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FORM 10-Q—QUARTERLY REPORT UNDER SECTION 13 OR

15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

Commission file number 0-24302

COLUMBIA BANCORP

(exact name of registrant as specified in its charter)

10480 Little Patuxent Parkway, Columbia, Maryland 21044

(Address of principal executive offices)

(410) 465-4800

(Registrant’s telephone number, including area code)

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

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

Indicate by check mark whether the registrant is an accelerated filer.  Yes  x  No  ¨

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 7,117,289 shares as of May 9, 2003.

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COLUMBIA BANCORP

CONTENTS

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PART I ITEM 1. FINANCIAL STATEMENTS

COLUMBIA BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CONDITION

(dollars in thousands)

See accompanying notes to consolidated financial statements.

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COLUMBIA BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

For the Three Months Ended March 31, 2003 and 2002

(dollars in thousands)

See accompanying notes to consolidated financial statements.

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COLUMBIA BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31, 2003 and 2002

(dollars in thousands)

See accompanying notes to consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of and for the three months

ended March 31, 2003 and 2002 is unaudited)

NOTE 1 - BASIS OF PRESENTATION

The accompanying consolidated financial statements for Columbia Bancorp (the “Company”) have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a full presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements should be read in conjunction with the audited financial statements included in the Company’s 2002 Annual Report on Form 10-K.

The consolidated financial statements include the accounts of the Company’s subsidiary, The Columbia Bank, and The Columbia Bank’s wholly-owned subsidiaries, McAlpine Enterprises, Inc., Columbia Leasing, Inc., Howard I, LLP and Howard II, LLP (collectively, the “Bank”). All significant intercompany balances and transactions have been eliminated.

The consolidated financial statements as of March 31, 2003 and for the three months ended March 31, 2003 and 2002 are unaudited but include all adjustments, consisting only of normal recurring adjustments, which the Company considers necessary for a fair presentation of financial position and results of operations for those periods. The results of operations for the three months ended March 31, 2003 are not necessarily indicative of the results that will be achieved for the entire year.

The Company uses the intrinsic value method to account for stock-based employee compensation plans. Under this method, compensation cost is recognized for awards of shares of common stock to employees only if the quoted market price of the stock at the grant date (or other measurement date, if later) is greater than the amount the employee must pay to acquire the stock. The following table summarizes the pro forma effect on net earnings and earnings per share of common stock using an optional fair value-based method, rather than the intrinsic value-based method, to account for stock-based compensation awarded since 1995.

Certain amounts for 2002 have been reclassified to conform to the 2003 presentation.

NOTE 2 - INVESTMENTS

The amortized cost and estimated fair values of investment securities and securities available-for-sale at March 31, 2003 were as follows:

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The amortized cost and estimated fair values of investment securities and securities available-for-sale at December 31, 2002 were as follows:

NOTE 3 – PER SHARE DATA

Information relating to the calculations of earnings per common share (“EPS”) is summarized as follows:

NOTE 4 – COMMITMENTS AND CONTINGENT LIABILITIES

The Company is party to financial instruments with off-balance-sheet risk in the normal course of business in order to meet the financing needs of customers. These financial instruments include commitments to extend credit, standby letters of credit and mortgage loans sold with limited recourse.

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The Company applies the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. A summary of the financial instruments at March 31, 2003 whose contract amounts represent potential credit risk is as follows:

NOTE 5 – NEW ACCOUNTING STANDARDS

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS 145”). SFAS 145, among other things, restricts the classification of gains and losses from extinguishment of debt as extraordinary to only those transactions that are unusual and infrequent in nature as defined by accounting principles generally accepted in the United States of America. Certain aspects of SFAS No. 145 were effective January 1, 2003, while other aspects became effective during 2002. The Company does not currently classify gains or losses on extinguishment of debt as extraordinary items.

