** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

### **FORM10-Q**

 

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

 

## **For the quarterly period endedDecember 31, 2001**

 

**or**

 

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

 

## **For the transitionperiod from              to             **

 

**Commissionfile number 1-13691**

 

**Bay StateBancorp, Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                                                     |   | **04-3398630**                       |
|----------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization)                   |   | (I.R.S. Employer Identification No.) |
|                                                                             |   |                                 |
| **1299 Beacon Street, Brookline, Massachusetts**                                 |   | **02446**                            |
| (Address of principal executive offices)                                         |   | (Zip Code)                           |
|                                                                             |   |                                 |
| Registrant’s telephone number, including area code: **(617) 739–9500** |

 

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

 

The number ofshares of common stock, par value $0.01, outstanding as of February 8, 2002 was1,646,141.

 

 

**BAY STATE BANCORP, INC. AND SUBSIDIARIES**

 

**INDEX**

 
| PART I - FINANCIAL  INFORMATION                                                                                                               |
|-----------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                          |
| Item 1-  Condensed Consolidated Financial Statements                                                                                          |
|                                                                                                                                          |
| Condensed  Consolidated Balance Sheets - December 31, 2001 (unaudited) and March 31,  2001                                                    |
|                                                                                                                                          |
| Condensed  Consolidated Income Statements - For the three and nine months ended December  31, 2001 and 2000 (unaudited)                       |
|                                                                                                                                          |
| Condensed  Consolidated Statements of Cash Flows - For the nine months ended December  31, 2001 and 2000 (unaudited)                          |
|                                                                                                                                          |
| Condensed  Consolidated Statements of Changes in Stockholders’ Equity -For the nine  months ended December 31, 2001 and 2000 (unaudited) |
|                                                                                                                                          |
| Notes  to Unaudited Condensed Consolidated Financial Statements for the Period Ended  December 31, 2001                                       |
|                                                                                                                                          |
| Item  2 - Management’s Discussion and Analysis of Financial Condition and Results  of Operations                                         |
|                                                                                                                                          |
| Item  3 - Quantitative and Qualitative Disclosures about Market Risk                                                                          |
|                                                                                                                                          |
| PART II - OTHER INFORMATION                                                                                                                   |
|                                                                                                                                          |
| Item 1 - Legal Proceedings                                                                                                                    |
|                                                                                                                                          |
| Item  2 - Changes in Securities and Use of Proceeds                                                                                           |
|                                                                                                                                          |
| Item 3 -  Defaults Upon Senior Securities                                                                                                     |
|                                                                                                                                          |
| Item  4 - Submission of Matters to a Vote of Security Holders                                                                                 |
|                                                                                                                                          |
| Item 5 - Other Information                                                                                                                    |
|                                                                                                                                          |
| Item 6 -  Exhibits and Reports on Form 8-K                                                                                                    |
|                                                                                                                                          |
| SIGNATURES                                                                                                                                    |
|                                                                                                                                          |
| EXHIBITS                                                                                                                                      |
|                                                                                                                                          |
| Computation of per share earnings - Exhibit 11                                                                                                |

 

----

 

**PART I - FINANCIAL INFORMATION**

**Item 1 - Condensed Financial Statements**

 

Bay State Bancorp, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(Dollars in thousands, except per share data)

 
|                                                                       |   | **December  31,** |    | **March 31,** |   |
|----------------------------------------------------------------------------|--------|-------------------|---------|---------------|--------|
|                                                                       |   | **2001**          |    | **2001**      |   |
|                                                                       |   | **(Unaudited)**   |    |          |   |
| **ASSETS**                                                                 |   |              |    |          |   |
|                                                                       |   |              |    |          |   |
| Cash and due from banks                                                    |   | $                 | 8,808   |          | $      | 9,985 |   |
| Short-term investments                                                     |   | 7,626             |    | 114           |   |
| Cash and Cash Equivalents                                                  |   | 16,434            |    | 10,099        |   |
| Investment in available-for-sale securities (at fair value)                |   | 34,556            |    | 34,356        |   |
| Investments in held-to-maturity securities (fair values of $201 and  $345) |   | 192               |    | 336           |   |
| Stock in Federal Home Loan Bank of Boston                                  |   | 8,455             |    | 8,455         |   |
| Loans receivable, net                                                      |   | 446,193           |    | 417,704       |   |
| Mortgage loans held for sale                                               |   | 377               |    | —        |   |
| Accrued interest receivable                                                |   | 3,134             |    | 3,268         |   |
| Premises and equipment, net                                                |   | 3,024             |    | 3,222         |   |
| Deferred tax asset, net                                                    |   | 2,774             |    | 2,816         |   |
| Investment in bank owned life insurance                                    |   | 8,546             |    | 8,269         |   |
| Other assets                                                               |   | 3,902             |    | 3,332         |   |
| Total assets                                                               |   | $                 | 527,587 |          | $      | 491,857 |   |
|                                                                       |   |              |    |          |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                              |   |              |    |          |   |
| Liabilities:                                                               |   |              |    |          |   |
| Deposits                                                                   |   | $                 | 317,004 |          | $      | 273,263 |   |
| Federal Home Loan Bank Advances                                            |   | 150,343           |    | 158,139       |   |
| Other borrowed funds                                                       |   | 2,000             |    | 2,000         |   |
| Accrued expenses and other liabilities                                     |   | 5,537             |    | 4,695         |   |
| Total liabilities                                                          |   | 474,884           |    | 438,097       |   |
| Stockholders’ equity:                                                 |   |              |    |          |   |
| Common stock, par value $.01 per share,2,535,232 shares issued             |   | 25                |    | 25            |   |
| Additional paid-in capital                                                 |   | 49,099            |    | 49,275        |   |
| Retained earnings                                                          |   | 27,420            |    | 24,382        |   |
| Accumulated other comprehensive income                                     |   | 635               |    | 617           |   |
| Less: Unearned ESOP shares                                                 |   | (2,420            | )       | (2,420        | )      |
| Unearned 1998 Stock-Based Incentive Plan shares                            |   | (886              | )       | (1,208        | )      |
| Treasury stock, 887,591 and 769,689 shares                                 |   | (21,170           | )       | (16,911       | )      |
| Total stockholders’ equity                                            |   | 52,703            |    | 53,760        |   |
| Total liabilities and stockholders’ equity                            |   | $                 | 527,587 |          | $      | 491,857 |   |
|                                                                       |   |              |    |          |   |
| Equity-to-asset ratio                                                      |   | 9.99              | %       | 10.93         | %      |
|                                                                       |   |              |    |          |   |
| Book value per share                                                       |   | $                 | 34.62   |          | $      | 32.77 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

1

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## BayState Bancorp, Inc. and Subsidiaries

Condensed ConsolidatedIncome Statements

(Dollars in thousands, except per share data)

