##### Table of Contents




UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





---




FORM 10-Q





(Mark One)





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




For the quarterly period ended June 30, 2002





or





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




For the transition period from  to





Commission File Number 0-28389





---




Connecticut Bancshares, Inc.


---

(Exact name of registrant as specified in its charter)





Delaware

06-1564613(State or other jurisdiction

(I.R.S. Employerof incorporation or organization)

Identification No.)





923 Main Street, Manchester, Connecticut

06040(Address of principal executive offices)

(Zip Code)





(860) 646-1700


---

(Registrants telephone number, including area code)





Not Applicable


---

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





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





Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest
practicable date: the Issuer had 11,250,826 shares of common stock, par value $0.01 per share, outstanding as of August 5, 2002.




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##### Table of Contents




CONNECTICUT BANCSHARES, INC.


FORM 10-Q





INDEX





PagePART I:    FINANCIAL INFORMATIONItem 1.

Financial Statements (unaudited)Condensed Consolidated Statements of Condition as of June 30, 2002 and December 31, 2001

2Condensed Consolidated Statements of Operations for the Three Months Ended June 30, 2002 and 2001

3Condensed Consolidated Statements of Operations for the Six Months Ended June 30, 2002 and 2001

4Condensed Consolidated Statement of Changes in Stockholders Equity for the Six Months Ended June 30, 2002 and 2001

5Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001

6Notes to Condensed Consolidated Financial Statements

7Item 2.

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

12Item 3.

Quantitative and Qualitative Disclosures About Market Risk

27PART II:    OTHER INFORMATION


Item 1.

Legal Proceedings

28Item 2.

Changes in Securities and Use of Proceeds

28Item 3.

Defaults Upon Senior Securities

28Item 4.

Submission of Matters to a Vote of Security Holders

28Item 5.

Other Information

29Item 6.

Exhibits and Reports on Form 8-K

29SIGNATURES

30







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##### Table of Contents




PART I.    FINANCIAL INFORMATION





Item 1.    
Financial Statements





CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY





CONDENSED CONSOLIDATED STATEMENTS OF CONDITION





(Dollars in thousands)








June 30,2002


December 31, 2001(unaudited)ASSETSCash and cash equivalents

$
69,191


$
122,624Securities available for sale, at fair value


762,407



758,534Loans held for sale


159



746Loans, net


1,501,500



1,421,143Federal Home Loan Bank Stock, at cost


30,783



30,783Premises and equipment, net


18,242



19,348Accrued interest receivable


13,399



12,933Other real estate owned


58



84Cash surrender value of life insurance


42,589



41,396Current and deferred income taxes






1,686Goodwill


19,970



19,970Other intangible assets


10,655



12,927Other assets


6,559



4,250Total assets

$
2,475,512


$
2,446,424LIABILITIES AND STOCKHOLDERS EQUITYDeposits

$
1,615,514


$
1,590,938Short-term borrowed funds


113,136



117,180Mortgagors escrow accounts


16,145



10,580Advances from Federal Home Loan Bank


453,550



465,355Current and deferred income taxes


262



Accrued benefits and other liabilities


25,832



26,997Total liabilities


2,224,439



2,211,050Commitments and ContingenciesStockholders equity:Common stock ($.01 par value; 45,000,000 authorized shares; 11,259,748 and 11,235,608 shares issued at June 30, 2002 and
December 31, 2001, respectively)


113



112Additional paid-in capital


109,682



108,354Retained earnings


138,414



127,737ESOP unearned compensation


(7,754
)


(8,065
)Restricted stock unearned compensation


(5,596
)


(6,395
)Treasury stock, at cost (8,922 shares at June 30, 2002)


(232
)


Accumulated other comprehensive income


16,446



13,631Total stockholders equity


251,073



235,374Total liabilities and stockholders equity

$
2,475,512


$
2,446,424





The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.




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##### Table of Contents




CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS





(Dollars in thousands, except for per share
data)





For the Three Months EndedJune 30, 2002


June 30, 2001(unaudited)Interest and dividend income:Interest income on loans

$
25,250


$
19,786Interest and dividends on investment securities


10,170



5,228Total interest and dividend income


35,420



25,014Interest expense:Interest on deposits


8,844



8,401Interest on short-term borrowed funds


406



764Interest on Advances from Federal Home Loan Bank


5,909



1,666Total interest expense


15,159



10,831Net interest income


20,261



14,183Provision for loan losses


375



375Net interest income after provision for loan losses


19,886



13,808Noninterest income:Service charges and fees


3,063



2,323Increase in cash surrender value of life insurance


607



49Brokerage commission income


458



271Gains on sales of securities, net


368



76Other than temporary impairment of investment securities


(270
)


Gains on mortgage loan sales, net


61



131Other


211



143Total noninterest income


4,498



2,993Noninterest expense:Salaries


5,063



3,934Employee benefits


2,747



2,112Fees and services


1,994



1,170Amortization of other intangible assets


1,277



108Furniture and equipment


1,009



733Occupancy, net


941



760Marketing


616



440Foreclosed real estate expense


27



28Net losses on sales of repossessed assets


17



3Other operating expenses


1,647



1,384Total noninterest expense


15,338



10,672Income before provision for income taxes


9,046



6,129Provision for income taxes


2,931



2,084Net income

$
6,115


$
4,045Earnings per share:Basic

$
0.60


$
0.40Diluted

$
0.56


$
0.38Weighted average shares outstanding:Basic


10,162,179



9,994,395Diluted


10,837,085



10,593,425





The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.




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##### Table of Contents




CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS





(Dollars in thousands, except for per share
data)





For the Six Months EndedJune 30, 2002


June 30, 2001(unaudited)Interest and dividend income:Interest income on loans

$
50,188


$
39,729Interest and dividends on investment securities


20,266



10,359Total interest and dividend income


70,454



50,088Interest expense:Interest on deposits


18,555



16,950Interest on short-term borrowed funds


863



1,538Interest on Advances from Federal Home Loan Bank


11,852



3,308Total interest expense


31,270



21,796Net interest income


39,184



28,292Provision for loan losses


750



750Net interest income after provision for loan losses


38,434



27,542Noninterest income:Service charges and fees


5,908



4,473Increase in cash surrender value of life insurance


1,192



49Brokerage commission income


818



548Gains on sales of securities, net


1,052



311Other than temporary impairment of investment securities


(270
)


Gains on mortgage loan sales, net


149



213Other


370



292Total noninterest income


9,219



5,886Noninterest expense:Salaries


9,674



8,021Employee benefits


5,791



4,239Fees and services


3,846



2,667Amortization of other intangible assets


2,549



216Occupancy, net


2,017



1,582Furniture and equipment


1,972



1,494Marketing


1,091



880Foreclosed real estate expense


91



66Net gains on sales of repossessed assets


(7
)


(6
)Other operating expenses


3,342



2,555Total noninterest expense


30,366



21,714Income before provision for income taxes


17,287



11,714Provision for income taxes


5,601



3,983Net income

$
11,686


$
7,731Earnings per share:Basic

$
1.15


$
0.76Diluted

$
1.08


$
0.72Weighted average shares outstanding:Basic


10,138,947



10,167,365Diluted


10,793,600



10,730,946





The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.