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In July 2002, the FASB issued Statement of Financial Accounting Standards No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”). The requirements of SFAS No. 146 are effective prospectively for qualifying activities initiated after December 31, 2002. SFAS No. 146 applies to costs associated with an exit activity, including restructuring, or with a disposal of long-lived assets. The statement has had no effect on the Company’s financial statements to date.

Statement of Financial Accounting Standards No. 147 “Acquisitions of Certain Financial Institutions” (“SFAS No. 147”) was issued in October 2002 and is effective for acquisitions on or after October 1, 2002. The provisions of SFAS No. 147 amend SFAS No. 72, “Accounting for Certain Acquisitions of Banking or Thrift Institutions,” SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, and FASB Interpretation No. 9. Except for transactions between two or more mutual enterprises, this Statement removes acquisitions of financial institutions from the scope of both SFAS No. 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”. In addition, this Statement amends SFAS No. 144 to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that SFAS No. 144 requires for other long-lived assets that are held and used. As of March 31, 2003, the Company did not have any goodwill or other intangible assets that would be subject to these accounting standards.

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“Interpretation No. 45”). Beginning in 2003, Interpretation No. 45 requires recognition of liabilities at their fair value for newly issued guarantees. The adoption of Interpretation No. 45 did not have a material effect on the Company’s financial statements.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS No. 148”). SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based compensation and required disclosure in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. The Company has adopted the disclosure provisions of SFAS No. 148. The Company has not determined whether it will change to the fair value-based method of accounting for stock-based compensation and, if so, which of the alternative methods of transition it will adopt.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“Interpretation No. 46”), which explains identification of variable interest entities and the assessment of whether to consolidate those entities. Interpretation No. 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among the involved parties. The provisions of Interpretation No. 46 are effective for all financial statements issued after January 1, 2003. The Company holds no significant variable interest entities that would require consolidation.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”). SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments imbedded in other contracts, and for hedging activities under Statement 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, with some exceptions. The Company has not determined what impact, if any, SFAS No. 149 will have on its financial statements.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD – LOOKING STATEMENTS

In addition to historical information, this quarterly report contains forward-looking statements, which are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such a difference include, but are not limited to, those discussed in this section. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. The Company undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof.

THE COMPANY

Columbia Bancorp was formed November 16, 1987 and is a Maryland chartered bank holding company. The Company holds all of the issued and outstanding shares of common stock of the Bank. The Bank is a Maryland trust company that engages in general commercial banking operations. The Bank provides a full range of financial services to individuals, businesses and organizations through 24 branch banking offices, as well as mortgage and commercial loan origination offices and 25 Automated Teller

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Machines. Deposits in the Bank are insured by the Federal Deposit Insurance Corporation. The Company considers its core market area to be the communities in the Baltimore/Washington Corridor and adjacent areas of central Maryland.

REVIEW OF FINANCIAL CONDITION

Liquidity

Liquidity describes the ability of the Company to meet financial obligations, including lending commitments and contingencies, that arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the customers of the Company, as well as to meet current and planned expenditures.

The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit (collectively “commitments”), which totaled $425.0 million at March 31, 2003. Historically, many of the commitments expire without being fully drawn; therefore, the total commitment amounts do not necessarily represent future cash requirements. Commitments are available to customers so long as there are no violations of any contractual provision. Commitments for real estate development and construction, which totaled $228.7 million, or 53.8% of the $425.0 million, generally turn over rapidly, satisfying cash requirements with principal repayments from sales of the properties financed. Commercial commitments totaled $103.8 million, or 24.4% of the $425.0 million, at March 31, 2003 and generally do not extend for more than 12 months. At March 31, 2003, available home equity lines totaled $87.1 million. Home equity credit lines generally extend for a period of 15 years and are reviewed annually. Commitments to extend credit for residential mortgage loans totaled $5.4 million at March 31, 2003.