 
|                                                                        |   | **Three  months ended** |   | **Nine months  ended** |   |
|-----------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                        |   | **December  31,**       |   | **December  31,**      |   |
|                                                                        |   | **2001**                |   | **2000**               |   | **2001** |   | **2000** |   |
|                                                                        |   | **(Unaudited)**         |   |
| Interest income:                                                            |   |                    |   |                   |   |   |   |   |   |
| Loans                                                                       |   | $                       | 8,893  |                   | $      | 8,854 |   | $ | 26,474 |   | $ | 25,429 |   |
| Investments                                                                 |   | 639                     |   | 749                    |   | 2,088 |   | 2,160 |   |
| Total interest income                                                       |   | 9,532                   |   | 9,603                  |   | 28,562 |   | 27,589 |   |
| Interest expense:                                                           |   |                    |   |                   |   |   |   |   |   |
| Deposits                                                                    |   | 2,360                   |   | 2,939                  |   | 8,010 |   | 8,481 |   |
| Borrowed funds                                                              |   | 1,821                   |   | 2,619                  |   | 6,020 |   | 7,390 |   |
| Total interest expense                                                      |   | 4,181                   |   | 5,558                  |   | 14,030 |   | 15,871 |   |
| Net interest income before provision for loan  losses                       |   | 5,351                   |   | 4,045                  |   | 14,532 |   | 11,718 |   |
| Provision for loan losses                                                   |   | 125                     |   | 60                     |   | 262 |   | 375 |   |
| Net interest income after provision for loan losses                         |   | 5,226                   |   | 3,985                  |   | 14,270 |   | 11,343 |   |
| Non-interest income:                                                        |   |                    |   |                   |   |   |   |   |   |
| Service charges on deposit accounts                                         |   | 143                     |   | 113                    |   | 419 |   | 317 |   |
| Unrealized (loss) gain on trading securities                                |   | 16                      |   | (207                   | )      | (47 | ) | (170 | ) |
| Gain on sale of investments and other assets                                |   | —                  |   | —                 |   | 142 |   | 40 |   |
| Gain on sale of loans                                                       |   | 54                      |   | 4                      |   | 82 |   | 11 |   |
| Net increase in cash surrender value of bank owned  life insurance policies |   | 94                      |   | 79                     |   | 278 |   | 287 |   |
| Other income                                                                |   | 64                      |   | 55                     |   | 178 |   | 162 |   |
| Total non-interest income                                                   |   | 371                     |   | 44                     |   | 1,052 |   | 647 |   |
| Income before non-interest expense and income taxes                         |   | 5,597                   |   | 4,029                  |   | 15,322 |   | 11,990 |   |
| Non-interest expense:                                                       |   |                    |   |                   |   |   |   |   |   |
| Salaries and employee benefits                                              |   | 2,009                   |   | 1,468                  |   | 5,564 |   | 4,925 |   |
| Occupancy and equipment expense                                             |   | 407                     |   | 383                    |   | 1,217 |   | 1,111 |   |
| Professional fees                                                           |   | 87                      |   | 77                     |   | 304 |   | 223 |   |
| Advertising                                                                 |   | 141                     |   | 122                    |   | 422 |   | 375 |   |
| Data processing                                                             |   | 115                     |   | 93                     |   | 341 |   | 256 |   |
| Other expenses                                                              |   | 456                     |   | 391                    |   | 1,076 |   | 1,009 |   |
| Total non-interest expense                                                  |   | 3,215                   |   | 2,534                  |   | 8,924 |   | 7,899 |   |
| Income before income taxes                                                  |   | 2,382                   |   | 1,495                  |   | 6,398 |   | 4,091 |   |
| Income tax expense                                                          |   | 959                     |   | 554                    |   | 2,534 |   | 1,487 |   |
| Net income                                                                  |   | $                       | 1,423  |                   | $      | 941 |   | $ | 3,864 |   | $ | 2,604 |   |
| Comprehensive net income                                                    |   | $                       | 1,441  |                   | $      | 1,444 |   | $ | 3,882 |   | $ | 4,531 |   |
|                                                                        |   |                    |   |                   |   |   |   |   |   |
| Weighted average basic shares outstanding                                   |   | 1,532,504               |   | 1,709,033              |   | 1,592,410 |   | 1,769,102 |   |
| Weighted average fully diluted shares outstanding                           |   | 1,628,880               |   | 1,771,940              |   | 1,685,153 |   | 1,806,124 |   |
| Basic earnings per share                                                    |   | $                       | 0.93   |                   | $      | 0.55 |   | $ | 2.43 |   | $ | 1.47 |   |
| Diluted earnings per share                                                  |   | $                       | 0.87   |                   | $      | 0.53 |   | $ | 2.29 |   | $ | 1.44 |   |
| Dividends per share                                                         |   | $                       | 0.18   |                   | $      | 0.12 |   | $ | 0.48 |   | $ | 0.44 |   |

 

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

 

2

----

 

# Bay State Bancorp,Inc. and Subsidiaries

Condensed ConsolidatedStatements of Cash Flows

(In thousands)

 
|                                                                               |   | **Nine months ended December 31,** |   |
|------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                               |   | **2001**                           |   | **2000** |   |
|                                                                               |   | **Unaudited**                      |   |
| Net cash flows from operating activities:                                          |   |                               |   |   |   |
| Net income                                                                         |   | $                                  | 3,864  |   | $ | 2,604 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |                               |   |   |   |
| Earned stock based incentive plan                                                  |   | 284                                |   | 302 |   |
| Provision for loan losses                                                          |   | 262                                |   | 375 |   |
| Net (increase) in mortgage loans held-for-sale                                     |   | (377                               | )      | — |   |
| Gain on sale of other real estate owned                                            |   | —                             |   | (7 | ) |
| Gain on sale of investments                                                        |   | (70                                | )      | (40 | ) |
| Gain on sale of other assets                                                       |   | (72                                | )      | (11 | ) |
| Depreciation and amortization                                                      |   | 347                                |   | 321 |   |
| Accretion of securities, net of amortization                                       |   | (33                                | )      | (40 | ) |
| Change in loan fees and discounts                                                  |   | (29                                | )      | (3 | ) |
| Net change in trading securities                                                   |   | 3                                  |   | 200 |   |
| Increase in cash surrender value B.O.L.I.                                          |   | (277                               | )      | (289 | ) |
| Decrease (increase) in accrued interest receivable                                 |   | 134                                |   | (900 | ) |
| Decrease in deferred income tax assets, net                                        |   | 50                                 |   | 96 |   |
| Increase in prepaid expense and other assets                                       |   | (589                               | )      | (400 | ) |
| Increase in accrued expenses and other liabilities                                 |   | 617                                |   | 710 |   |
| Net cash provided by operating activities                                          |   | 4,114                              |   | 2,918 |   |
| Net cash flows from investing activities:                                          |   |                               |   |   |   |
| Maturities and principal repayments on investments  held to maturity          |   | 144                                |   | 139 |   |
| Maturities and principal repayments on investments  available for sale             |   | 7,391                              |   | 4,868 |   |
| Proceeds from sales of available-for-sale  securities                              |   | 72                                 |   | 1,205 |   |
| Purchases of Federal Home Loan Bank stock                                          |   | —                             |   | (270 | ) |
| Purchases of investments available-for-sale                                        |   | (7,329                             | )      | (4,244 | ) |
| Net decrease (increase) in loans                                                   |   | 6,495                              |   | (5,683 | ) |
| Proceeds from sale of other assets                                                 |   | 92                                 |   | — |   |
| Loans purchased                                                                    |   | (35,217                            | )      | (20,971 | ) |
| Payment received on other real estate owned                                        |   | —                             |   | 20 |   |
| Proceeds from sales of other real estate owned                                     |   | —                             |   | 117 |   |
| Capital expenditures                                                               |   | (149                               | )      | (507 | ) |
| Net cash used in investing activities                                              |   | (28,501                            | )      | (25,326 | ) |
| Net cash flows from financing activities:                                          |   |                               |   |   |   |
| Net deposit activity                                                               |   | 43,741                             |   | 17,827 |   |
| Proceeds of borrowings                                                             |   | 155,390                            |   | 229,000 |   |
| Repayment of borrowings                                                            |   | (163,186                           | )      | (214,491 | ) |
| Net decrease in other borrowed funds                                               |   | —                             |   | (6,105 | ) |
| Proceeds from issuance of common stock                                             |   | 481                                |   | — |   |
| Dividends on common stock                                                          |   | (826                               | )      | (612 | ) |
| Purchases of treasury stock                                                        |   | (4,878                             | )      | (3,270 | ) |
| Net cash provided by financing activities                                          |   | 30,722                             |   | 22,349 |   |
| Net increase (decrease) in cash and cash  equivalents                              |   | 6,335                              |   | (59 | ) |
| Cash and cash equivalents at beginning of period                                   |   | 10,099                             |   | 5,992 |   |
| Cash and cash equivalents at end of period                                         |   | $                                  | 16,434 |   | $ | 5,933 |   |
| Supplemental disclosures of cash flow information:                                 |   |                               |   |   |   |
| Cash paid during period for:                                                       |   |                               |   |   |   |
| Interest                                                                           |   | $                                  | 14,240 |   | $ | 15,699 |   |
| Income taxes                                                                       |   | $                                  | 2,698  |   | $ | 1,783 |   |
| Loans transferred to other real estate owned                                       |   | $                                  | — |   | $ | 68 |   |

 

The accompanying notes are anintegral part of these condensed consolidated financial statements.

 

3

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## BayState Bancorp, Inc. and Subsidiaries

## Condensed Consolidated Statements ofChanges in Stockholders’ Equity

(Dollars in thousands,except per share data)