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##### Table of Contents




CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY





CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY


For the Six Months Ended June 30, 2002 and 2001
(unaudited)





(Dollars in thousands)





Additional Paid-In Capital


Retained Earnings


ESOP Unearned
Compen- sation


Restricted Stock Unearned Compen- sation


Treasury Stock


Accumulated Other Comprehensive IncomeCommon StockShares


Amount








TotalBALANCE, January 1, 2002

11,235,608


$112


$108,354


$127,737


$(8,065
)

$(6,395
)

$


$13,631


$235,374Change in ESOP unearned compensation







571





311











882Exercise of stock options, including tax benefits

24,140


1


513

















514Tax benefits from vesting of restricted stock awards







244

















244Dividends declared ($0.13 per share)










(1,361
)













(1,361
)Treasury stock purchased

(8,922
)
















(232
)




(232
)Change in restricted stock unearned compensation
















799








799Other










352














352Comprehensive income:Net income










11,686














11,686Change in unrealized gain on securities available for sale, net of taxes






















2,815


2,815Total comprehensive income










11,686











2,815


14,501BALANCE, June 30, 2002

11,250,826


$113


$109,682


$138,414


$(7,754
)

$(5,596
)

$(232
)

$16,446


$251,073BALANCE, January 1, 2001

11,232,000


$112


$108,257


$119,691


$(8,685
)

$


$


$13,164


$232,539Granting of restricted stock awards

449,280


4


8,195








(8,199
)







Funding of trustee repurchase of restricted stock

(449,280
)

(4
)

(9,360
)
















(9,364
)Change in ESOP unearned compensation







329





310











639Change in restricted stock unearned compensation
















820








820Accelerated vesting of stock options







3

















3Dividends declared ($0.18 per share)










(2,022
)













(2,022
)Comprehensive income:Net income










7,731














7,731Change in unrealized gain on securities available for sale, net of taxes






















(2,966
)

(2,966
)Total comprehensive income










7,731











(2,966
)

4,765BALANCE, June 30, 2001

11,232,000


$112


$107,424


$125,400


$(8,375
)

$(7,379
)

$


$10,198


$227,380





The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.




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CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS





(In thousands)





For the Six Months EndedJune 30, 2002


June 30, 2001(unaudited)CASH FLOWS FROM OPERATING ACTIVITIES:Net income

$
11,686


$
7,731Adjustments to reconcile net income to net cash provided by operating activities, excluding effects of
acquisition:Provision for loan losses


750



750Depreciation


1,586



1,230Amortization/accretionOther intangible assets


2,549



216Premium (discount) on loans and bonds


2,852



(583
)Amortization/accretion of fair market adjustment from First Federal acquisitionLoans


675



Time deposits


(1,382
)


Advances from Federal Home Loan Bank


(1,734
)


Amortization of mortgage servicing rights


269



227Net gains on sales of other real estate owned


(21
)


(6
)Net loss on disposal of fixed assets


137



9Gains on sales of securities, net


(1,052
)


(311
)Other than temporary impairment of securities


270



Gains on mortgage loan sales, net


(149
)


(213
)Deferred income tax provision (benefit)


1,006



(1,018
)Accelerated vesting of stock options






3ESOP compensation expense


882



639Change in restricted stock unearned compensation


799



820Appreciation in cash surrender value life insurance


(1,192
)


(49
)Changes in operating assets and liabilities, net of amounts acquiredAccrued interest receivable


(466
)


208Other assets


(1,206
)


(1,973
)Other liabilities


(1,165
)


2,776Net cash provided by operating activities


15,094



10,456CASH FLOWS FROM INVESTING ACTIVITIES:Loan originations and purchases, net of repayments


(84,300
)


(62,632
)Proceeds from sales of loans


3,163



3,957Proceeds from maturities and calls of available for sale securities


10,090



14,944Proceeds from sales of available for sale securities


146,095



30,901Purchases of available for sale securities


(224,512
)


(35,245
)Purchases of Federal Home Loan Bank stock






(838
)Proceeds from principal payments of mortgage-backed securities and collateralized mortgage obligations


65,453



18,790Proceeds from sales of other real estate owned


138



152Purchase of life insurance






(20,000
)Proceeds from sales of premises and equipment


1,565



Purchases of premises and equipment


(2,182
)


(1,517
)Other investing activities


(277
)


Net cash used in investing activities


(84,767
)


(51,488
)CASH FLOWS FROM FINANCING ACTIVITIES:Funding of trustee purchases of restricted stock






(9,364
)Purchase of treasury stock


(232
)


Proceeds from exercise of stock options


425



Dividends paid


(1,361
)


(1,011
)Net increase in savings, money market, NOW and demand deposits


76,281



45,098Net decrease in certificates of deposit


(50,323
)


(8,937
)Net (decrease) increase in short-term borrowed funds


(4,044
)


3,486Increase in mortgagors escrow accounts


5,565



1,875(Decrease) increase in advances from Federal Home Loan Bank


(10,071
)


20,000Net cash provided by financing activities


16,240



51,147Net (decrease) increase in cash and cash equivalents


(53,433
)


10,115CASH AND CASH EQUIVALENTS, beginning of period


122,624



64,797CASH AND CASH EQUIVALENTS, end of period

$
69,191


$
74,912SUPPLEMENTAL INFORMATION:Cash paid forInterest

$
31,348


$
21,963Income taxes, net


4,836



5,000Non-cash transactionsTransfers from loans to other real estate owned


91



118Dividends declared not paid






1,011





The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.




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##### Table of Contents

CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





(Unaudited)





(1)    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Basis of financial statements presentation





The
accompanying condensed consolidated financial statements were prepared in accordance with instructions to Form 10-Q and, therefore, do not include information or notes necessary for a complete presentation of financial position, results of
operations and cash flows in conformity with accounting principles generally accepted in the United States of America. However, all normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the
financial statements have been included. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto for Connecticut Bancshares, Inc. (CTBS) and
subsidiary included in Connecticut Bancshares, Inc.s Form 10-K for the year ended December 31, 2001. The results for the six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2002.





Principles of consolidation and presentation





The accompanying condensed consolidated financial statements include the accounts of CTBS and its wholly-owned subsidiary, The Savings Bank of Manchester (SBM
or the Bank), and its wholly-owned subsidiaries (collectively, the Company). All material intercompany balances and transactions have been eliminated in consolidation.





Business





The Bank, with its main office located
in Manchester, Connecticut, operates through twenty-eight branches located primarily in eastern Connecticut. The Banks primary source of income is interest received on loans to customers, which include small and middle market businesses and
individuals residing within the Banks service area.





On April 22, 2002, CTBS declared a quarterly cash
dividend of $0.13 per share on outstanding shares of its common stock. The dividend was paid on May 20, 2002 to stockholders of record as of the close of business on May 6, 2002.





Earnings per share





Basic earnings per share represents
income available to stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential shares had
been issued or earned. The following table sets forth the calculation of basic and diluted earnings per share for the periods indicated (dollars in thousands, except per share amounts):




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##### Table of Contents




For the Three Months Ended


For the Six Months EndedJune 30, 2002


June 30, 2001


June 30, 2002


June 30, 2001(unaudited)


(unaudited)Net income

$
6,115


$
4,045


$
11,686


$
7,731Weighted average shares outstanding:Weighted average shares outstanding


10,920,798



10,812,918



10,905,012



10,993,334Less: unearned ESOP shares


(758,619
)


(818,523
)


(766,065
)


(825,969
)Basic


10,162,179



9,994,395



10,138,947



10,167,365Dilutive impact of:Stock options


345,681



179,949



314,259



135,813Restricted stock


329,225



419,081



340,394



427,768Diluted


10,837,085



10,593,425



10,793,600



10,730,946Earnings per share:Basic

$
0.60


$
0.40


$
1.15


$
0.76Diluted

$
0.56


$
0.38


$
1.08


$
0.72





Reclassifications





Certain prior period amounts have been reclassified to conform to the current period presentation.





(2)    RECENT ACCOUNTING PRONOUNCEMENTS





Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires the Company to test goodwill for
impairment by applying an annual fair-value-based test rather than amortizing the goodwill. Recognized intangible assets, such as core deposit intangibles, will continue to be amortized over their useful lives. The Company has evaluated the useful
lives as required by SFAS No. 142, and no change was made regarding lives upon adoption. SFAS No. 142 prohibits the amortization of goodwill but requires that it be tested for impairment at least annually at the reporting unit level. The Company
tested its $19.97 million of goodwill related to the 2001 acquisition of First Federal Savings and Loan Association of East Hartford (First Federal), in accordance with the provisions of SFAS No. 142. As a result of this testing, no
impairment charges were recorded. See Note (5) for further information on intangible assets.





In April 2002, the
Financial Accounting Standards Board (FASB) issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 rescinds SFAS No. 4,
Reporting Gains and Losses from Extinguishment of Debt and an amendment of that statement, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145 also rescinds SFAS No. 44,
Accounting for Intangible Assets of Motor Carriers. SFAS No. 145 amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or




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##### Table of Contents

describe their applicability under changed conditions. The adoption of SFAS No. 145 is not expected to have a material effect on the Companys condensed consolidated financial statements.