Customer withdrawals are also a principal use of liquidity, but are generally mitigated by growth in the Company’s funding provided by its customers in deposits and short-term borrowings in the form of commercial paper and securities sold under repurchase agreements. Customer funding, which is the Company’s primary source of liquidity, was $890.2 million at March 31, 2003. While balances may fluctuate up and down in any given period, historically the Company has experienced a steady increase in total customer funding sources. Fluctuations may be influenced by the rates paid, general consumer confidence and the overall economic environment. In addition, the Company may experience fluctuation in customer funding sources as a result of several large depository relationships with title companies. During periods of significant refinancing activity such as that experienced most recently, these depository relationships tend to fluctuate to a higher degree. In addition, month-end balances for these relationships tend to be inflated, as compared to balances throughout the month. At March 31, 2003, total funding from title companies was $101.5 million, or 11.4% of total customer funding. The three largest title company relationships accounted for $36.2 million, or 4.1% of total customer funding. Core deposits, defined as all deposits except certificates of deposit of $100,000 or more, totaled $708.7 million, or 79.6% of total customer funding at March 31, 2003 and $585.9 million, or 77.1% of total customer funding at March 31, 2002.

Additional internal sources of liquidity include maturities and likely calls in the Company’s investment portfolio as well as the Company’s overnight investment in federal funds sold. Securities scheduled to mature and likely to be called in one year, based on interest rates at March 31, 2003, totaled $95.0 million, and federal funds sold were $78.1 million on March 31, 2003.

The Company also has the ability to utilize established credit as an additional source of liquidity. The Bank is a member of the Federal Home Loan Bank (“FHLB”). Generally, member banks of the FHLB have approval to borrow an amount equal to 14% of total assets as reported on the most recent regulatory report. Collateral must be pledged to the FHLB before advances can be obtained. The Bank had pledged sufficient collateral to the FHLB at March 31, 2003 to permit borrowing of up to $99.9 million. At March 31, 2003, outstanding advances from the FHLB totaled $20.0 million. The Bank also has an established borrowing capacity at the Federal Reserve Bank (“FRB”). At March 31, 2003, the Bank had pledged sufficient collateral to permit borrowing of up to $61.7 million from the FRB; no balances were outstanding on that date.

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Capital Resources

Total stockholders’ equity was $78.4 million at March 31, 2003, representing an increase of $1.5 million or 1.9% from December 31, 2002. The growth of stockholders’ equity in the first three months of 2003 was primarily attributable to the earnings of the Company of $2.5 million less dividends declared on common stock of $889,000 and less $200,000 in accumulated other comprehensive income, resulting from a decrease in market value of securities available-for-sale. Capital was also increased by $99,000 as a result of stock options that were exercised during the first quarter of 2003.

Dividends declared for the first three months of 2003 were $889,000, or $.125 per share, compared to $788,000, or $.11 per share, in 2002.

The following table summarizes the Company’s risk-based capital ratios:

Market Risk and Interest Rate Sensitivity

The Company’s interest rate risk represents the level of exposure it has to fluctuations in interest rates and is primarily measured as the change in earnings and the theoretical market value of equity that results from changes in interest rates. The Asset/Liability Management Committee of the Board of Directors (the “ALCO”) oversees the Company’s management of interest rate risk. The objective of the management of interest rate risk is to optimize net interest income during periods of volatile as well as stable interest rates while maintaining a balance between the maturity and repricing characteristics of assets and liabilities that is consistent with the Company’s liquidity, asset and earnings growth, and capital adequacy goals. Critical to the management of this process is the ALCO’s interest rate program, designed to manage interest rate sensitivity (gap management) and balance sheet mix and pricing (spread management). Gap management represents those actions taken to measure and monitor rate sensitive assets and rate sensitive liabilities. Spread management requires managing investments, loans, and funding sources to achieve an acceptable spread between the Company’s return on its earning assets and its cost of funds.

