-of-credit  |  |                       
|Unadvanced funds on personal lines-of-credit    |  |                       
|Unadvanced funds on construction loans          |  |                       



Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The
commitments for lines-of-credit may expire without being drawn upon, therefore, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customers credit worthiness on a case-by-case basis.
Commitments to grant loans and lines-of-credit are secured by real estate or other collateral, if deemed necessary.



Operating lease commitments



Pursuant to the terms of noncancelable lease agreements in effect at June 30, 2003 pertaining to banking premises and equipment, future minimum rent
commitments are as follows:



|                     |  | Amount                
|-------------------- |  | ----------------------
|                     |  | (Dollars in Thousands)
|Year Ending June 30, |  |                       
|2004                 |  | $                     
|2005                 |  |                       
|2006                 |  |                       
|2007                 |  |                       
|2008                 |  |                       
|Thereafter           |  |                       
|                     |  |                       
|                     |  | $                     
|                     |  |                       



These leases contain
options to extend for periods from five to ten years. The cost of such rentals is not included above. Total rent expense for the years ended June 30, 2003 and 2002 amounted to $511,000 and $537,000, respectively.



13.    FAIR VALUE OF FINANCIAL INSTRUMENTS



Statement of Financial Accounting Standards No. 107, Disclosures about
Fair Value of Financial Instruments requires disclosure of estimated fair values of all financial instruments where it is practicable to estimate such values. In cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.



62



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following methods and assumptions were used by the Company in estimating fair value disclosures
for financial instruments:



Cash and cash
equivalents:    The carrying amounts of cash and short-term investments approximate fair values.



Certificates of deposit:    The carrying amount of certificates of deposit approximates fair value.



Securities:    Fair values for
securities are based on quoted market prices.



FHLB stock:    The carrying value of FHLB stock is deemed to approximate fair value, based on the redemption provisions of the FHLB.



Loans:    For variable-rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms and adjusted for credit risk.
Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.



Deposits:    The fair values disclosed for non-certificate accounts are, by definition, equal to the amount
payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to
a schedule of aggregated expected monthly maturities on time deposits.



FHLB advances:    The fair values for the FHLB advances are estimated using discounted cash flow analyses based on rates currently in effect for similar types of borrowing arrangements.



Accrued
interest:    The carrying amounts of accrued interest approximate fair value.



Off-balance-sheet instruments:    Fair values for off-balance-sheet lending commitments are based on fees
currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties credit standing and are not material.



The estimated fair values and related carrying amounts of the Companys financial instruments are as follows:



|                                |  | June 30,              
|------------------------------- |  | ----------------------
|                                |  | 2003                  
|                                |  | CarryingAmount        
|                                |  | (Dollars in Thousands)
|Financial assets:               |  |                       
|Cash and cash equivalents       |  | $                     
|Certificate of deposit          |  |                       
|Securities available for sale   |  |                       
|Securities held to maturity     |  |                       
|FHLB stock                      |  |                       
|Loans, net                      |  |                       
|Accrued interest receivable     |  |                       
|Financial liabilities:          |  |                       
|Deposits                        |  |                       
|Federal Home Loan Bank advances |  |                       



63



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



14.    CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY



Condensed financial information pertaining only to the Company is as
follows:



|                                                                                 
|---------------------------------------------------------------------------------
|BALANCE SHEETS                                                                   
|                                                                                 
|                                                                                 
|                                                                                 
|Interest-bearing deposit in Strata Bank                                          
|Investment in common stock of Strata Bank                                        
|Loan receivable from Strata Bank ESOP                                            
|Other assets                                                                     
|                                                                                 
|Total assets                                                                     
|                                                                                 
|Liabilities                                                                      
|Stockholders equity                                                             
|                                                                                 
|Total liabilities and stockholders equity                                       
|                                                                                 
|                                                                                 
|STATEMENTS OF INCOME                                                             
|                                                                                 
|                                                                                 
|                                                                                 
|Interest income from Strata Bank                                                 
|Operating expenses                                                               
|                                                                                 
|Income before income taxes                                                       
|Provision for income taxes                                                       
|                                                                                 
|                                                                                 
|Equity in undistributed net income of Strata Bank                                
|                                                                                 
|Net income                                                                       
|                                                                                 
|                                                                                 
|STATEMENTS OF CASH FLOWS                                                         
|                                                                                 
|                                                                                 
|                                                                                 
|Cash flows from operating activities:                                            
|Net income                                                                       
|Adjustments to reconcile net income to net cash provided by operating activities:
|Change in other assets and liabilities                                           
|Amortization of RRP stock                                                        
|Equity in undistributed net income of Strata Bank                                
|                                                                                 
|Net cash (used) provided by operating activities                                 
|                                                                                 
|Cash flows from investing activities:                                            
|Capital contribution to Strata Bank                                              
|Repayment of ESOP loan                                                           
|                                                                                 
|Net cash (used) provided by investing activities                                 
|                                                                                 
|Cash flows from financing activities:                                            
|Stock option exercises                                                           
|Purchase of treasury stock                                                       
|                                                                                 
|Net cash (used) provided by financing activities                                 
|                                                                                 
|Net change in cash and cash equivalents                                          
|Cash and cash equivalents at beginning of year                                   
|                                                                                 
|Cash and cash equivalents at end of year                                         
|                                                                                 



64



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SERVICE BANCORP, INC. AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



15.    QUARTERLY DATA (UNAUDITED)



|                                                     |  | Years Ended June 30,                        
|---------------------------------------------------- |  | --------------------------------------------
|                                                     |  | 2003                                        
|                                                     |  | FourthQuarter                               
|                                                     |  | (Dollars in Thousands, Except Share Amounts)
|Interest and dividend income                         |  | $                                           
|Interest expense                                     |  |                                             
|                                                     |  |                                             
|Net interest income                                  |  |                                             
|Provision for loan losses                            |  |                                             
|                                                     |  |                                             
|Net interest income, after provision for loan losses |  |                                             
|Net gain (loss) on securities available for sale     |  |                                             
|Fee and other income                                 |  |                                             
|Non-interest expense                                 |  |                                             
|                                                     |  |                                             
|Income before income taxes                           |  |                                             
|Provision for income taxes                           |  |                                             
|                                                     |  |                                             
|Net income                                           |  | $                                           
|                                                     |  |                                             
|Earnings per share (basic)                           |  | $                                           
|                                                     |  |                                             
|Earnings per share (diluted)                         |  | $                                           
|                                                     |  |                                             



65



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##### Table of Contents

ITEM 8.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.



None.



ITEM 8A.    Controls and Procedures



|(a) |  | Evaluation of disclosure controls and procedures.
|--- |  | -------------------------------------------------



As required by new Rule 13a-15 under the Securities Exchange Act of 1934 (the Exchange Act), the Companys management conducted
an evaluation with the participation of the Companys Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the Companys disclosure controls and procedures as of the end of the last fiscal quarter. In
designing and evaluating the Companys disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only a reasonable assurance of achieving
the desired control objectives, and management necessarily was required to apply its judgement in evaluating and implementing possible controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Companys disclosure controls and procedures are reasonably effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities and Exchange Commissions rules and forms. We intend to continue to review and document our disclosure controls and procedures, including our internal controls and
procedures for financial reporting, and we may from time to time make changes to the disclosure controls and procedures to enhance their effectiveness and to ensure that our systems evolve with our business.



|(b) |  | Change in internal controls.
|--- |  | ----------------------------



There were no changes in the Companys controls over financial reporting identified in connection with the Companys evaluation
of its disclosure controls and procedures that occurred during the Companys last fiscal quarter that has materially affected, or is reasonably likely to materially affect the Companys internal control over financial reporting.



PART III



ITEM 9.    Directors and Executive Officers of the Registrant



The Proposal 1Election of Directors section of the Companys definitive Proxy Statement for the Companys 2003 Annual Meeting
of Stockholders (the 2003 Proxy Statement) is incorporated herein by reference.