In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities. SFAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). The adoption of SFAS No. 146 is not expected to have a material effect on the Companys condensed consolidated financial statements.





(3)    LOANS





Loans are summarized as follows:





June 30, 2002


December 31, 2001(in thousands)One- to four-family mortgages

$
879,393


$
841,895Construction mortgages


87,318



76,551Commercial and multi-family mortgages


253,196



231,644Commercial business loans


175,550



166,314Installment loans


121,368



119,967Total loans


1,516,825



1,436,371Less: Allowance for loan losses


(15,325
)


(15,228
)Total loans, net

$
1,501,500


$
1,421,143




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##### Table of Contents




A summary of the allowance for loan losses is as follows:





For the Six Months Ended June 30, 2002

For the Year Ended
December 31, 2001(in thousands)Balance, beginning of period

$15,228

$11,694Acquisition of First Federal Savings and Loan Association of East Hartford



2,174Provision for loan losses

750

2,000Loans charged off

(828)

(1,131)Recoveries

175

491Balance, end of period

$15,325

$15,228





(4)    DEPOSITS





Deposits were as follows:





June 30, 2002

December 31, 2001(in thousands)Certificates of deposit:Original maturity of less than one year

$   135,805

$   145,200Original maturity of one year or more

461,266

498,341Time certificates in denominations of $100,000 or more

88,175

93,410Total certificates of deposit

685,246

736,951Savings accounts

395,560

357,512Money market accounts

188,411

171,207NOW accounts

227,375

214,825Demand deposits

118,922

110,443Total deposits

$1,615,514

$1,590,938




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##### Table of Contents




(5)    INTANGIBLE ASSETS





June 30, 2002

December 31, 2001(in thousands)Intangible assets subject to amortization:Core deposit intangible

$
7,925

$
8,477Branch premiums


1,319


1,535Noncompete agreements


591


2,366Other


271


Total


10,106


12,378Intangible assets not subject to amortization:Goodwill


19,970


19,970Minimum pension liability


549


549Total


20,519


20,519Total intangible assets

$
30,625

$
32,897June 30, 2002(in thousands)Accumulated net amortization for intangible assets subject to amortization:Core deposit intangible

$
921Branch premiums


2,992Noncompete agreements


2,957Other


6Total


6,876For the Six Months Ended June 30, 2002

For the Six Months Ended June 30, 2001(in thousands)Amortization expense:Noncompete agreements

$
1,774

$
Core deposit intangible


553


Branch premiums


216


216Other


6


Total

$
2,549

$
216





For the five years ending December 31, the estimated aggregate
amortization expense is as follows:





(in thousands)2002

$3,9282003

1,5762004

1,5762005

1,3382006

1,169





During the six months ended June 30, 2002, there was no goodwill
acquired, no impairment losses recognized and no goodwill included in the gain or loss on disposal of a reporting unit.




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##### Table of Contents




(6)    OTHER THAN TEMPORARY IMPAIRMENT OF SECURITIES





On a quarterly basis, the Company reviews available for sale investment securities with unrealized depreciation for six consecutive months
to assess whether the 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. In accordance with this policy, during the three months ended June 30, 2002 the Bank recorded an other than temporary impairment charge for one equity security for $270,000.





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





The following analysis discusses changes in the financial condition and results of operations for the three and six months ended June 30, 2002 and 2001, and should be read in conjunction with Connecticut Bancshares, Inc. and
subsidiarys condensed consolidated financial statements and the notes thereto, appearing elsewhere herein.





Forward Looking
Statements





This Form 10-Q contains forward looking statements that are based on assumptions and describe
future plans, strategies and expectations of the Company. These forward looking statements are generally identified by use of the words believe, expect, intend, anticipate, estimate,
project, or similar expressions. The Companys ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the
Company include, but are not limited to, changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve
Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Banks market area and accounting principles and guidelines. These risks and
uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. Subject to applicable laws and regulations, the Company does not undertakeand specifically disclaims any
obligationto publicly release the result of any revisions which may be made to any forward looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated
events. Further information concerning the Company and its business, including additional factors that could materially affect the Companys financial results, is included in the Companys Form 10-K filing for the year ended December 31,
2001.





Acquisition of First Federal





On August 31, 2001, the Company completed its acquisition of First Federal in a transaction accounted for under the purchase method of accounting. Accordingly, the assets and liabilities of First
Federal are reflected in the Companys condensed consolidated balance sheet at June 30, 2002, and the results of operations of First Federal for the three and six months ended June 30, 2002 are included in the condensed consolidated statements
of operations for the three and six months ended June 30, 2002, as required by the purchase method of accounting. The results of operations of First Federal for the three and six months ended June 30, 2001 are not included in the condensed
consolidated statements of operations for such periods.




12




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General





The Companys results of operations depend primarily on net interest income, which represents the difference between interest income earned on interest-earning assets, such as loans and
securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. The Bank generates noninterest income primarily from fees charged on customers accounts and fees earned on activities such as investment
services provided through a third party registered broker-dealer. The Banks noninterest expenses primarily consist of employee compensation and benefits, occupancy expense, marketing and other operating expenses. The Companys results of
operations are also affected by general economic and competitive conditions, notably changes in market interest rates, government policies and regulations. The Bank exceeded all of its regulatory capital requirements at June 30, 2002.





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





Total assets increased $29.09 million, or 1.19%, to $2.48 billion at June 30, 2002 as compared to $2.45 billion at December 31, 2001. The
increase in assets was attributable to a $80.36 million increase in net loans and a $3.88 million increase in securities, partially offset by a $53.43 million decrease in cash and cash equivalents. The increase in loans was primarily due to a $37.49
million increase in one- to four-family mortgages and a $21.56 million increase in commercial and multi-family mortgages. Cash and cash equivalents decreased as the Company invested funds from December 2001 security sales, which had been temporarily
invested in short-term investments, primarily in asset-backed securities. The growth in assets was primarily funded by an increase in deposits of $24.57 million, partially offset by a decrease in Federal Home Loan Bank (FHLB) advances of
$11.81 million. The deposit increase was mainly in savings and money market accounts, partially offset by a decrease in certificates of deposit. Stockholders equity increased $15.70 million, primarily due to net income for the first six months
of 2002 and an increase in accumulated other comprehensive income, primarily due to the increase in unrealized gains on investment securities.




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The following table presents the amortized cost and fair value of the
Companys investment securities, by type, at the dates indicated:





At June 30, 2002

At December 31, 2001Amortized Cost

Fair Value

Amortized Cost

Fair Value(in thousands)Debt securities available for sale:Asset-backed securities

$
115,554

$
117,162

$
23,907

$
25,208U.S. Government and agency obligations


168,366


174,300


180,106


183,813Municipal obligations


23,607


23,533


23,717


23,194Debt mutual funds


9,113


9,122


23,872


23,886Corporate securities


58,591


60,386


53,138


55,420Total


375,231


384,503


304,740


311,521Equity securities available for sale:Marketable equity securities


21,884


29,078


26,349


37,670Other equity securities


945


945


992


992Total


22,829


30,023


27,341


38,662Total debt and equity securities


398,060


414,526


332,081


350,183Collateralized mortgage obligations


221,633


227,212


257,581


258,601Mortgage-backed securities


117,411


120,669


147,901


149,750Total available for sale securities

$
737,104

$
762,407

$
737,563

$
758,534





Available for sale securities increased $3.88 million, or 0.51%,
from a fair value of $758.53 million at December 31, 2001 to a fair value of $762.41 million at June 30, 2002. The Company had proceeds from sales of $146.10 million (including net gains of $1.05 million), maturities and calls of $10.09 million and
principal payments of $65.45 million of securities during the six months ended June 30, 2002. The Company also experienced an increase in unrealized gains on securities of $4.34 million. Securities purchased totaled $224.51 million during the six
months ended June 30, 2002.