(Unaudited)

 
|                                                                               |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Retained  Earnings** |   | **Accumulated  Other   Comprehensive  Income (Loss)** |   | **Unearned   ESOP Shares** |   | **Unearned  Stock-based  Incentive Plan  Shares** |   | **Treasury  Stock** |    | **Total  Stockholders’  Equity** |   |
|------------------------------------------------------------------------------------|--------|-------------------|--------|----------------------------------|--------|------------------------|--------|-------------------------------------------------------|--------|----------------------------|--------|---------------------------------------------------|--------|---------------------|---------|---------------------------------------|--------|
| Balance at March 31, 2001                                                          |   | $                 | 25     |                             | $      | 49,275                 |   | $                                                     | 24,382 |                       | $      | 617                                               |   | $                   | (2,420) |                                  | $      | (1,208) |   | $ | (16,911) |   | $ | 53,760 |   |
| Net Income                                                                         |   | 3⁄4            |   | 3⁄4                           |   | 3,864                  |   | 3⁄4                                                |   | 3⁄4                     |   | 3⁄4                                            |   | 3⁄4              |    | 3⁄4                                |   |
| Net change in unrealized gain on available  for sale securities, net of tax effect |   | 3⁄4            |   | 3⁄4                           |   | 3⁄4                 |   | 18                                                    |   | 3⁄4                     |   | 3⁄4                                            |   | 3⁄4              |    | 3⁄4                                |   |
| Comprehensive income                                                               |   | 3⁄4            |   | 3⁄4                           |   | 3⁄4                 |   | 3⁄4                                                |   | 3⁄4                     |   | 3⁄4                                            |   | 3⁄4              |    | 3,882                                 |   |
| Purchase of treasury stock, 143,277 shares                                         |   | 3⁄4            |   | 3⁄4                           |   | 3⁄4                 |   | 3⁄4                                                |   | 3⁄4                     |   | 3⁄4                                            |   | (4,878              | )       | (4,878                                | )      |
| Exercise of 25,375 stock options issued from  treasury stock                       |   | 3⁄4            |   | (138                             | )      | 3⁄4                 |   | 3⁄4                                                |   | 3⁄4                     |   | 3⁄4                                            |   | 619                 |    | 481                                   |   |
| Dividends paid, $0.48 per share                                                    |   | 3⁄4            |   | 3⁄4                           |   | (826                   | )      | 3⁄4                                                |   | 3⁄4                     |   | 3⁄4                                            |   | 3⁄4              |    | (826                                  | )      |
| Issuance of stock incentive plan shares                                            |   | 3⁄4            |   | (38                              | )      | 3⁄4                 |   | 3⁄4                                                |   | 3⁄4                     |   | 322                                               |   | 3⁄4              |    | 284                                   |   |
| Balance at December 31, 2001 (Unaudited)                                           |   | $                 | 25     |                             | $      | 49,099                 |   | $                                                     | 27,420 |                       | $      | 635                                               |   | $                   | (2,420  | )                                     | $      | (886 | ) | $ | (21,170 | ) | $ | 52,703 |   |
|                                                                               |   |              |   |                             |   |                   |   |                                                  |   |                       |   |                                              |   |                |    |                                  |   |
| Balance at March 31, 2000                                                          |   | $                 | 25     |                             | $      | 49,207                 |   | $                                                     | 21,600 |                       | $      | (1,788                                            | )      | $                   | (2,826  | )                                     | $      | (1,681 | ) | $ | (11,907 | ) | $ | 52,630 |   |
| Net Income                                                                         |   | 3⁄4            |   | 3⁄4                           |   | 2,604                  |   | 3⁄4                                                |   | 3⁄4                     |   | 3⁄4                                            |   | 3⁄4              |    | 3⁄4                                |   |
| Net change in unrealized loss on available for sale securities, net of  tax effect |   | 3⁄4            |   | 3⁄4                           |   | 3⁄4                 |   | 1,927                                                 |   | 3⁄4                     |   | 3⁄4                                            |   | 3⁄4              |    | 3⁄4                                |   |
| Comprehensive income                                                               |   | 3⁄4            |   | 3⁄4                           |   | 3⁄4                 |   | 3⁄4                                                |   | 3⁄4                     |   | 3⁄4                                            |   | 3⁄4              |    | 4,531                                 |   |
| Purchase of treasury stock, 130,714 shares                                         |   | 3⁄4            |   | 3⁄4                           |   | 3⁄4                 |   | 3⁄4                                                |   | 3⁄4                     |   | 3⁄4                                            |   | (3,270              | )       | (3,270                                | )      |
| Dividends paid, $0.32 per share                                                    |   | 3⁄4            |   | 3⁄4                           |   | (612                   | )      | 3⁄4                                                |   | 3⁄4                     |   | 3⁄4                                            |   | 3⁄4              |    | (612                                  | )      |
| Issuance of stock incentive plan shares                                            |   | 3⁄4            |   | (38                              | )      | 3⁄4                 |   | 3⁄4                                                |   | 3⁄4                     |   | 340                                               |   | 3⁄4              |    | 302                                   |   |
| Balance at December 31, 2000 (Unaudited)                                           |   | $                 | 25     |                             | $      | 49,169                 |   | $                                                     | 23,592 |                       | $      | 139                                               |   | $                   | (2,826  | )                                     | $      | (1,341 | ) | $ | (15,177 | ) | $ | 53,581 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

4

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NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS

FOR THE PERIOD ENDEDDECEMBER 31, 2001

(Unaudited)

 

*(1) Organization*

 

Bay State Bancorp,Inc. (the “Company” or “Bay State”) was incorporated under the laws of Delawarein October 1997 for the purpose of serving as the holding company of Bay StateFederal Bank (the “Bank”) as part of the Bank’s conversion from the mutual formof organization to the stock form of organization (the “Conversion”). TheCompany is a savings and loan holding company and is subject to regulation bythe Office of Thrift Supervision (the “OTS”), the Federal Deposit InsuranceCorporation (the “FDIC”) and the Securities and Exchange Commission (the“SEC”).  Prior to the Conversion, BayState had not engaged in any material operations.

 

*(2) Accounting Principles*

 

The accompanying unaudited condensed consolidated financial statementsof Bay State have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim financialinformation and with the instructions to Form 10-Q and with RegulationS-X.  Accordingly, the financialstatements do not include all of the information and footnotes required byaccounting principles generally accepted in the United States of America forcomplete financial statements.  In theopinion of management, all adjustments (consisting of a normal recurringnature) considered necessary for a fair presentation have been included.  Operating results for the nine months endedDecember 31, 2001 are not necessarily indicative of the results that may beexpected for the current fiscal year.

 

For further information, refer to the consolidated financial statementsincluded in the Company’s annual report and Form 10-K for the period endedMarch 31, 2001, filed with the SEC.

 

The March 31,2001 condensed balance sheet data was derived from audited financialstatements, but does not include all disclosures required by accountingprinciples generally accepted in the United States of America.

 

*(3) Stock Repurchase Program*

 

On September26, 2001, the Company announced the completion of the repurchase of 88,277shares under its seventh 5% stock repurchase program and the approval of aneighth 5% repurchase program consisting of 84,315 shares.  As of February 8, 2002, approximately 56,500shares have been repurchased under this program, at an average price of $35.29.

 

5

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*(4) Impact on New Accounting Standards*

 

In June 1998, the FASB issued SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities.” Statement No. 133, as amended by SFAS No. 138, establishes accountingand reporting standards for derivative instruments, including certainderivative instruments embedded in other contracts and for hedgingactivities.  The Statement is effectivefor all fiscal quarters of fiscal years beginning after June 15, 2000.  In management’s opinion, SFAS No. 133 didnot have a material effect on the Company’s consolidated financial statements.

 

FASB issued SFAS No. 140, Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities.  This Statement replaced SFAS No. 125, Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities, andrescinded SFAS Statement No. 127, “Deferral of the Effective Date of CertainProvisions of FASB Statement No. 125.” SFAS No. 140 provides accounting and reporting standards for transfersand servicing of financial assets and extinguishments of liabilities.  This statement provides consistent standardsfor distinguishing transfers of financial assets that are sales from transfersthat are secured borrowings.  Thisstatement is effective for transfers and servicing of financial assets andextinguishments of liabilities occurring after March 31, 2001; however, thedisclosure provisions are effective for fiscal years ending after December 15,2000.  The effect of this statement didnot have a material impact on the Company’s financial position or result ofoperations.

 

Statement of Financial Accounting Standards No. 141 improves theconsistency of the accounting and reporting for business combinations byrequiring that all business combinations be accounted for under a single method- the purchase method.  Use of the pooling-of-interestsmethod is no longer permitted. Statement No. 141 requires that the purchase method be used for businesscombinations initiated after June 30, 2001. Management does not anticipate any impact on the consolidated financialstatements upon adoption of this statement.

 

Statement of Financial Accounting Standards No. 142 requires thatgoodwill no longer be amortized to earnings, but instead be reviewed forimpairment.  The amortization ofgoodwill ceases upon adoption of the Statement, which for most companies willbe January 1, 2002.  Management does notanticipate any impact on the consolidated financial statements upon adoption ofthis statement.

 

6

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**Item 2 - Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

**(Unaudited)**

 

This report contains certain forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities Exchange Act of 1934, as amended.  The Company intends such forward-lookingstatements to be covered by the safe harbor provisions for forward-lookingstatements contained in the Private Securities Litigation Reform Act of 1995,and is including this statement for purposes of these safe harbor provisions.  Forward-looking statements, which are basedon certain assumptions and describe future plans, strategies and expectationsof the Company, are generally identified by use of the words “believe,”“expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions.  The Company’s ability to predict results orthe actual effect of future plans or strategies is inherently uncertain.  Factors which could have a material adverseeffect on the operations of the Company and its subsidiaries include, but arenot 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 ReserveBoard, the quality or composition of the loan or investment portfolios, demandfor loan products, deposit flows, competition, demand for financial services inthe Company’s market area and accounting principles and guidelines.  These risks and uncertainties should beconsidered in evaluating forward-looking statements and undue reliance shouldnot be placed on such statements. Further information concerning the Company and its business, includingadditional factors that could materially affect the Company’s financialresults, is included in the Company’s Form 10-K filing with the SEC for thefiscal year ended March 31, 2001.