One tool used by the Company to assess and manage its interest rate risk is the gap analysis. The gap analysis, summarized in the following table, measures the mismatch in repricing between interest-sensitive assets and interest-sensitive liabilities and provides a general indication of the interest sensitivity of the balance sheet at a specified point in time. By limiting the size of the gap position, the Company can limit the net interest income at risk arising from repricing imbalances. The following table summarizes the anticipated maturities or repricing of the Company’s interest-earning assets and interest-bearing liabilities as of March 31, 2003 and the Company’s interest sensitivity gap position at that date. The Company’s cumulative sensitivity gap through twelve months is a positive 12.66%. A positive sensitivity gap for any time period indicates that more interest-earning assets will mature or reprice during that time period than interest-bearing liabilities. The Company’s goal is generally to maintain a reasonably balanced cumulative interest sensitivity gap position for the period of one year or less in order to mitigate the impact of changes in interest rates on liquidity, interest margins and corresponding operating results. During periods of falling interest rates, a short-term positive interest sensitivity gap position would generally result in a decrease in net interest income, and during periods of rising interest rates, a short-term positive interest sensitivity gap position would generally result in an increase in net interest income (assuming all earning assets and interest-bearing liabilities are affected by a rate change equally and simultaneously).

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The analysis provided in the table above includes the following significant assumptions: Fixed-rate loans are scheduled by contractual maturity and variable-rate loans are scheduled by repricing date. Variable-rate loans that have reached a pre-established interest rate floor are classified as fixed-rate loans and reprice according to contractual maturity. Investments other than mortgage-backed securities are scheduled according to the earlier of contractual maturity date or most likely call date, given current interest rates. Mortgage-backed securities are scheduled according to estimated maturity based upon the most recent monthly prepayment factors, which may change. Residential mortgage loans originated for sale are scheduled based on their expected sale dates, generally 14 to 30 days after settlement. Projected runoff of deposits that do not have a contractual maturity date, such as NOW, savings and money market accounts, was computed based upon the most recently proposed decay rate assumptions set forth by the Federal Financial Institutions Examination Council (“FFIEC”). Penalty-free certificates of deposit are scheduled by stated maturity date. If rates begin to increase, a portion these certificates may reprice prior to contractual maturity. Long-term advances from the FHLB are scheduled according to their maturity dates.

The Company also uses a computer simulation analysis to assess and manage its interest rate risk. The simulation analysis assumes an immediate, parallel shift of 200 basis points in the Treasury Yield Curve. During 2001, as market rates approached historically low levels, the Company adjusted the assumptions used in the simulation process to incorporate interest rate floors for certain deposit products, recognizing the practical concept that rates on interest bearing products would not reprice below a certain point. Also the Company recognized that for evaluating interest rate risk in the current rate environment, a downward shift of 200 basis points is not practical. As a result, the simulation applied a 100 basis point shift downward and the upward shift remained at 200 basis points. The analysis measures the potential change in earnings and in the market value of portfolio equity over a one-year time horizon, captures optionality factors such as call features imbedded in investment and loan portfolio contracts, and includes assumptions as to the timing and magnitude of movements in interest rates associated with the Company’s funding sources not fixed in price. Measured based on December 31, 2002 data, the simulation analysis reflects a 2.7% drop in net interest income and an 4.4% increase in economic value of equity if rates fall 100 basis points and a 7.0% increase in net interest income and an 13.4% drop in economic value of equity with a 200 basis point increase in rates.

Both of the above tools used to assess interest rate risk have strengths and weaknesses. Because the gap analysis reflects a static position at a single point in time, it is limited in quantifying the total impact of market rate changes which do not affect all earning assets and interest-bearing liabilities equally or simultaneously. In addition, gap reports depict the existing structure, excluding exposure arising from new business. While the simulation process is a powerful tool in analyzing interest rate sensitivity, many of the assumptions used in the process are highly qualitative and subjective and are subject to the risk that past historical activity may not generate accurate predictions of the future. Both

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measurement tools, however, provide a comprehensive evaluation of the Company’s exposure to changes in interest rates, enabling management to control the volatility of earnings.