Net loans increased $80.36 million, or 5.65%, from $1.42 billion at December 31, 2001
to $1.50 billion at June 30, 2002. Residential mortgages (including residential construction mortgages) increased $35.59 million, or 4.12%, from $864.07 million to $899.66 million due to continuing loan demand mainly due to refinancing activity in a
low interest rate environment. Commercial real estate, commercial construction and business loans increased $43.47 million, or 9.61%, from $452.33 million at December 31, 2001, to $495.80 million at June 30, 2002, primarily due to an increase in
commercial mortgage originations. As of June 30, 2002, commercial loans represented 32.69% of the Banks loan portfolio.





Deposits totaled $1.62 billion at June 30, 2002, an increase of $24.57 million, or 1.54%, compared to $1.59 billion at December 31, 2001. The increase in deposits was primarily in savings and money market accounts, which increased
$55.25 million, or 10.45%, from $528.72 million at December 31, 2001 to $583.97 million at June 30, 2002. Checking accounts also increased during the six month period from $325.27 million at December 31, 2001 to $346.30 million at June 30, 2002.
Offsetting these increases was a decrease in certificates of deposit of $51.70 million from $736.95 million at December 31, 2001 to $685.25 million at June




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##### Table of Contents

30, 2002. With certificate of deposit rates at a relatively low level, retail depositors may be holding their funds in savings, money market and checking accounts until interest rates rise. In
addition, the Bank offers a short-term transactional repurchase agreement (repo) account to commercial businesses and retail customers. These repo accounts are shown as short-term borrowed funds in the accompanying condensed consolidated statements
of condition. Short-term borrowed funds decreased $4.04 million, or 3.45%, from $117.18 million to $113.14 million during the first six months of 2002. Advances from the FHLB decreased $11.81 million, or 2.54%, from $465.36 million to $453.55
million during the first six months of 2002.





Nonperforming assets totaled $8.88 million at June 30, 2002,
compared to $7.76 million at December 31, 2001, an increase of $1.12 million, or 14.43%. The increase in nonperforming loans was primarily due to increases in nonperforming commercial mortgage and business loans. Other real estate owned declined
$26,000, or 30.95%, from $84,000 to $58,000 during the first six months of 2002 due to the sale of two residential properties, partially offset by the foreclosure of three residential properties.




15




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The following table sets forth information regarding nonperforming loans and
other real estate owned:





June 30, 2002


December 31, 2001(in thousands)Nonperforming loans:Real estate:One- to four-family

$
1,018


$
1,272Commercial and multi-family


3,306



2,601Total real estate loans


4,324



3,873Commercial


4,294



3,262Consumer


206



544Total nonperforming loans


8,824



7,679Other real estate owned


58



84Total nonperforming assets

$
8,882


$
7,763Total nonperforming loans as a percentage of gross loans


0.58
%


0.53
%Total nonperforming assets as a percentage of total assets


0.36
%


0.32
%





The allowance for loan losses was $15.33 million at June 30, 2002,
an increase of $97,000 from the $15.23 million recorded at December 31, 2001. The allowance for loan losses as a percentage of gross loans was 1.01% at June 30, 2002 as compared to 1.06% at December 31, 2001. The allowance for loan losses as a
percentage of nonperforming loans was 173.67% at June 30, 2002 as compared to 198.31% at December 31, 2001.





The Bank devotes significant attention to maintaining high loan quality through its underwriting standards, active servicing of loans and aggressive management of nonperforming assets. The allowance for loan losses is maintained at a
level estimated by management to provide adequately for probable loan losses which are inherent in the loan portfolio. Probable loan losses are estimated based on a quarterly review of the loan portfolio, loss experience, specific problem loans,
economic conditions and other pertinent factors. In assessing risks inherent in the portfolio, management considers the risk of loss on nonperforming and classified loans including an analysis of collateral in each situation. The Banks
methodology for assessing the appropriateness of the allowance for loan losses includes several key elements. Problem loans are identified and analyzed individually to estimate specific losses. The loan portfolio is also segmented into pools of
loans that are similar in type and risk characteristics (i.e., commercial, consumer and mortgage loans). Loss factors are applied using the Banks historical experience and may be adjusted for significant factors that, in managements
judgment, affect the collectability of the portfolio as of the evaluation date. Additionally, the portfolio is segmented into pools based on internal risk ratings with loss factors applied to each rating category.




16




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##### Table of Contents




Other factors considered in determining probable loan losses are the impact of
larger concentrations in the portfolio, trends in loan growth, the relationship and trends in recent years of recoveries as a percentage of prior chargeoffs and peer banks loss experience.





The allowance for loan losses consists of a formula allowance for various loan portfolio classifications and a valuation allowance for loans identified as impaired, if
necessary. The allowance is an estimate, and ultimate losses may vary from current estimates. Changes in the estimate are recorded in the results of operations in the period in which they become known, along with provisions for estimated losses
incurred during that period.





A portion of the allowance for loan losses is not allocated to any specific segment
of the loan portfolio. This non-specific reserve is maintained for two primary reasons: there exists an inherent subjectivity and imprecision to the analytical processes employed, and the prevailing business environment, as it is affected by
changing economic conditions and various external factors, which may impact the portfolio in ways currently unforeseen. Moreover, management has identified certain risk factors, which could impact the degree of loss sustained within the portfolio.
These include: market risk factors, such as the effects of economic variability on the entire portfolio, and unique portfolio risk factors that are inherent characteristics of the Banks loan portfolio. Market risk factors may consist of
changes to general economic and business conditions that may impact the Banks loan portfolio customer base in terms of ability to repay and that may result in changes in value of underlying collateral. Unique portfolio risk factors may include
industry or geographic concentrations, or trends that may exacerbate losses resulting from economic events which the Bank may not be able to fully diversify out of its portfolio.





Due to the inherent imprecise nature of the loan loss estimation process and ever changing conditions, these risk attributes may not be adequately captured in data related
to the formula-based loan loss components used to determine allocations in the Banks analysis of the adequacy of the allowance for loan losses. Management, therefore, has established and maintains a non-specific allowance for loan losses. The
amount of the non-specific allowance was $2.05 million at June 30, 2002 as compared to $3.05 million at December 31, 2001. As a percentage of the allowance for loan losses, the unallocated was 13.37% of the total allowance for loan losses at June
30, 2002 and 20.03% of the total allowance for loan losses at December 31, 2001. Although the unallocated reserve as a percentage of the total allowance has declined, management believes the unallocated and total reserves are adequate based on the
overall economic outlook and delinquency trends within the Banks portfolio.





The Banks largest
nonperforming asset is a $2.39 million loan secured by real estate. The Bank has been advised by the borrower that it has received a commitment from another lender to refinance the project during the third quarter of 2002. If the pending refinance
by the third party institution occurs, the Bank expects to receive full payment of the loan as well as a recovery of approximately $700,000 of previously charged off amounts.





Although management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may
be necessary, and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while the Bank believes it has established its existing allowance for loan
losses consistent with accounting principles generally accepted in the United States of America, there can be no assurance that regulators, in reviewing the Banks loan portfolio, will not request the Bank to increase its allowance for loan
losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above. Material increases in the allowance for loan losses will adversely affect the Banks financial condition and results of operations.





Other assets increased $2.31 million from $4.25 million at December 31, 2001 to $6.56 million at June 30, 2002. The increase was primarily
due to unsettled security sales at June 30, 2002. The losses relating to these unsettled sales were included in gains on sales of securities, net during the second quarter of 2002.




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##### Table of Contents




Total stockholders equity increased $15.70 million, or 6.67%, to $251.07
million at June 30, 2002 compared to $235.37 million on December 31, 2001. The increase is due primarily to net income of $11.69 million for the six months ended June 30, 2002 and an increase in accumulated other comprehensive income, primarily due
to the increase in unrealized gains on debt securities. The Company did not repurchase any shares of its common stock during the second quarter of 2002, and repurchased 8,922 shares of its common stock during the three months ended March 31, 2002.