 

Except as required by applicable law and regulations, the Company doesnot undertake, and specifically disclaims any obligation, to publicly releasethe result of any revisions which may be made to any forward-looking statementsto reflect events or circumstances after the date of such statements or toreflect the occurrence of anticipated or unanticipated events.

 

*General*

The Bank is a federally chartered savings bank and is subject toregulation by the OTS.  The Bank’sbusiness activities are concentrated in Eastern Massachusetts through six fullservice retail banking offices located in Norfolk and Suffolk counties,Massachusetts.  Through these offices,the Bank offers a full range of retail and commercial banking products andservices and conducts other business as allowable for federally charteredbanks.  The Bank primarily makesresidential first mortgages, commercial and multi-family real estate loans and,to a lesser extent, home equity lines of credit, other consumer loans,residential construction loans, development and land loans and commercialloans.  Lending operations, particularlyloan originations are conducted from the retail offices and at the point ofsale.  Neither the Company nor the Banknor any of their subsidiaries conduct business on a national or internationalbasis.

 

The operating results of the Company depend primarily on its netinterest and dividend income, which is the difference between (i) interest anddividend income on earning assets, primarily loans and investment securitiesand (ii) interest expense on interest bearing liabilities, which consist ofdeposits and borrowings.  Results ofoperations are also affected by the provision for loan losses, the level ofnon-interest income, including deposit and loan fees, gains on sales of assets,operating expenses and income taxes.

 

7

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**Comparison of Financial Condition at December 31, 2001and March 31, 2001 (Unaudited)**

 

Total assets at December 31,2001 were $527.6 million, compared to $491.9 million at March 31, 2001, anincrease of 7.3%.  Short-terminvestments, consisting of federal funds invested at the FHLB and the BankInvestment Fund increased $7.5 million. Due to the favorable interest rate environment and the increased levelof new loan originations, loans receivable, including mortgage loans held forsale, increased $28.9 million, or 6.9%, primarily in multi-family loans,commercial real estate and commercial loans. The increase in assets was funded primarily from a $43.8 million, or16.0%, increase in deposits, which was also used to reduce Federal Home LoanBank advances by $7.8 million, or 4.9%. The increase in deposits was a result of increased marketing efforts,competitively priced products offered by the Bank and continued customermigration from other consolidating financial institutions and from thefinancial markets to the more stable deposit accounts of banks.  Total stockholders’ equity was $52.7million, or 9.99% of total assets, at December 31, 2001, a decrease of $1.1million, or 2.0%, from the $53.8 million, or 10.93% of total assets, at March31, 2001. The net decrease in equity was the result of a net increase intreasury stock of 117,902 shares at net cost of $4.3 million and the payment ofdividends, offset by net income for the period and a reduction in thestock-based benefit plans.  TheCompany’s book value per share at December 31, 2001 was $34.62, compared to$32.77 at March 31, 2001, an increase of 5.6%.

 

*Investments*

Investment securities available-for-sale increased $200,000, or 0.6%,primarily due to an increase in Trust Preferred Securities and Corporate Bondsand Notes, offset by a decrease in Mortgage-backed and Government AgencySecurities.

 

The Company’s investment portfolio at December 31, 2001 reflects a$635,000 net unrealized gain on available-for-sale securities net of tax,compared to $617,000 at March 31, 2001.

 

The table below shows the investment securities portfolio at the datespresented. The amortized cost and estimated fair value of investmentsavailable-for-sale were:

** **
|                               |   | **December  31, 2001** |   | **March 31,  2001** |   |
|------------------------------------|--------|------------------------|--------|---------------------|--------|
|                               |   | **Amortized**          |   | **Fair**            |   | **Amortized** |   | **Fair** |   |
|                               |   | **Cost**               |   | **Value**           |   | **Cost** |   | **Value** |   |
|                               |   | **(In  thousands)**    |   |                |   |   |   |   |   |
| Marketable  equity securities      |   | $                      | 7,781  |                | $      | 8,968 |   | $ | 7,496 |   | $ | 8,654 |   |
| Mortgage-backed  securities        |   | 7,773                  |   | 7,939               |   | 14,141 |   | 14,314 |   |
| Trust  preferred equity securities |   | 9,602                  |   | 9,860               |   | 7,559 |   | 7,510 |   |
| Corporate  bonds and notes         |   | 6,455                  |   | 6,340               |   | 1,452 |   | 1,408 |   |
| Preferred  stocks                  |   | 1,500                  |   | 1,449               |   | 1,500 |   | 1,467 |   |
| Government  agency securities      |   | —                 |   | —              |   | 1,000 |   | 1,003 |   |
| Total                              |   | $                      | 33,111 |                | $      | 34,556 |   | $ | 33,148 |   | $ | 34,356 |   |

 

8

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The amortized cost and estimated market values of investmentsheld-to-maturity were:

 
|                                                   |   | **December  31, 2001** |   | **March 31,  2001** |   |
|--------------------------------------------------------|--------|------------------------|--------|---------------------|--------|
|                                                   |   | **Amortized**          |   | **Fair**            |   | **Amortized** |   | **Fair** |   |
|                                                   |   | **Cost**               |   | **Value**           |   | **Cost** |   | **Value** |   |
|                                                   |   | **(In  thousands)**    |   |
| Mortgage-backed  and mortgage-related securities       |   | $                      | 192    |                | $      | 201 |   | $ | 336 |   | $ | 345 |   |
| Total Mortgage-backed  and mortgage related securities |   | $                      | 192    |                | $      | 201 |   | $ | 336 |   | $ | 345 |   |

* *

*Loans*

During the nine-month period ended December 31,2001, net loans receivable, including mortgage loans held for sale, increasedby $28.9 million, or 6.9%, as detailed below:

 
|                                                                   |   | **December  31,  2001**     |    | **% of total  Loans** |   | **March 31,  2001** |   | **% of total  Loans** |   |
|------------------------------------------------------------------------|--------|-----------------------------|---------|-----------------------|--------|---------------------|--------|-----------------------|--------|
|                                                                   |   | **(Dollars  in thousands)** |    |
| Mortgage loans:                                                        |   |                        |    |                  |   |                |   |                  |   |
| Residential 1 –  4 family                                         |   | $                           | 192,083 |                  | 41.85  | %                   | $      | 205,284               |   | 47.93 | % |
| Multi-family                                                           |   | 98,588                      |    | 21.48                 |   | 87,040              |   | 20.32                 |   |
| Commercial real  estate                                                |   | 116,654                     |    | 25.42                 |   | 98,566              |   | 23.01                 |   |
| Construction and  development/land                                     |   | 20,060                      |    | 4.36                  |   | 17,319              |   | 4.04                  |   |
| Total mortgage  loans                                                  |   | 427,385                     |    | 93.11                 |   | 408,209             |   | 95.30                 |   |
| Commercial loans                                                       |   | 13,548                      |    | 2.95                  |   | 3,893               |   | 0.91                  |   |
| Consumer loans:                                                        |   |                        |    |                  |   |                |   |                  |   |
| Equity lines                                                           |   | 12,723                      |    | 2.77                  |   | 11,819              |   | 2.76                  |   |
| Other consumer  loans                                                  |   | 5,337                       |    | 1.17                  |   | 4,397               |   | 1.03                  |   |
| Total loans                                                            |   | 458,993                     |    | 100.00                | %      | 428,318             |   | 100.00                | %      |
| Deduct:                                                                |   |                        |    |                  |   |                |   |                  |   |
| Allowance for  loan losses                                             |   | 4,485                       |    |                  |   | 4,258               |   |                  |   |
| Undisbursed  proceeds of construction and development loans in process |   | 8,141                       |    |                  |   | 6,154               |   |                  |   |
| Unearned income,  net                                                  |   | 174                         |    |                  |   | 202                 |   |                  |   |
| Loans, net                                                             |   | 446,193                     |    |                  |   | 417,704             |   |                  |   |
| Mortgage loans  held-for-sale                                          |   | 377                         |    |                  |   | —              |   |                  |   |
| Loans, net and  mortgage loans held-for-sale                           |   | $                           | 446,570 |                  |   |                | $      | 417,704               |   |   |   |

 

At December 31, 2001 loans serviced for otherswas $28.9 million, compared to $22.6 million at March 31, 2001.

* *

*Asset Quality*

At December 31, 2001 non-performing assets totaled $233,000, a decreaseof $135,000, or 36.7%, from $368,000 at March 31, 2001.  Non-performing assets consist of all loansthat are delinquent 90 days or more, and any real estate owned. This decreasewas the result of certain non-accrual loans being brought

 

9

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current and paid off, and the charge-off of certain consumerloans.  The Bank had no real estateowned at December 31, 2001 and March 31, 2001. At December 31, 2001, non-performing assets represented 0.04% of totalassets and 0.05% of loans receivable net, compared to 0.07% and 0.09%,respectively, at March 31, 2001.