Material Changes in Financial Condition

Cash and Due from Banks:

Cash and due from banks represents cash on hand, cash on deposit with other banks and cash items in the process of collection. As a result of the Company’s cash management services provided to large, sophisticated corporate customers (which includes cash concentration activities and processing coin and currency transactions), the Company’s cash balances may fluctuate more widely on a daily basis and may be higher than industry averages for banks of a similar asset size.

Residential Mortgage Loans Originated for Sale:

The outstanding balance of mortgage loans originated for sale increased $4.2 million, from $10.5 million at December 31, 2002 to $14.7 million at March 31, 2003, due to continued first mortgage origination activity corresponding to the declining interest rate environment.

Loans and Nonperforming Assets:

At March 31, 2003, the Company’s loan portfolio, net of unearned income, totaled $696.3 million, or 70.1% of its total assets of $993.6 million. The most significant categories of loans in the Company’s portfolio were real estate development and construction, commercial, residential and commercial mortgages and retail.

Since December 31, 2002, total loans increased $31.6 million, or 4.8%. Real estate development and construction loans and commercial loans rose $22.6 million and $6.2 million, respectively, since December 31, 2002. Residential mortgage loans increased $2.1 million. Retail and other loans increased $1.7 million. Commercial mortgage loans declined $1.0 million.

Real estate development and construction loans constitute the largest portion of the Company’s lending activities, totaling $209.6 million at March 31, 2003. A breakdown by type follows:

The Company makes residential real estate development and construction loans generally to provide interim financing on property during the development and construction period. Borrowers include builders, developers and persons who will ultimately occupy the single-family dwellings. Residential real estate development and construction loan funds are disbursed periodically as pre-specified stages of completion are attained based upon site inspections. Interest rates on these loans are usually adjustable. The Company has limited loan losses in this area of lending through monitoring of development and construction loans with on-site inspections and control of disbursements on loans in process. Development and construction loans are secured by the properties under development or construction and personal guarantees are typically obtained. Further, to assure that reliance is not placed solely upon the value of the underlying collateral, the Company considers the financial condition and reputation of the borrower and any guarantors, the amount of the borrower’s equity in the project, independent appraisals, cost estimates and pre-construction sales information.

Commercial loans constitute the second largest portion of the Company’s loan portfolio. Commercial business loans are made to provide working capital to businesses in the form of lines of

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credit, which may be secured by real estate, accounts receivable, inventory, equipment or other assets. Commercial mortgages are typically secured by office condominiums, retail buildings, warehouse and general purpose space. These loans generally have maturities of five years or less. At March 31, 2003, commercial loans totaled $204,419 million, or 29.3% of total loans, and commercial mortgages totaled $121.4 million, or 17.4% of total loans. The financial condition and cash flow of commercial borrowers are monitored by the submission of corporate financial statements, personal financial statements and income tax returns. The frequency of submissions of required information depends upon the size and complexity of the credit and the collateral that secures the loan. It is also the Company’s general policy to obtain personal guarantees from the principals of the commercial loan borrowers.

Retail loans, principally loans secured by home equity, represent the third largest component of the Company’s loan portfolio, totaling $143.4 million, or 20.6% of the Company’s total loan portfolio, at March 31, 2003. Of this amount, $131.9 million was comprised of second mortgage loans and home equity lines of credit. Such loans are typically originated for up to 90% of the appraised value of the property, less the amount of any prior liens on the property. Home equity lines of credit have maximum terms of fifteen to thirty years and the interest rates are generally adjustable. The Company secures these loans with mortgages on the homes (typically a second mortgage). The second mortgage loans originated by the Company have maximum terms ranging from ten to thirty years. They generally carry a fixed rate of interest for the first five years, repricing every five years thereafter at a predetermined spread to the prime rate of interest.

The following table provides information concerning nonperforming assets and past-due loans:

At March 31, 2003, nonaccrual loans totaled $806,000, comprised primarily of eight commercial relationships with loans totaling $774,000, of which $591,000 was guaranteed by the Small Business Administration. Also included in nonaccrual loans were two consumer loans carried at a total of $15,000 and one residential mortgage loan carried at $17,000.