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





Net Income.    Net income for the quarter ended June 30, 2002 was $6.12 million compared to $4.05
million for the second quarter of 2001. The results for the quarter ended June 30, 2002 include a $6.08 million, or 42.88%, increase in net interest income, primarily due to higher average interest-earning assets and a lower cost of funds, partially
offset by higher average interest-bearing liabilities and lower asset yields. Net income also increased from an increase in service charge and fee income of $740,000, an increase in income from the cash surrender value life insurance of $558,000,
and an increase in net security gains of $292,000. Net income was decreased by an other than temporary impairment of an equity security of $270,000, higher salary and employee benefits of $1.77 million, higher amortization of intangible assets of
$1.17 million and higher fees and services of $824,000.





Net Interest Income.    Net
interest income increased $6.08 million, or 42.88%, to $20.26 million for the second quarter of 2002 compared to $14.18 million for the second quarter of 2001. The increase was primarily a result of higher interest income from an increase in average
interest-earning assets. Total interest and dividend income increased $10.41 million, or 41.62%, to $35.42 million for the second quarter of 2002 from $25.01 million for the second quarter of 2001. Interest income on loans increased $5.46 million,
or 27.59%, to $25.25 million for the three months ended June 30, 2002 compared to $19.79 million for the three months ended June 30, 2001. The increase was due to a $451.44 million increase in the average balance of loans outstanding, the effect of
which was partially offset by a 83 basis point decrease in the average yield on such loans. The increase in volume was due to the acquisition of First Federal and the origination of new loans. Interest and dividend income from investment securities,
short-term investments and FHLB stock increased $4.94 million, or 94.46%, to $10.17 million for the three months ended June 30, 2002 compared to $5.23 million for the three months ended June 30, 2001 primarily due to investments acquired from First
Federal. The increase in interest and dividend income from investment securities, short-term investments and FHLB stock was due to an increase in the average balance of $493.20 million, or 147.68%, to $827.17 million for the quarter ended June 30,
2002 as compared to $333.97 million for the quarter ended June 30, 2001. Partially offsetting this increase, the yields on investment securities, short-term investments and FHLB stock decreased 136 basis points to 5.01% for the quarter ended June
30, 2002 as compared to 6.37% for the quarter ended June 30, 2001. The lower yields earned on loans and investments were primarily due to the lower overall interest rate environment as compared to the prior year.





Interest expense increased $4.33 million, or 39.98%, to $15.16 million for the three months ended June 30, 2002 compared to $10.83 million
for the quarter ended June 30, 2001. The increase was primarily due to an increase in average interest-bearing deposit balances of $599.85 million and an increase in average FHLB advances of $352.89 million acquired from First Federal. This increase
was partially offset by a decrease in the overall cost of funds for interest-bearing liabilities of 95 basis points. The cost of funds for the second quarter of 2002 was 2.93% as compared to 3.88% for the second quarter of 2001.





Average Balances, Interest and Average Yields/Cost.    The following table presents certain
information for the periods indicated regarding average balances of assets and liabilities, as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and
the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. The yields and rates include
fees which are considered adjustments to yields.




18




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##### Table of Contents




For the Three Months Ended June 30,2002


2001Average Balance

Interest

Average Yield/Rate


Average Balance

Interest

Average Yield/Rate(dollars in thousands)Interest-earning assets:Loans(1):Real estate

$
1,203,343

$
20,394

6.78
%

$
814,143

$
15,145

7.44
%Consumer


120,500


2,051

6.81



80,599


1,529

7.59Commercial(5)


173,019


2,817

6.53



150,675


3,130

8.33Total loans(5)


1,496,862


25,262

6.75



1,045,417


19,804

7.58Mortgage-backed securities(2)


121,389


1,899

6.26



70,948


1,281

7.22Collateralized mortgage obligations(2)


226,355


3,059

5.41








0.00Investment securities(2)(5):U.S. Government and agency obligations


166,772


1,950

4.69



72,493


1,250

6.92Municipal Obligations


23,666


420

7.10



2,891


54

7.47Corporate securities


58,558


901

6.15



49,262


1,003

8.14Common stock and mutual funds


35,282


314

3.56



36,034


294

3.26Other investment securities


961


2

0.83



432




0.00Asset-backed securities


115,827


1,314

4.54



27,332


574

8.40Other interest-bearing assetsFHLB stock


30,783


288

3.74



7,492


119

6.35Short-term investments


47,574


216

1.82



67,089


739

4.42Total interest-earning assets(5)


2,324,029

$
35,625

6.13
%


1,379,390

$
25,118

7.29
%Noninterest-earning assets


136,327








45,028Total assets

$
2,460,356







$
1,424,418Interest-bearing liabilities:Deposits:NOW accounts

$
214,587

$
307

0.57
%

$
127,212

$
227

0.72
%Savings and money market accounts


570,166


1,943

1.37



313,634


1,890

2.42Certificates of deposit


694,134


6,541

3.78



442,474


6,222

5.64Escrow deposits


12,731


53

1.67



8,446


62

2.94Total interest-bearing deposits


1,491,618


8,844

2.38



891,766


8,401

3.78Short-term borrowed funds


108,546


406

1.50



107,838


764

2.84Advances from FHLB


472,893


5,909

5.01



120,000


1,666

5.57Total interest-bearing liabilities


2,073,057

$
15,159

2.93
%


1,119,604

$
10,831

3.88
%Noninterest-bearing liabilities


140,590








79,187Total liabilities


2,213,647








1,198,791Stockholders equity


246,709








225,627Total liabilities and stockholders equity

$
2,460,356







$
1,424,418Net interest-earning assets

$
250,972







$
259,786Net interest income(5)




$
20,466







$
14,287Interest rate spread(3)(5)







3.20
%







3.41
%Net interest margin(4)(5)







3.52
%







4.14
%Ratio of interest-earning assets to interest-bearing liabilities







112.11
%







123.20
%Taxable-equivalent adjustmentsLoans




$
12







$
18Investment securities





193








86Total




$
205







$
104


---

|(1) |  | Balances are net of undisbursed proceeds of construction loans in process and include nonperforming loans.
|--- |  | ----------------------------------------------------------------------------------------------------------

|(2) |  | Yields are calculated on amortized cost and exclude the impact of unrealized gains and losses on available for sale securities.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing
liabilities.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Net interest margin represents fully taxable-equivalent net interest income as a percentage of average interest-earning assets.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Fully taxable-equivalent yields are calculated assuming a 35% federal income tax rate.
|--- |  | --------------------------------------------------------------------------------------




Rate/Volume Analysis.    The following table presents the effects of changing rates and volumes on the interest income and interest expense
of the Company. The table presents the effects on a fully taxable-equivalent basis using amortized cost as described in footnotes 2, 4 and 5 in the previous section. The rate column shows the effects attributable to changes in rate (changes in rate
multiplied by prior volume). The volume column shows




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##### Table of Contents

the effects attributable to changes in volume (changes in volume multiplied by prior rate). The rate/vol column shows the effects attributable to changes in both rate and volume, which cannot be
segregated. The net column represents the sum of the prior columns.





For the Three Months Ended June 30, 2002 Compared to the Three MonthsEnded June 30, 2001Increase (Decrease) Due toRate


Volume

Rate/Vol


Net(in thousands)Interest-earning assets:Loans:Real estate

$
(1,347
)

$
7,240

$
(644
)

$
5,249Consumer


(157
)


757


(78
)


522Commercial


(677
)


464


(100
)


(313
)Total loans


(2,181
)


8,461


(822
)


5,458Mortgage-backed securities


(171
)


911


(122
)


618Collateralized mortgage obligations






3,059






3,059Investment securities


(1,370
)


4,210


(1,468
)


1,372Total interest-earning assets


(3,722
)


16,641


(2,412
)


10,507Interest-bearing liabilities:Deposits:NOW accounts


(45
)


156


(31
)


80Savings and money market accounts


(821
)


1,546


(672
)


53Certificates of deposit


(2,052
)


3,539


(1,168
)


319Other


(27
)


31


(13
)


(9
)Total deposits


(2,945
)


5,272


(1,884
)


443Short-term borrowed funds


(361
)


5


(2
)


(358
)Advances from FHLB


(167
)


4,899


(489
)


4,243Total interest-bearingliabilities


(3,473
)


10,176


(2,375
)


4,328Increase in net interest income

$
(249
)

$
6,465

$
(37
)

$
6,179





Provision for Loan Losses.    The
provision for loan losses was $375,000 for the quarter ended June 30, 2002 compared to $375,000 for the quarter ended June 30, 2001. The allowance for loan losses was 1.01% of total loans and 173.67% of nonperforming loans at June 30, 2002 compared
to 1.06% and 198.31%, respectively, at December 31, 2001.