 

The composition of non-performing assets, which consist solely ofnon-performing loans for the dates presented were:

 
|                                       |   | **December  31,**           |   | **March 31,** |   |
|--------------------------------------------|--------|-----------------------------|--------|---------------|--------|
|                                       |   | **2001**                    |   | **2000**      |   | **2001** |   |
|                                       |   | **(Dollars  in thousands)** |   |
| Non-accrual  loans:                        |   |                        |   |          |   |   |   |
| Mortgage  Loans:                           |   |                        |   |          |   |   |   |
| One-to-four-family                         |   | $                           | 233    |          | $      | 286 |   | $ | 320 |   |
| Multi-family                               |   | —                      |   | —        |   | — |   |
| Commercial  real estate                    |   | —                      |   | 375           |   | — |   |
| Construction  and development              |   | —                      |   | —        |   | — |   |
| Total  mortgage loans                      |   | 233                         |   | 661           |   | 320 |   |
| Consumer  Loans:                           |   |                        |   |          |   |   |   |
| Equity  lines                              |   | —                      |   | 20            |   | 20 |   |
| Other  consumer loans                      |   | —                      |   | 50            |   | 28 |   |
| Total  consumer loans                      |   | —                      |   | 70            |   | 48 |   |
| Total  non-accrual loans                   |   | 233                         |   | 731           |   | 368 |   |
| Real  estate owned, net                    |   | —                      |   | —        |   | — |   |
| Total  non-performing assets               |   | $                           | 233    |          | $      | 731 |   | $ | 368 |   |
| Non-performing  assets as a percentage of: |   |                        |   |          |   |   |   |
| Loans  receivable, net                     |   | 0.05                        | %      | 0.17          | %      | 0.09 | % |
| Total  assets                              |   | 0.04                        |   | 0.15          |   | 0.07 |   |

 

The following represents the activity inthe allowance for loan losses for the nine months ended December 31, 2001:

 
|                          |   | **(In thousands)** |   |
|-------------------------------|--------|--------------------|--------|
| Balance  at March 31, 2001    |   | $                  | 4,258  |   |
| Provision  for loan losses    |   | 262                |   |
| Losses  charged to allowance  |   | (49                | )      |
| Recoveries                    |   | 14                 |   |
| Balance  at December 31, 2001 |   | $                  | 4,485  |   |

 

The allowance for loan losses was $4.5million at December 31, 2001 and $4.3 at March 31, 2001, respectively, whichrepresents 1,924.9% of non-performing assets and 0.99% of total loans atDecember 31, 2001, compared to 1,157.1% of non-performing assets and 1.01% oftotal loans at March 31, 2001.

 

The allowance for loan losses is based onmanagement’s estimate of the credit losses inherent in the loan portfolio andmanagement’s ongoing review of the existing loan portfolio, current marketconditions and the volume and mix of the Bank’s existing loan originationpipeline.  To estimate potential lossexposure in the Bank’s loan portfolio, management establishes an allocatedallowance based upon its review of internal loan classification reports whichidentify any loans classified as special mention, sub-standard, doubtful orloss and applies an allocation factor based upon its estimated exposure onthese specific loans.  An unallocatedallowance is maintained based on the remaining portfolio, which is classifiedinto various

 

10

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groups based upon loan type, under-lyingcollateral, and delinquency status and payment performance history.  The loss factor applied to these loans isbased upon management’s review of historical loss experience, current local andnational economic conditions and industry experience and standards.  In addition, as part of the regulatoryexamination process, the OTS periodically reviews the Company’s allowance forloan losses and may require additional provisions for estimated losses basedupon judgments different from those of management.

 

The Company will continue to monitor and modifyits allowance for loan losses as conditions dictate.  While management believes the Company’s allowance for loan losseswas sufficient to absorb losses inherent in its loan portfolio at December 31,2001, no assurances can be given that the Company’s level of allowance for loanlosses will be sufficient to cover future loan losses incurred by the Companyor that future adjustments to the allowance for loan losses will not benecessary if economic conditions and actual loss experience differs from thoseassumed by management in determining the current level of the allowance forloan losses.

 

*Deposits and Borrowed Funds*

As of December 31, 2001 and March 31, 2001 deposits are as follows:

 
|                           |   | **December  31,**           |    | **% of total** |   | **March 31,** |   | **% of total** |   |
|--------------------------------|--------|-----------------------------|---------|----------------|--------|---------------|--------|----------------|--------|
|                           |   | **2001**                    |    | **deposits**   |   | **2001**      |   | **deposits**   |   |
|                           |   | **(Dollars  in thousands)** |    |
| Regular  savings accounts      |   | $                           | 28,754  |           | 9.07   | %             | $      | 28,031         |   | 10.26 | % |
| NOW  accounts                  |   | 31,322                      |    | 9.88           |   | 30,146        |   | 11.03          |   |
| Money market accounts          |   | 116,500                     |    | 36.75          |   | 77,857        |   | 28.49          |   |
| Non-interest  bearing deposits |   | 17,804                      |    | 5.62           |   | 11,721        |   | 4.29           |   |
|                           |   | 194,380                     |    | 61.32          |   | 147,755       |   | 54.07          |   |
| Term  deposits                 |   | 122,624                     |    | 38.68          |   | 125,508       |   | 45.93          |   |
| Total  deposits                |   | $                           | 317,004 |           | 100.00 | %             | $      | 273,263        |   | 100.00 | % |

 

Duringthe period, FHLB advances decreased $7.8 million, or 4.9%.

 

11

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**Comparison of Operating Results for the Three MonthsEnded December 31, 2001 and 2000.**

 

*General*

Consolidated net income for the three months ended December 31, 2001totaled $1.4 million, or $0.93 basic and $0.87 fully diluted earnings pershare, compared to $941,000, or $0.55 basic and $0.53 fully diluted earningsper share, for the same period last year. This represents an increase of $482,000, or 51.2%, in net income, a$0.38, or 69.1%, increase in basic earnings per share and a $0.34, or 64.2%,increase in fully diluted earnings per share.

 

The increase was primarily due to higher net interest income as aresult of the growth in lower costing core deposits and a decrease in theoverall cost of funds from the lower interest rate levels, and as a result ofthe reduction in level of borrowings and the lower cost of renewed borrowingsduring the period, offset in part by higher income taxes and an increase innon-interest expense.

 

*Interest Income*

Interestincome for the three months ended December 31, 2001 decreased $71,000, or0.74%, to $9.5 million, compared to $9.6 million for the same period lastyear.  The decrease in interest incomewas primarily the net result of a decrease in interest on investments totaling$110,000, or 14.7%, and an increase in interest on loans of $39,000, or0.4%.  Interest on investments was downdue to a decline in the yield on the investment portfolio and a decrease in theaverage balance of mortgage-backed securities, which decreased from $17.8million for the quarter December 31, 2000 to $14.0 million for the quarterended December 31, 2001, a decrease of $3.8 million, or 21.4%.  The increase in loan interest income was theresult of an increase in the average balance of loans by $24.1 million, or5.8%, and a decline in the overall yield on the loan portfolio.  The yield on interest-earning assetsdecreased 49 basis points to 7.88%, due primarily to the lower interest rate environment.

 

*Interest Expense*

Interestexpense for the three months ended December 31, 2001 decreased $1.4 million, or24.8%, to $4.2 million compared to $5.6 million for the same period lastyear.  The decrease in interest expensewas the net result of a $20.7 million, or 5.0%, increase in the average balanceof interest-bearing liabilities which increased from $416.4 million for thethree months ended December 31, 2000 to $437.1 million for the three monthsended December 31, 2001, and a decrease in the cost of funds to 3.83%.  The increase in the average balance ofinterest-bearing liabilities was primarily a net result of an increase in theaverage balance of lower costing core deposits of $46.8 million, or 38.6%, adecrease in the average balance of FHLB advances of $17.5 million, or 11.0% anda decrease in the average balance of higher costing certificates of depositstotaling $8.5 million, or 6.3%. Although the average balance of interest bearing liabilities increasedthe decrease in interest expense was attributed to the deposit growth being inthe lower costing core deposits and the reduction and repricing of maturingcertificates of deposit at current interest rate levels.

 

12

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*Net interest income*

The table below shows the average balance sheet,the interest earned and paid on interest-earning assets and interest-bearingliabilities and the resulting net interest spread and margin for the periodspresented.