ITEM 10.     Executive Compensation.



The Proposal 1Election of Directors section of the Companys 2003 Proxy Statement is incorporated herein by reference.



ITEM 11.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.



The Proposal 1Election of Directors and Ownership by Management and Other Stockholders sections of the Companys
2003 Proxy Statement is incorporated herein by reference.



66



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##### Table of Contents

ITEM 12.    Certain Relationships and Related Transactions.



The Transactions with Certain Related Persons section of the Companys 2003 Proxy Statement is incorporated herein by reference.



ITEM 13.    Exhibits and Reports on Form 8-K.



|     | 
|---- | 
|(a)  | 
|     | 
|3.1  | 
|     | 
|3.2  | 
|     | 
|4.1  | 
|     | 
|10.1 | 
|     | 
|10.2 | 
|     | 
|10.3 | 
|     | 
|10.4 | 
|     | 
|10.5 | 
|     | 
|10.6 | 
|     | 
|10.7 | 
|     | 
|10.8 | 
|     | 
|14.1 | 
|     | 
|21.1 | 
|     | 
|23.1 | 
|     | 
|31.1 | 
|     | 
|31.2 | 
|     | 
|32.1 | 



67



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##### Table of Contents

|     | 
|---- | 
|32.2 | 
|     | 
|(b)  | 



The Company filed a
Current Report on Form 8-K on April 30, 2003



Item Reported:
Earnings announcement for the quarter ended March 31, 2003



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##### Table of Contents

SIGNATURES



In accordance with
the requirements of Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|Date: September 12, 2003 |  |  |  | SERVICE BANCORP, INC.
|------------------------ |  |  |  | ---------------------
|                         |  |  |  |                      
|                         |  |  |  |                      
|                         |  |  |  |                      



In accordance with the
Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.



|                         |  |                                                                                                    |  |                         
|------------------------ |  | -------------------------------------------------------------------------------------------------- |  | ------------------------
|By:                      |  | /s/ PAMELA J. MONTPELIER                                                                           |  |                         
|                         |  | Pamela J. Montpelier President, Chief Executive Officer and Director (Principal Executive Officer) |  |                         
|Date: September 12, 2003 |  |                                                                                                    |  | Date: September 12, 2003
|                         |  |                                                                                                    |  |                         
|By:                      |  | /s/ MICHAEL J. SHEEHAN                                                                             |  |                         
|                         |  | Michael J. Sheehan, Director (Chairman of the Board)                                               |  |                         
|Date: September 12, 2003 |  |                                                                                                    |  | Date: September 15, 2003
|                         |  |                                                                                                    |  |                         
|By:                      |  | /s/ JOHN HASENJAEGER                                                                               |  |                         
|                         |  | John Hasenjaeger, Director                                                                         |  |                         



|Date: September 12, 2003 |  |                               |  | Date: September 12, 2003
|------------------------ |  | ----------------------------- |  | ------------------------
|                         |  |                               |  |                         
|By:                      |  | /s/ KENNETH C.A. ISAACS       |  |                         
|                         |  | Kenneth C.A. Isaacs, Director |  |                         



|Date: September 15, 2003 |  |                              |  | Date: September 15, 2003
|------------------------ |  | ---------------------------- |  | ------------------------
|                         |  |                              |  |                         
|By:                      |  | /s/ EUGENE R. LISCOMBE       |  |                         
|                         |  | Eugene R. Liscombe, Director |  |                         



|Date: September 12, 2003 |  |                           |  | Date: September 12, 2003
|------------------------ |  | ------------------------- |  | ------------------------
|                         |  |                           |  |                         
|By:                      |  | /s/ JAMES W. MURPHY       |  |                         
|                         |  | James W. Murphy, Director |  |                         
|Date:
September 12, 2002 |  |                           |  | Date:
September 12, 2003
|                         |  |                           |  |                         
|By:                      |  | /s/ EUGENE G. STONE       |  |                         
|                         |  | Eugene G. Stone, Director |  |                         
|Date:
September 15, 2003 |  |                           |  |                         



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