The Banks largest nonperforming asset is a $2.39
million loan secured by real estate. The Bank has been advised by the borrower that it has received a commitment from another lender to refinance the project during the third quarter of 2002. If the pending refinance by the third party institution
occurs, the Bank expects to receive full payment of the loan as well as a recovery of approximately $700,000 of previously charged off amounts.




20




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##### Table of Contents




Noninterest Income.    Noninterest income was $4.50
million and $2.99 million for the three months ended June 30, 2002 and 2001, respectively. The increase was primarily due to increased service charges and fees, an increase in the cash surrender value of life insurance and an increase in gains on
sales of securities, net. These increases were partially offset by an other than temporary impairment charge for an investment security. Service charges and fees were $3.06 million for the three months ended June 30, 2002 compared to $2.32 million
for the three months ended June 30, 2001. Income from service charges and fees increased $262,000 from increased fees on demand deposit accounts, $196,000 from merchant services, $121,000 from increased debit card fees and $101,000 from ATM fees.
The Bank purchased and also acquired from First Federal cash surrender value life insurance during the second and third quarters of 2001. The Bank earns a competitive tax-exempt yield on these policies. Net security gains increased $292,000 from the
prior year quarter as the Company sold various debt and equity securities throughout the second quarter of 2002. During the second quarter of 2002, the Bank recorded an other than temporary impairment charge of $270,000 on an equity security it
continues to hold. The Banks policy is to evaluate all investment securities for other than temporary impairment on a quarterly basis. This equity security has been below the Banks carrying value for more than six months and after
evaluating all available evidence relating to the security, management deemed the security to be other than temporarily impaired.





Noninterest Expense.    Noninterest expense increased $4.67 million, or 43.77%, from $10.67 million for the three months ended June 30, 2001 to $15.34 million for the three months ended June 30, 2002.
Increases in noninterest expense for the quarter included salaries, employee benefit costs, amortization of other intangible assets and fees and services. Salaries increased $1.13 million due mainly to the higher number of employees after the First
Federal acquisition. Employee benefit costs increased by $635,000 from the prior year period. Pension and post-retirement benefits increased $367,000 primarily due to the First Federal acquisition and valuation and assumption changes for qualified
and nonqualified plans. ESOP expense increased $121,000 mainly due to a higher average stock price. Payroll taxes increased $81,000 primarily due to the higher number of employees after the First Federal acquisition. Due to the acquisition of First
Federal, the Company recorded other intangible assets related to noncompete agreements with former First Federal executives and core deposits. The amortization increase of $1.17 million over the prior year is primarily due to the acquisition. Fees
and services increased $824,000 primarily due to increased software licensing, investment consulting, information technology consulting, debit card processing and correspondent banking fees. A large portion of the increase in these fees is related
to the First Federal acquisition.





Provision for Income Taxes.    Income tax expense
increased $847,000 from $2.08 million for the second quarter of 2001 to $2.93 million for the quarter ended June 30, 2002. The effective tax rate for the current quarter was 32.40% compared to 34.00% in the prior year quarter. The decrease in the
effective tax rate is mainly due to the purchase and acquisition of cash surrender value life insurance as well as an increase in tax exempt municipal bonds acquired from First Federal.





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





Net Income.    Net income for the six months ended June 30, 2002 was $11.69 million compared to $7.73 million for the first six months of 2001.
The results for the six months ended June 30, 2002 include a $10.89 million, or 38.49%, increase in net interest income, primarily due to higher average interest-earning assets and a lower cost of funds, partially offset by higher average
interest-bearing liabilities and lower asset yields. Net income was also increased by higher service charge and fee income of $1.44 million, an increase in income from the cash surrender value life insurance of $1.14 million, and an increase in net
security gains of $741,000. Net income was decreased by an other than temporary impairment charge for an equity security of $270,000, higher salary and employee benefits of $3.20 million, higher amortization of other intangible assets of $2.33
million, higher fees and services of $1.18 million and higher other expenses of $787,000.





Net
Interest Income.    Net interest income increased $10.89 million, or 38.49%, to $39.18 million for the first half of 2002 compared to $28.29 million for the first half of 2001. The increase was primarily a result of higher




21




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##### Table of Contents

interest income from an increase in average interest-earning assets. Total interest and dividend income increased $20.36 million, or 40.65%, to $70.45 million for the first half of 2002 from
$50.09 million for the first half of 2001. Interest income on loans increased $10.46 million, or 26.33%, to $50.19 million for the six months ended June 30, 2002 compared to $39.73 million for the six months ended June 30, 2001. The increase was due
to a $446.17 million increase in the average balance of loans outstanding, the effect of which was partially offset by a 92 basis point decrease in the average yield on such loans. The increase in volume was due to the acquisition of First Federal
and the origination of new loans. Interest and dividend income from investment securities, short-term investments and FHLB stock increased $9.91 million, or 95.66%, to $20.27 million for the six months ended June 30, 2002 compared to $10.36 million
for the six months ended June 30, 2001 primarily due to investments acquired from First Federal. The increase in interest and dividend income from investment securities, short-term investments and FHLB stock was due to an increase in the average
balance of $516.26 million, or 158.49%, to $841.99 million for the six months ended June 30, 2002 as compared to $325.73 million for the six months ended June 30, 2001. Partially offsetting this increase, the yields on investment securities,
short-term investments and FHLB stock decreased 157 basis points to 4.92% for the six months ended June 30, 2002 as compared to 6.49% for the six months ended June 30, 2001. The lower yields earned on loans and investments were primarily due to the
lower overall interest rate environment as compared to the prior year period.





Interest expense increased $9.47
million, or 43.44%, to $31.27 million for the six months ended June 30, 2002 compared to $21.80 million for the six months ended June 30, 2001. The increase was primarily due to deposits and FHLB advances acquired from First Federal. The increase
was due to an increase in average interest-bearing deposit balances of $608.48 million and an increase in average FHLB advances of $363.15 million. This increase was partially offset by a decrease in the overall cost of funds for interest-bearing
liabilities of 96 basis points. The cost of funds for the first half of 2002 was 3.04% as compared to 4.00% for the first half of 2001.





Average Balances, Interest and Average Yields/Cost.The following table presents certain information for the periods indicated regarding average balances of assets and liabilities, as well as
the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and the resulting average yields and costs. The yields and costs for the periods indicated are derived by
dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. The yields and rates include fees which are considered adjustments to yields.




22




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##### Table of Contents




For the Six Months Ended June 30,2002


2001Average Balance

Interest

Average Yield/Rate


Average Balance

Interest

Average Yield/Rate(dollars in thousands)Interest-earning assets:Loans(1):Real estate

$
1,187,927

$
40,463

6.81
%

$
803,099

$
30,185

7.52
%Consumer


120,186


4,135

6.88



80,300


3,173

7.90Commercial(5)


170,137


5,614

6.65



148,684


6,407

8.69Total loans(5)


1,478,250


50,212

6.80



1,032,083


39,765

7.72Mortgage-backed securities(2)


130,442


4,034

6.19



73,184


2,708

7.40Collateralized mortgage obligations(2)


237,483


6,201

5.22








0.00Investment securities(2)(5):U.S. Government and agency obligations


164,918


3,605

4.41



74,810


2,593

6.99Municipal Obligations


23,686


838

7.08



2,903


107

7.37Corporate securities


54,414


1,772

6.51



51,056


1,972

7.72Common stock and mutual funds


40,136


779

3.88



35,956


611

3.40Other investment securities


976


4

0.82



432




0.00Asset-backed securities


100,685


2,335

4.64



28,844


1,071

7.43Other interest-bearing assetsFHLB stock


30,783


572

3.72



7,085


253

7.14Short-term investments


58,466


532

1.83



51,464


1,221

4.78Total interest-earning assets(5)