Potential problem loans consist of loans that are currently performing in accordance with contractual terms but for which management has concerns about the ability of the obligor to continue to comply with repayment terms because of the obligor’s potential operating or financial difficulties. At March 31, 2003, loans of this type that are not included in the above table of nonperforming and past-due loans amounted to approximately $3.9 million, of which $1.7 million is guaranteed by the Small Business Administration. The majority of these loans represent commercial loan relationships. Depending on changes in the economy and other future events, these loans and others not presently identified as problem loans could be reclassified as nonperforming or impaired loans in the future.

A loan is determined to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan is not considered impaired during a period of delay in payment if the Company expects to collect all amounts due, including past-due interest. The Company generally considers a period of delay in payment to include delinquency up to 90 days.

Impaired loans at March 31, 2003 totaled $775,000, of which $150,000 were collateral dependent loans. Collateral dependent loans are measured based on the fair value of the collateral. Impaired loans

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that are not collateral dependent are measured at the present value of expected future cash flows using the loans’ effective interest rates. At March 31, 2003, specific reserves assigned to impaired loans totaled $20,000. An impaired loan is charged off when the loan, or a portion thereof, is considered uncollectible.

Allowance for Credit Losses:

The Company provides for credit losses through the establishment of an allowance for credit losses (the “Allowance”) by provisions charged against earnings. The Allowance is maintained at a level which represents management’s best estimate of known and inherent losses in the existing portfolio. The Allowance consists of three elements: (1) specific reserves for individual credits; (2) general reserves for types or portfolios of loans based on historical loan loss experience, judgmentally adjusted for current conditions and credit risk concentrations; and (3) unallocated reserves. Combined specific reserves and general reserves by loan type are considered allocated reserves. All outstanding loans are considered in evaluating the Allowance. The Allowance does not provide for estimated losses stemming from uncollectible interest because the Company generally requires all accrued but unpaid interest to be reversed once a loan is placed on nonaccrual status.

The process of establishing the Allowance with respect to the Company’s commercial and commercial real estate loan portfolios begins when a loan officer initially assigns each loan a risk grade, using established credit criteria. Risk grades are reviewed and validated annually by an independent consulting firm, as well as periodically by the Company’s internal credit review function. Management reviews, on a quarterly basis, current conditions that affect various lines of business and may warrant adjustments to historical loss experience in determining the required Allowance. Adjustment factors that are considered include: the level and trends in past-due and nonaccrual loans; trends in loan volume; effects of any changes in lending policies and procedures or underwriting standards; and the experience and depth of lending management. Historical factors by product type are adjusted each quarter based on actual loss history. Management also evaluates credit risk concentrations, including trends in large dollar exposures to related borrowers, and industry concentrations. All nonaccrual loans in the commercial and real estate (construction and non-residential mortgage) portfolios, as well as other loans in the portfolios identified as having the potential for further deterioration, are analyzed individually to confirm the appropriate risk grading and accrual status and to determine the need for a specific reserve.

Retail and residential mortgage loans are segregated into homogeneous pools with similar risk characteristics. Trends and current conditions in retail and residential mortgage pools are analyzed and historical loss experience is adjusted accordingly. Adjustment factors for the retail and residential mortgage portfolios are consistent with those for the commercial portfolios.

The unallocated portion of the Allowance is intended to provide for losses that are not identified when establishing the specific and general portions of the Allowance. The Company has risk management practices designed to ensure timely identification of changes in loan risk profiles; however, undetected losses may exist inherently within the loan portfolios. The judgmental aspects involved in applying the risk grading criteria, analyzing the quality of individual loans and assessing collateral values can also contribute to undetected, but probable, losses. At March 31, 2003, the Allowance was 1.31% of total loans, net of unearned income. The Allowance at March 31, 2003 is considered by management to be sufficient to address the credit risk in the current loan portfolio. The changes in the Allowance are presented in the following table.

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