 

For the threemonths ended December 31,

 
|                                      |   | **2001**                   |    | **2000**     |   |
|-------------------------------------------|--------|----------------------------|---------|--------------|--------|
|                                      |   |                       |    | **Interest** |   |   |   |   |   | **Interest** |   |   |   |
|                                      |   | **Average**                |    | **Income/**  |   | **Yield/** |   | **Average** |   | **Income/** |   | **Yield/** |   |
|                                      |   | **balance**                |    | **expense**  |   | **rate** |   | **balance** |   | **expense** |   | **rate** |   |
|                                      |   | **(Dollars in thousands)** |    |
| Assets                                    |   |                       |    |         |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                  |   |                       |    |         |   |   |   |   |   |   |   |   |   |
| Short-term  investments                   |   | $                          | 2,605   |         | $      | 15 |   | 2.30 | % | $ | 1,988 |   | $ | 35 |   | 7.04 | % |
| Interest-earning  deposits                |   | 769                        |    | 6            |   | 3.12 |   | 769 |   | 14 |   | 7.28 |   |
| Taxable  investment securities            |   | 25,911                     |    | 445          |   | 6.87 |   | 22,420 |   | 411 |   | 7.33 |   |
| Mortgage  backed & related securities |   | 13,951                     |    | 173          |   | 4.96 |   | 17,752 |   | 290 |   | 6.53 |   |
| Loans  (net of unearned income)           |   | 440,331                    |    | 8,893        |   | 8.08 |   | 416,183 |   | 8,854 |   | 8.51 |   |
| Total  interest-earning assets            |   | 483,567                    |    | 9,532        |   | 7.88 |   | 459,112 |   | 9,604 |   | 8.37 |   |
| Non  interest-earning assets              |   | 32,145                     |    |         |   |   |   | 28,849 |   |   |   |   |   |
| Total                                     |   | $                          | 515,712 |         |   |   |   |   | $ | 487,961 |   |   |   |   |   |
| Liabilities  and Equity                   |   |                       |    |         |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:            |   |                       |    |         |   |   |   |   |   |   |   |   |   |
| Now accounts                              |   | $                          | 30,285  |         | $      | 43 |   | 0.57 | % | $ | 25,095 |   | $ | 54 |   | 0.86 | % |
| Regular  savings accounts                 |   | 28,380                     |    | 79           |   | 1.11 |   | 26,909 |   | 135 |   | 2.01 |   |
| Money  market accounts                    |   | 109,267                    |    | 759          |   | 2.78 |   | 69,171 |   | 770 |   | 4.45 |   |
| Certificate  accounts                     |   | 125,800                    |    | 1,479        |   | 4.70 |   | 134,321 |   | 1,980 |   | 5.90 |   |
| Total  interest-bearing deposits          |   | 293,732                    |    | 2,360        |   | 3.21 |   | 255,496 |   | 2,939 |   | 4.60 |   |
| FHLB  advances                            |   | 141,378                    |    | 1,806        |   | 5.00 |   | 158,900 |   | 2,585 |   | 6.37 |   |
| Other  borrowings                         |   | 2,000                      |    | 15           |   | 2.93 |   | 2,000 |   | 34 |   | 6.65 |   |
| Total  interest-bearing liabilities       |   | 437,110                    |    | 4,181        |   | 3.83 |   | 416,396 |   | 5,558 |   | 5.34 |   |
| Demand  deposits                          |   | 15,775                     |    |         |   |   |   | 8,835 |   |   |   |   |   |
| Other  liabilities                        |   | 9,857                      |    |         |   |   |   | 9,241 |   |   |   |   |   |
| Equity                                    |   | 52,970                     |    |         |   |   |   | 53,489 |   |   |   |   |   |
| Total                                     |   | $                          | 515,712 |         |   |   |   |   | $ | 487,961 |   |   |   |   |   |
| Net  interest income                      |   |                       |    | $            | 5,351  |   |   |   |   |   | $ | 4,046 |   |   |   |
| Interest  rate spread                     |   |                       |    |         |   | 4.06 | % |   |   |   |   | 3.03 | % |
| Net  interest margin                      |   |                       |    |         |   | 4.43 | % |   |   |   |   | 3.52 | % |

 

13

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*Provision for Loan Losses*

Provisions for loan losses are charged tooperations to bring the allowance for loan losses to a level considered bymanagement to be adequate to cover estimated losses on loans receivable whichare deemed probable and estimable based on information currently known tomanagement.  The provision for loanlosses totaled $125,000 for the quarter ended December 31, 2001, compared to$60,000 for the same period last year. The current quarter’s provision wasbased upon the growth in the loan portfolio during the period, specifically inhigher risk multi-family and commercial real estate loans and commercialloans.  The provision also reflects management’sanalysis of the overall portfolio mix and the current level of non-performingloans and delinquency trends, which continued to declined during theperiod.  The Company plans to add to theprovision for loan losses to support any loan portfolio expansion and change innon-performing loan levels, as considered necessary by management.

 

*Non-interest income*

Total non-interest income,net of gains and losses on investment activities and other assets, was $355,000for the quarter ended December 31, 2001, compared to $251,000 for the same periodlast year, an increase of $104,000, or 41.4%. These increases were primarily a result of increases in fees on loansand deposit accounts due to the increased number of deposit accounts and fromthe gains onsales ofloans.  The increase in gain on sale ofloans was a result of the current interest rate environment, as the Bankoriginated more 30 year fixed rate residential loans than in previous periods.It is the Bank’s strategy to sell its long-term fixed rate loans to reduceinterest rate risk, this increased level of originations and sales resulted inthe recognized gains.  In addition, theCompany recognized a net gain of $16,000, for the three month period endedDecember 31, 2001, in gains and losses on trading and investment securitiescompared to a loss of $207,000 for the three-month period last year.  This net gain represents the changes in themarket value of the assets supporting certain employee benefit plans.

 

*Non-interest expense*

Total non-interest expense was $3.2million for the quarter ended December 31, 2001, compared to $2.5 million forthe same period last year, an increase of $681,000, or 26.9%.  Total salaries and benefits increased$541,000, or 36.9%, primarily the result of an increase in the number ofemployees in the lending and retail banking areas, an increase in the cost ofmedical and retirement plans, and an increase in the costs associated with theCompany’s stock compensation plans that are directly impacted by the increasein the Company’s stock price.  Occupancyand equipment expense totaled $407,000 compared to $383,000 for the same periodlast year, an increase of $24,000, or 6.3%. This was the result of an increase in utility and maintenance costs ofthe Bank’s various locations. Advertising expense totaled $141,000 compared to $122,000 for the sameperiod last year, an increase of $19,000, or 15.6%, primarily as a result ofspecial product promotions run by the Bank. Data processing costs increased$22,000, or 23.7%, due to the increased level of deposits and new products andservices being offered.  Other expenses,including professional fees, increased $75,000, or 16.0%, primarily a result ofincreases in consulting, education and training expense as well as an increasein postage and telecommunication expenses from the higher level of deposit andloan accounts serviced by the Bank.

 

*Income Taxes*

Forthe quarter ended December 31, 2001 income taxes of $959,000 were provided onnet income before tax of $2.4 million for an effective rate of 40.3%, comparedto $554,000 on income before taxes of $1.5 million for an effective rate of37.0%, for the same period last year. The change in effective tax rates from year to year was a result ofsetting up a valuation allowance on the deferred tax asset for the contributiondeduction carryover relating to the funding of the Bay State Federal SavingsCharitable Foundation and the increase in the non-deductible expense portionassociated with the Company’s ESOP plan.

 

14

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##### **Comparison of Operating Results for theNine Months Ended December 31, 2001 and 2000**

 

*General*

Consolidated net income for the nine months ended December 31, 2001totaled $3.9 million, or $2.43 basic and $2.29 fully diluted earnings pershare, compared to $2.6 million, or $1.47 basic and $1.44 fully dilutedearnings per share, for the same period last year.  This represents an increase of $1.3 million, or 48.4% in netincome, a $0.96, or 65.3%, increase in basic earnings per share, and $0.85, or59.2%, increase in fully diluted earnings per share.

 

*Interest Income*

Interest income for the nine months ended December 31, 2001 increased$973,000, or 3.5%, to $28.6 million, compared to $27.6 million for the sameperiod last year.  The increase ininterest income was primarily due to an increase in the average balance ofinterest-earning assets, specifically loans receivable.  The average balance of interest-earningassets increased from $449.2 million for the nine months ended December 31,2000 to $470.2 million for the nine months ended December 31, 2001, an increaseof $21.0 million, or 4.7%.  The increasein the average balance of interest-earning assets was primarily the result ofan increase in the average balance of loans receivable, net, of $20.4 million,or 5.0%, and an increase in the average balance of taxable investmentsecurities totaling of $3.4 million, or 15.5%, offset by a decrease in theaverage balance of mortgage-backed securities of $3.1 million, or 19.9%.  The yield on interest-earning assetsdecreased 9 basis points, to 8.10%, primarily due to the lower interest rateenvironment.