2,320,239

$
70,884

6.12
%


1,357,817

$
50,301

7.42
%Noninterest-earning assets


133,199








45,893Total assets

$
2,453,438







$
1,403,710Interest-bearing liabilities:Deposits:NOW accounts

$
209,816

$
600

0.58
%

$
123,350

$
439

0.72
%Savings and money market accounts


557,799


4,207

1.52



305,820


3,772

2.49Certificates of deposit


710,974


13,664

3.88



443,915


12,637

5.74Escrow deposits


9,926


84

1.71



6,954


102

2.96Total interest-bearing deposits


1,488,515


18,555

2.51



880,039


16,950

3.88Short-term borrowed funds


110,311


863

1.58



103,690


1,538

2.99Advances from FHLB


477,104


11,852

5.01



113,945


3,308

5.85Total interest-bearing liabilities


2,075,930

$
31,270

3.04
%


1,097,674

$
21,796

4.00
%Noninterest-bearing liabilities


133,482








76,799Total liabilities


2,209,412








1,174,473Stockholders equity


244,026








229,237Total liabilities and stockholders equity

$
2,453,438







$
1,403,710Net interest-earning assets

$
244,309







$
260,143Net interest income(5)




$
39,614







$
28,505Interest rate spread(3)(5)







3.08
%







3.42
%Net interest margin(4)(5)







3.40
%







4.18
%Ratio of interest-earning assets to interest-bearing liabilities







111.77
%







123.70
%Taxable-equivalent adjustmentsLoans




$
24







$
36Investment securities





406








177Total




$
430







$
213


---

|(1) |  | Balances are net of undisbursed proceeds of construction loans in process and include nonperforming loans.
|--- |  | ----------------------------------------------------------------------------------------------------------

|(2) |  | Yields are calculated on amortized cost and exclude the impact of unrealized gains and losses on available for sale securities.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing
liabilities.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Net interest margin represents fully taxable-equivalent net interest income as a percentage of average interest-earning assets.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Fully taxable-equivalent yields are calculated assuming a 35% federal income tax rate.
|--- |  | --------------------------------------------------------------------------------------



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##### Table of Contents




Rate/Volume Analysis.    The following table presents
the effects of changing rates and volumes on the interest income and interest expense of the Company. The table presents the effects on a fully taxable-equivalent basis using amortized cost as described in footnotes 2, 4 and 5 in the previous
section. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The rate/vol
column shows the effects attributable to changes in both rate and volume, which cannot be segregated. The net column represents the sum of the prior columns.








For the Six Months Ended June 30, 2002 Compared to the Six Months EndedJune 30, 2001Increase (Decrease) Due toRate


Volume

Rate/Vol


Net(in thousands)Interest-earning assets:Loans:Real estate

$
(2,830
)

$
14,464

$
(1,356
)

$
10,278Consumer


(410
)


1,576


(204
)


962Commercial


(1,501
)


924


(216
)


(793
)Total loans


(4,741
)


16,964


(1,776
)


10,447Mortgage-backed securities


(445
)


2,119


(348
)


1,326Collateralized mortgage obligations






6,201






6,201Investment securities


(2,459
)


7,770


(2,702
)


2,609Total interest-earning assets


(7,645
)


33,054


(4,826
)


20,583Interest-bearing liabilities:Deposits:NOW accounts


(87
)


308


(60
)


161Savings and money mkt accounts


(1,465
)


3,108


(1,208
)


435Certificates of deposit


(4,106
)


7,602


(2,469
)


1,027Other


(43
)


44


(19
)


(18
)Total deposits


(5,701
)


11,062


(3,756
)


1,605Short-term borrowed funds


(727
)


98


(46
)


(675
)Advances from FHLB


(477
)


10,543


(1,522
)


8,544Total interest-bearing liabilities


(6,905
)


21,703


(5,324
)


9,474Increase in net interest income

$
(740
)

$
11,351

$
498


$
11,109





Provision for Loan Losses.    The
provision for loan losses was $750,000 for each of the six months ended June 30, 2002 and June 30, 2001. The allowance for loan losses was 1.01% of total loans and 173.67% of nonperforming loans at June 30, 2002 compared to 1.06% and 198.31%,
respectively, at December 31, 2001.





The Banks largest nonperforming asset is a $2.39 million loan secured
by real estate. The Bank has been




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##### Table of Contents

advised by the borrower that it has received a commitment from another lender to refinance the project during the third quarter of 2002. If the pending refinance by the third party institution
occurs, the Bank expects to receive full payment of the loan as well as a recovery of approximately $700,000 of previously charged off amounts.





Noninterest Income.    Noninterest income was $9.22 million and $5.89 million for the six months ended June 30, 2002 and 2001, respectively. The increase was primarily due to
increased service charge and fee income, an increase in the cash surrender value of life insurance and an increase in gains on sales of securities, net. These increases were partially offset by a charge for an other than temporary impairment of an
investment security. Service charges and fees were $5.91 million for the six months ended June 30, 2002 compared to $4.47 million for the six months ended June 30, 2001. Income from service charges and fees increased $633,000 from increased fees on
demand deposit accounts, $334,000 from merchant services, $257,000 from increased debit fees and $179,000 from ATM fees. The Bank purchased and also acquired from First Federal cash surrender value life insurance during the second and third quarters
of 2001. The Bank earns a competitive tax-exempt yield on these policies. Net security gains increased $741,000 during the six months ended June 30, 2002 as compared to the prior year period as the Company sold various debt and equity securities
throughout the first six months of 2002. During the second quarter of 2002, the Bank recorded an other than temporary impairment charge of $270,000 on an equity security it continues to hold. The Banks policy is to evaluate all investment
securities for other than temporary impairment on a quarterly basis. This equity security has been below the Banks carrying value for more than six months and after evaluating all available evidence relating to the security, management deemed
the security to be other than temporarily impaired.





Noninterest
Expense.    Noninterest expense increased $8.66 million, or 39.89%, from $21.71 million for the six months ended June 30, 2001 to $30.37 million for the six months ended June 30, 2002. Increases in noninterest expense for the
first half of 2002 included salaries, employee benefit costs, amortization of other intangible assets, fees and services and other expenses. Salaries increased $1.65 million due mainly to the higher number of employees after the First Federal
acquisition. Employee benefit costs increased by $1.55 million from the prior year period. Retirement benefits increased $708,000 primarily due to the First Federal acquisition and valuation and assumption changes for qualified and nonqualified
plans. Payroll taxes increased $418,000 primarily due to the January 2, 2002 scheduled vesting of restricted stock previously granted, as well as the higher number of employees after the First Federal acquisition. ESOP expense increased $201,000
mainly due to a higher average stock price. Due to the acquisition of First Federal, the Company recorded other intangible assets related to noncompete agreements with former First Federal executives and core deposit intangibles. The amortization
increase of $2.33 million over the prior year is primarily due to the acquisition. Fees and services increased $1.18 million primarily due to increased software licensing, investment consulting, information technology consulting, debit card
processing, director and correspondent banking fees. Increases in other expenses included higher costs related to telephone, postage, supplies and insurance. A large portion of the increase in these fees is related to the First Federal acquisition.





Provision for Income Taxes.    Income tax expense increased $1.62 million from $3.98
million for the first half of 2001 to $5.60 million for the six months ended June 30, 2002. The effective tax rate for the current six month period was 32.40% compared to 34.00% in the prior year period. The decrease in the effective tax rate is
mainly due to the purchase and acquisition of cash surrender value life insurance as well as an increase in tax exempt municipal bonds acquired from First Federal.





Liquidity and Capital Resources





Liquidity is the ability
to meet current and future financial obligations of a short- term nature. The Company further defines liquidity as the ability to respond to the needs of depositors and borrowers as well as maintaining the flexibility to take advantage of investment
opportunities. Primary sources of funds consist of deposit inflows, loan repayments, maturities, paydowns, sales of collateralized mortgage obligations, investment and mortgage-backed securities and advances from FHLB. While maturities and scheduled
amortization of loans and securities are predictable sources of funds, deposit outflows and mortgage prepayments are influenced by general interest rates, economic conditions and competition.




25




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##### Table of Contents




The Companys primary investing activities are (1) originating residential
one- to four-family mortgage loans and, to a lesser extent, commercial business and real estate loans, multi-family loans, single-family construction loans, home equity loans and lines of credit and consumer loans and (2) investing in
mortgage-backed securities, collateralized mortgage obligations, U.S. Government and agency obligations and corporate equity securities and debt obligations. These activities are funded primarily by principal and interest payments on loans,
maturities of securities, deposit growth and Advances from FHLB. During the six months ended June 30, 2002, the Banks loan originations, net of repayments, totaled $84.30 million. For the six months ended June 30, 2002, the Company purchased
investments in mortgage-backed securities, U.S. Government and agency obligations and corporate equity securities and debt obligations totaling $224.51 million. The Bank experienced a net increase in total deposits of $25.96 million for the six
months ended June 30, 2002. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by the Bank and its local competitors and other factors. The Company closely monitors its liquidity position on a
daily basis. If the Company should require additional funds, additional funds are available through advances from FHLB and through repurchase agreement borrowing facilities.





Outstanding commitments for all loans and unadvanced construction loans and lines of credit totaled $239.49 million at June 30, 2002. Management of the Bank anticipates
that it will have sufficient funds available to meet its current loan commitments. Certificates of deposit that are scheduled to mature in one year or less from June 30, 2002 totaled $489.33 million. The Bank relies primarily on competitive rates,
customer service, and long-standing relationships with customers to retain deposits. Occasionally, the Bank will also offer special competitive promotions to its customers to increase retention and promote deposit growth. Based upon the Banks
historical experience with deposit retention, management believes that a significant portion of its deposits will remain with the Bank.





SBM must satisfy various regulatory capital requirements administered by the federal banking agencies including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a
framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At June 30, 2002, SBM exceeded all of its regulatory capital requirements with a leverage capital level of $171.65
million, or 7.14% of average assets, which is above the required level of $96.14 million, or 4.00%, and total risk-based capital of $186.98 million, or 11.64% of risk weighted assets, which is above the required level of $128.51 million, or 8.00%.
SBM is considered well capitalized under regulatory guidelines.





Impact of Inflation and Changing Prices





The condensed consolidated financial statements and related data presented in this report have been prepared in conformity 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 dollars, without considering changes in the relative purchasing power of money
over time due to inflation. Unlike many industrial companies, substantially all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Companys performance than
the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as inflation.





Impact of New Accounting Standards





Effective January 1, 2002, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires the Company to test goodwill for impairment by applying an annual fair-value-based test rather than
amortizing the goodwill. Recognized intangible assets, such as core deposit intangibles, will continue to be amortized over their useful lives. The Company has evaluated the useful lives as required by SFAS No. 142 and no change was made regarding
lives upon adoption. SFAS No. 142 prohibits the amortization of goodwill but requires that it be tested for impairment at least annually at the reporting unit level. The Company tested its $19.97 million of goodwill,




26




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##### Table of Contents

related to the 2001 acquisition of First Federal, in accordance with the provisions of SFAS No. 142. As a result of this testing, no impairment charges were recorded.





In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 rescinds SFAS No. 4, reporting Gains and Losses from Extinguishment of Debt and an amendment of that statement, SFAS No. 64,
Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145 also rescinds SFAS No. 44, Accounting for Intangible Assets of Motor Carriers. SFAS No. 145 amends SFAS No. 13, Accounting for
Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS
No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The adoption of SFAS No. 145 is not expected to have a material effect
on the Companys condensed consolidated financial statements.





In June 2002, the FASB issued SFAS No. 146,
accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring). The adoption of SFAS No. 146 is not expected to have a material effect on the Companys condensed consolidated financial statements.





Item 3.Quantitative and Qualitative Disclosures About Market Risk.





At June 30, 2002, there
have been no material changes in information regarding quantitative and qualitative disclosure about market risk from the information presented as of December 31, 2001 in the Companys Annual Report on Form 10-K.




27




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##### Table of Contents




PART II.    OTHER INFORMATION





Item 1.Legal Proceedings.





Periodically, there have been various claims and lawsuits
involving the Company, such as claims to enforce liens, condemnation proceedings on properties in which the Company holds security interests, claims involving the making and servicing of real property loans and other issues incident to the
Companys business. The Company is not a party to any pending legal proceedings that it believes would have a material adverse effect on the consolidated financial condition or operations of the Company.





Item 2.Changes in Securities and Use of Proceeds.





Not applicable.





Item 3.Defaults Upon Senior Securities.





None.





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





| | a. |  | An annual meeting of shareholders of the Company was held on May 16, 2002 (the Annual Meeting).
| | -- |  | -------------------------------------------------------------------------------------------------




| | b. |  | Not applicable.
| | -- |  | ---------------




| | c. |  | There were 11,249,826 shares of Common Stock of the Company eligible to be voted at the Annual Meeting, and 9,706,106 shares were represented at the meeting by
the holders thereof, which constituted a quorum. The items voted upon at the Annual Meeting and the vote for each proposal were as follows:
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




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





Director Nominees Elected For Three-Year Term

For

WithheldTimothy J. Devanney

9,030,267

675,839Sheila B. Flanagan

9,030,412

675,694Eric A. Marziali

9,029,937

676,169William D. O'Neill

9,029,537

676,569





2.    The approval of
Connecticut Bancshares, Inc. 2002 Equity Compensation Plan.





For

Against

Abstain

Broker Non-Votes5,932,470

1,414,152

121,649

2,237,835




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##### Table of Contents




| | 3. |  | The ratification of the appointment of Deloitte & Touche LLP as independent auditors of Connecticut Bancshares, Inc. for the fiscal year ending December 31,
2002.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------




For

Against

Abstain9,066,375

593,719

46,012





| | d. |  | Not applicable.
| | -- |  | ---------------




Item 5.Other Information.





None.





Item 6.Exhibits and Reports on Form 8-K.





| | (a) |  | Exhibits
| | --- |  | --------




| | 3.1 |  | Certificate of Incorporation of Connecticut Bancshares, Inc.(1)
| | --- |  | ---------------------------------------------------------------

| | 3.2 |  | Second Amended and Restated Bylaws of Connecticut Bancshares, Inc.(2)
| | --- |  | ---------------------------------------------------------------------

| | 4.0 |  | Stock Certificate of Connecticut Bancshares, Inc.(1)
| | --- |  | ----------------------------------------------------

| | 11.0 |  | Computation of Per Share Earnings (Incorporated by reference in Part I, hereto)
| | ---- |  | -------------------------------------------------------------------------------

| | 99.1 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
| | ---- |  | ----------------------------------------------------------------------------------------------------------------------

| | 99.2 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
| | ---- |  | ----------------------------------------------------------------------------------------------------------------------

| | 
| | 

| | (1) |  | Incorporated by reference into this document from the Exhibits filed with the Registration Statement on Form S-1, and any amendments thereto, Registration No.
333-90865.
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) |  | Incorporated by reference into this document from the Quarterly Report on Form 10-Q dated March 31, 2001 and filed with the Securities and Exchange Commission
on May 4, 2001.
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (b) |  | Reports on Form 8-K
| | --- |  | -------------------




A Form 8-K was filed on April 4, 2002, regarding the Companys announcement that its Board of Directors, upon the recommendation of its Audit Committee, terminated Arthur Andersen LLP who had previously acted as the
Companys independent auditors. The Company engaged Deloitte & Touche LLP as its new independent auditors to audit the consolidated financial statements of the Company for the fiscal year ending December 31, 2002, as well as to perform
timely reviews of its quarterly results for fiscal 2002.




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##### Table of Contents

SIGNATURES





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





CONNECTICUT BANCSHARES, INC.Dated: August 9, 2002



By:

/s/    Richard P. MeduskiRichard P. Meduski President
and Chief Executive Officer (principal executive officer)





Dated: August 9, 2002



By:

/s/    MICHAEL J.
HARTLMichael J. Hartl Senior Vice
President and Chief Financial Officer (principal financial and accounting officer)




30