 

*Interest Expense*

Interest expense for the nine months ended December 31, 2001 decreased$1.8 million, or 11.6%, to $14.0 million, compared to $15.9 million for thesame period last year.  During theperiod the average balance of interest-bearing liabilities increased $16.4million, or 4.0%, from $407.8 million for the nine months ended December 31,2000 to $424.3 million for the nine months ended December 31, 2001. Theincrease in the average balance of interest-bearing liabilities was primarilythe net result of an increase in the average balance of deposits totaling $28.1million, or 11.2%, offset by a decrease in the average balance of FHLB advancesof $10.3 million, or 6.7%. Although the average balance of interest bearingliabilities increased, due to the actions of the Federal Reserve loweringinterest rate levels, and the ability to replace the Federal Home loan Bankadvances with lower costing core deposit accounts, the cost of liabilitiesdecreased 78 basis points to 4.41%.

 

15

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*Net interest income*

The table below shows the average balances, the interest earned andpaid on interest-earning assets and interest-bearing liabilities and theresulting net interest spread and margin for the periods presented.

 

For the nine months ended December 31,

 
|                                     |   | **2001**                    |    | **2000**     |   |
|------------------------------------------|--------|-----------------------------|---------|--------------|--------|
|                                     |   |                        |    | **Interest** |   |   |   |   |   | **Interest** |   |   |   |
|                                     |   | **Average**                 |    | **income/**  |   | **Yield/** |   | **Average** |   | **income/** |   | **Yield/** |   |
|                                     |   | **balance**                 |    | **expense**  |   | **rate** |   | **balance** |   | **expense** |   | **rate** |   |
|                                     |   | **(Dollars in  thousands)** |    |
| Assets                                   |   |                        |    |         |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                 |   |                        |    |         |   |   |   |   |   |   |   |   |   |
| Short-term investments                   |   | $                           | 2,187   |         | $      | 50 |   | 3.05 | % | $ | 2,037 |   | $ | 103 |   | 6.74 | % |
| Taxable investment securities            |   | 25,044                      |    | 1,351        |   | 7.19 |   | 21,682 |   | 1,143 |   | 7.03 |   |
| Interest-earning deposits                |   | 769                         |    | 24           |   | 4.16 |   | 513 |   | 25 |   | 6.50 |   |
| Mortgage-backed & related securities |   | 15,758                      |    | 663          |   | 5.61 |   | 18,899 |   | 889 |   | 6.26 |   |
| Loans, net of unearned income            |   | 426,427                     |    | 26,474       |   | 8.28 |   | 406,058 |   | 25,429 |   | 8.35 |   |
| Total interest-earning assets            |   | 470,185                     |    | 28,562       |   | 8.10 |   | 449,189 |   | 27,589 |   | 8.19 |   |
| Non interest-earning assets              |   | 32,711                      |    |         |   |   |   | 30,723 |   |   |   |   |   |
| Total                                    |   | $                           | 502,896 |         |   |   |   |   | $ | 479,912 |   |   |   |   |   |
| Liabilities and Equity                   |   |                        |    |         |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:            |   |                        |    |         |   |   |   |   |   |   |   |   |   |
| NOW accounts                             |   | $                           | 28,531  |         | 168    |   | 0.79 | % | $ | 23,974 |   | 171 |   | 0.95 | % |
| Regular savings accounts                 |   | 27,719                      |    | 318          |   | 1.53 |   | 26,592 |   | 404 |   | 2.03 |   |
| Money market accounts                    |   | 97,432                      |    | 2,599        |   | 3.56 |   | 68,772 |   | 2,250 |   | 4.36 |   |
| Certificate accounts                     |   | 125,693                     |    | 4,925        |   | 5.22 |   | 131,924 |   | 5,656 |   | 5.72 |   |
| Total interest-bearing deposits          |   | 279,375                     |    | 8,010        |   | 3.82 |   | 251,262 |   | 8,481 |   | 4.50 |   |
| FHLB advances                            |   | 142,896                     |    | 5,960        |   | 5.46 |   | 153,203 |   | 7,235 |   | 6.18 |   |
| Other Borrowings                         |   | 2,000                       |    | 60           |   | 3.93 |   | 3,367 |   | 155 |   | 6.03 |   |
| Total interest-bearing liabilities       |   | 424,271                     |    | 14,030       |   | 4.41 |   | 407,832 |   | 15,871 |   | 5.19 |   |
| Demand deposits                          |   | 14,068                      |    |         |   |   |   | 7,659 |   |   |   |   |   |
| Other liabilities                        |   | 10,886                      |    |         |   |   |   | 10,841 |   |   |   |   |   |
| Equity                                   |   | 53,671                      |    |         |   |   |   | 53,580 |   |   |   |   |   |
| Total                                    |   | $                           | 502,896 |         |   |   |   |   | $ | 479,912 |   |   |   |   |   |
| Net interest income                      |   |                        |    | $            | 14,532 |   |   |   |   |   | $ | 11,718 |   |   |   |
| Interest rate spread                     |   |                        |    |         |   | 3.69 | % |   |   |   |   | 3.00 | % |
| Net interest margin                      |   |                        |    |         |   | 4.12 | % |   |   |   |   | 3.48 | % |

 

16

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*Provision for Loan Losses*

The provision for loan losses totaled $262,000for the nine months ended December 31, 2001, compared to $375,000 for the sameperiod last year.   The provision forthe nine months ended December 31, 2001 was made based upon an assessment ofcurrent level of non-performing loans during the period, which declined to0.05% of total loans, and with additional consideration in loan portfoliotrends, specifically changes in loan types and concentrations, and the rate ofloan portfolio growth for the period.

 

*Non-interest income*

Total non-interest income,net of gains and losses on investment activities and other assets, was $957,000for the nine months ended December 31, 2001, compared to $777,000 for the sameperiod last year, an increase of $180,000, or 23.2%.  These increases were primarily a result of increases in fees onloans and deposit accounts due to the increased number of deposit accounts andfrom the gains onsales of loansas mentioned in the quarterly results. In addition, the Company recognized a net gain of  $95,000 for the nine-month period in gainsand losses on trading and investment securities compared to a net loss of$130,000 for the same period last year. This net gain represents the changes in the market value of the assetssupporting certain employee benefit plans.

 

*Non-interest expense*

Total non-interest expense was $8.9million for the nine months ended December 31, 2001, compared to $7.9 millionfor the same period last year, an increase of $1.0 million, or 13.0%.  Total salaries and benefits increased$639,000, or 13.0%, primarily the result of a general increase in salaries andbenefits from annual salary increases, increased staffing levels and theincreased cost of certain employee benefit plans due to the increase in theCompany’s stock price.  Occupancy andequipment expense increased $106,000, or 9.5%. This increase was the result of the increased level of depreciation onimprovements associated with the added space for the retail and administrativeareas of the Bank.  Advertising expensetotaled $422,000 compared to $375,000 for the same period last year, anincrease of $47,000, or 12.5%, primarily as a result of the promotion andintroduction of new deposit products and retail services. Data processing costsincreased $85,000, or 33.2%, due to the increased level of deposits and newproducts and services being offered. Other expenses increased $148,000, or 12.0%, primarily a result ofincreases in consulting, education and training expense as well as an increasein postage and telecommunication expenses from the higher level of deposit andloan accounts serviced by the Bank.

 

*Income Taxes*

Forthe nine months ended December 31, 2001 income taxes of $2.5 million wereprovided on net income before tax of $6.4 million for an effective rate of39.6%, compared to $1.5 million on income before taxes of $4.1 million for aneffective rate of 36.4%, for the same period last year.  The change in effective tax rates from yearto year was a result of setting up a valuation allowance on the deferred taxasset for the contribution deduction carryover relating to the funding of theBay State Federal Savings Charitable Foundation and the increase in thenon-deductible expense portion associated with the Company’s ESOP plan.

 

17

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### **Item3 — Quantitative and Qualitative Disclosures about Market Risk**

 

Management is responsible for monitoring and limiting the Bank’sexposure to interest rate risk within established guidelines while maximizingnet interest income.  The Bank willcontinue to monitor its interest rate risk sensitivity with the primaryobjective to prudently structure the balance sheet so that movements ofinterest rates on assets and liabilities are highly correlated and produce areasonable net interest margin even in periods of volatile interest rates.  Further discussion on market risk is in theCompany’s Form 10-K for the year ended March 31, 2001 and the Form 10-Q for theperiods ending June 30, 2001 and September 30, 2001.

 

*Asset/Liability Management*

The principal objective of the Bank’s interest rate risk managementfunction is to evaluate the interest rate risk included in certain balancesheet accounts, determine the appropriate level of risk given the Bank’sbusiness strategy, operating environment, capital and liquidity requirementsand performance objectives and manage the risk consistent with the Board ofDirectors’ approved guidelines.  Throughsuch management, the Bank seeks to reduce the vulnerability of its operationsto changes in interest rates.

 

The Bank monitors its interest rate risk as such risk relates to itsoperating strategies.  The Bank’s Boardof Directors has established an Asset/Liability Committee, responsible forreviewing its asset/liability policies and interest rate risk position, whichmeets on a monthly basis and reports trends and interest rate risk position tothe Board of Directors on a quarterly basis. The extent of the movement of interest rates is an uncertainty thatcould have a negative impact on the earnings of the Bank.

 

In recent years, the Bank has primarilyutilized the following strategies to manage interest rate risk: (i) emphasizingthe origination and purchase of adjustable-rate loans; (ii) investing inCorporate Bonds and Notes, Equity Securities or mortgage-backed andmortgage-related securities with shorter estimated maturities; (iii) utilizingFHLB advances to better structure the maturities of its interest rate sensitiveliabilities; and (iv) selling in the secondary market longer-term fixed-ratemortgage loans originated while generally retaining the servicing rights onsuch loans.

 

*Gap Analysis.*

Thematching of assets and liabilities may be analyzed by examining the extent towhich such assets and liabilities are “interest rate sensitive” and bymonitoring a bank’s interest rate sensitivity “gap.”  Assets and liabilities are said to be interest rate sensitivewithin a specific time period if they will mature or reprice within that timeperiod.  The interest rate sensitivitygap is defined as the difference between the amount of interest-earning assetsmaturing or repricing within a specific time period and the amount ofinterest-bearing liabilities maturing or repricing within that same timeperiod.  At December 31, 2001, theCompany’s cumulative one-year interest rate gap (which is the differencebetween the amount of interest-earning assets maturing or repricing within oneyear and interest-bearing liabilities maturing or repricing within one year) asa percentage of total assets was a negative 19.7%.  A gap is considered negative when the amount of interest ratesensitive liabilities exceeds the amount of interest rate sensitiveassets.  Accordingly, during a period ofrising interest rates, an institution with a negative gap position would be ina worse position to invest in higher yielding assets which, consequently, mayresult in the cost of its interest-bearing liabilities increasing at a ratefaster than its yield on interest-earning assets than if it had a positivegap.  Conversely, during a period offalling interest rates, an institution with a negative gap would tend to haveits interest-bearing liabilities repricing downward at a faster rate than itsinterest earning assets as compared to an institution with a positive gapwhich, consequently, may tend to positively affect the growth of its netinterest income.

 

18

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|                                                                                            |   |                       |           | **More**           |   | **More**           |   | **More**           |          |         |   |         |   |
|-------------------------------------------------------------------------------------------------|--------|----------------------------|----------------|--------------------|--------|--------------------|--------|--------------------|---------------|--------------|--------|--------------|--------|
|                                                                                            |   |                       |           | **than**** ** |   | **than**** ** |   | **than**** ** |          |         |   |         |   |
|                                                                                            |   |                       |           | **1 Year**         |   | **3 Years**        |   | **5 Years**        |          | **Greater**  |   |         |   |
|                                                                                            |   | **1 Year**                 |           | **to**             |   | **to**             |   | **to**             |          | **than**     |   | **Total**    |   |
|                                                                                            |   | **or Less**                |           | **3 Years**        |   | **5 Years**        |   | **15 Years**       |          | **15 Years** |   | **Amount**   |   |
|                                                                                            |   | **(Dollars in thousands)** |           |
| **Interest-earning assets:**                                                                    |   |                       |           |               |   |               |   |               |          |         |   |         |   |
| Short-term investments                                                                          |   | $                          |  7,626    |               | $      |  —       |   | $                  |  —  |         | $      |  — |   | $ |  — |   | $ |  7,626 |   |
| Investment in B.O.L.I                                                                           |   | 8,546                      |           | —             |   | —             |   | —             |          | —       |   | 8,546        |   |
| Taxable  investment Securities                                                                  |   | 11,747                     |           | 497                |   | 959                |   | 12,135             |          | —       |   | 25,338       |   |
| Mortgage-backed  securities                                                                     |   | —                     |           | —             |   | —             |   | 2,827              |          | 5,138        |   | 7,965        |   |
| Stock  in FHLB-Boston                                                                           |   | 8,455                      |           | —             |   | —             |   | —             |          | —       |   | 8,455        |   |
| Loans  (1)                                                                                      |   | 110,343                    |           | 77,200             |   | 83,094             |   | 115,080            |          | 64,728       |   | 450,445      |   |
| Total  interest-earning assets                                                                  |   | $                          | 146,717        |               | $      | 77,697             |   | $                  | 84,053        |         | $      | 130,042      |   | $ | 69,866 |   | $ | 508,375 |   |
| **Interest-bearing liabilities:**                                                               |   |                       |           |               |   |               |   |               |          |         |   |         |   |
| Money  market accounts                                                                          |   | $                          | 93,200         |               | $      | 17,475             |   | $                  |  5,825   |         | $      |  — |   | $ |  — |   | $ | 116,500 |   |
| Regular  savings accounts                                                                       |   | 4,313                      |           | 8,626              |   | 8,626              |   | 7,189              |          | —       |   | 28,754       |   |
| NOW  accounts                                                                                   |   | 1,566                      |           | 3,132              |   | 3,132              |   | 7,831              |          | 15,661       |   | 31,322       |   |
| Certificate  accounts                                                                           |   | 95,459                     |           | 22,086             |   | 5,079              |   | —             |          | —       |   | 122,624      |   |
| Other  borrowed funds                                                                           |   | 2,000                      |           | —             |   | —             |   | —             |          | —       |   | 2,000        |   |
| FHLB  advances                                                                                  |   | 53,845                     |           | 21,498             |   | 5,000              |   | 70,000             |          | —       |   | 150,343      |   |
| Total  interest-bearing liabilities                                                             |   | $                          | 250,383        |               | $      | 72,817             |   | $                  | 27,662        |         | $      | 85,020       |   | $ |  15,661 |   | $ | 451,543 |   |
| Interest-earning  assets less interest-bearing liabilities                                      |   | $                          |  (103,666 | )                  | $      |  4,880        |   | $                  |  56,391  |         | $      |  45,022 |   | $ |  54,205 |   | $ | 56,832 |   |
| Cumulative  interest-rate sensitivity gap                                                       |   | $                          |  (103,666 | )                  | $      | (98,786            | )      | $                  |  (42,395 | )            | $      |  2,627  |   | $ |  56,832 |   |   |   |
| Cumulative  interest-rate gap as a percentage of total assets                                   |   | (19.65                     | )%             | (18.72             | )%     | (8.04              | )%     | 0.50               | %             | 10.77        | %      |         |   |
| Cumulative  interest-rate gap as a percentage of total interest–earning assets             |   | (20.39                     | )%             | (19.43             | )%     | (8.34              | )%     | 0.52               | %             | 11.18        | %      |         |   |
| Cumulative  interest-earning assets as a percentage of cumulative interest-bearing  liabilities |   | 58.60                      | %              | 69.44              | %      | 87.92              | %      | 100.60             | %             | 112.59       | %      |         |   |

 

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(1) Excludes non-accrualloans

 

19

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**PART II -OTHER INFORMATION**

 

**Item 1 - Legal Proceedings**

 

Neither the Company nor any of its subsidiariesis party to any pending legal proceedings, which are material other thanroutine litigation incidental to their business activities.

 

**Item 2 - Changes in Securities and Use of Proceeds**

 

Not applicable.

 

**Item 3 - Defaults Upon Senior Securities**

 

Not applicable.

 

**Item 4 - Submission of Matters to a Vote of SecurityHolders**

 

Not applicable.

** **

**Item 5 - Other Information**

 

Not applicable.

 

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

(a)          Exhibits

 
| 3.1  |   | Certificate  of Incorporation of Bay State Bancorp, Inc. * |
|------|--------|------------------------------------------------------------|
| 3.2  |   | Amended  and Restated Bylaws of Bay State Bancorp, Inc. ** |
| 4.0  |   | Stock  Certificate of Bay State Bancorp, Inc. *            |
| 11.0 |   | Computation of per share earnings  (filed herewith)        |

 

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*  Incorporated herein by reference from the exhibits to Form SB-2registration statement as amended, Registration No. 333-40115

** Incorporated herein by reference fromthe registrants Form 10-KSB, as filed with the Securities and ExchangeCommission on  September 14, 1999.

 

(b)           Reports on Form 8-K                                None

 

20

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SIGNATURES

 

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

 
|               | Bay  State Bancorp, Inc.                      |
|--------------------|-----------------------------------------------|
|               |                                          |
| February  12, 2002 | \s\  John F. Murphy                           |
| Date               | John  F. Murphy                               |
|               | Chairman,  President, and                     |
|               | Chief  Executive Officer                      |
|               | (Principal  Executive Officer)                |
|               |                                          |
| February  12, 2002 | \s\  Michael O. Gilles                        |
| Date               | Michael  O. Gilles                            |
|               | Senior  Vice President and                    |
|               | Chief  Financial Officer                      |
|               | (Principal  Accounting and Financial Officer) |

 

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