SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

For the quarterly period ended June 30, 2004
Commission File Number: 1-9047

Independent Bank Corp.

288 Union Street, Rockland, Massachusetts 02370
(Address of principal executive offices, including zip code)

(781) 878-6100
(Registrant’s telephone number, including area code)

     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 o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes x No o

     As of August 2, 2004, there were 15,290,404 shares of the issuer’s common stock outstanding, par value $0.01 per share.

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INDEX

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PART 1. FINANCIAL INFORMATION

INDEPENDENT BANK CORP.

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

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INDEPENDENT BANK CORP.

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

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INDEPENDENT BANK CORP.

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

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INDEPENDENT BANK CORP.

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

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CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

     Independent Bank Corp. (the “Company”) is a state chartered, federally registered bank holding company headquartered in Rockland, Massachusetts and was incorporated in 1986. The Company is the sole stockholder of Rockland Trust Company (“Rockland” or “the Bank”), a Massachusetts trust company chartered in 1907. The Company also owns 100% of the common stock of Independent Capital Trust III (“Trust III”) and Independent Capital Trust IV (“Trust IV”), each of which have issued trust preferred securities to the public. As of March 31, 2004, Trust III and Trust IV are no longer included in the Company’s consolidated financial statements (see FIN 46R discussion in Note 3 to the Condensed Notes to Unaudited Consolidated Financial Statements below). The Bank’s subsidiaries consist of two Massachusetts securities corporations, RTC Securities Corp. I and RTC Securities Corp. X; Taunton Avenue Inc.; and Rockland Trust Community Development LLC. Taunton Avenue Inc. was formed in May 2003 to hold loans, industrial development bonds and other assets. Rockland Trust Community Development LLC was formed in August 2003 to provide investment capital to low-income communities and low-income persons. All material intercompany balances and transactions have been eliminated in consolidation. Certain amounts in prior year financial statements have been reclassified to conform to the current year’s presentation.

     The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the financial statements, primarily consisting of normal recurring adjustments, have been included. Operating results for the quarter and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ended December 31, 2004 or any other interim period. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission.

NOTE 2 - STOCK BASED COMPENSATION

     The Company has three stock option plans; the Amended and Restated 1987 Incentive Stock Option Plan (“The 1987 Plan”), the 1996 Non-employee Directors’ Stock Option Plan (“The 1996 Plan”) and the 1997 Employee Stock Option Plan (“The 1997 Plan”). All three plans were approved by the Company’s Board of Directors. The Company measures compensation cost for stock-based compensation plans as the excess, if any, of the exercise price of options granted over the fair market value of the Company’s stock at the grant date. Compensation cost is not recognized as the exercise price has historically equaled the grant date fair value of the underlying stock; however, the Company discloses pro forma net income and earnings per share in the notes to its consolidated financial statements as if compensation was measured at the date of grant based on the fair value, as determined using the Black Scholes model, of the award and recognized over the service period.

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     Had the Company recognized compensation cost for these plans determined as the fair market value of the Company’s stock at the grant date and recognized over the service period, the Company’s net income and earnings per share would have been reduced to the following pro forma amounts:

     The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model. Annual grant dates for the 1997 plan are in December, consequently full year 2003 assumptions are shown below for the 1997 plan. On an exception basis, grants are made to new employees that meet plan specifications. The following weighted average assumptions were used for grants under the 1997 and 1996 plans:

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(1) On January 8, 2004 and June 10, 2004, 5,000 options were granted from the 1997 Plan to the Company’s Managing Director of Business Banking. The risk free rate, expected dividend yield, expected life and expected volatility for this grant were determined on January 8, 2004 and June 10, 2004, respectively. The normal annual grant of 1997 Plan options is expected to occur in December of 2004 upon which a risk free interest rate, expected dividend yield, expected life and expected volatility will be determined for those grants.

(2) On April 27, 2004, 11,000 options were granted from the 1996 Plan to the Company’s Board of Directors. The risk free rate, expected dividend yield, expected life and expected volatility for this grant were determined on April 27, 2004.

(3) On December 11, 2003, 127,350 options were granted from the 1997 Plan to the Company’s members of Senior Management. The risk free rate, expected dividend yield, expected life and expected volatility for this grant were determined on December 11, 2003.

(4) On January 9, 2003, 50,000 options were granted from the 1997 Plan to the Company’s President and Chief Executive Officer. The risk free rate, expected dividend yield, expected life and expected volatility for this grant were determined on January 9, 2003.

(5) On April 15, 2003, 11,000 options were granted from the 1996 Plan to the Company’s Board of Directors. The risk free rate, expected dividend yield, expected life and expected volatility for this grant were determined on April 15, 2003.

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NOTE 3 - RECENT ACCOUNTING DEVELOPMENTS

     Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 46 “Consolidation of Variable Interest Entities – an Interpretation of Accounting Research Bulletin No. 51” In January 2003, the FASB issued FIN No. 46. FIN 46 established accounting guidance for consolidation of variable interest entities (“VIE”) that function to support the activities of the primary beneficiary. The primary beneficiary of a VIE is the entity that absorbs a majority of the VIE’s expected losses, receives a majority of the VIE’s expected residual returns, or both, as a result of ownership, controlling interest, contractual relationship or other business relationship with a VIE. Prior to the implementation of FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity. The Company adopted FIN No. 46 as of February 1, 2003 for all arrangements entered into after January 31, 2003.

     In December 2003, the FASB issued a revised FIN No. 46 (“FIN 46R”), which, in part, addressed limited purpose trusts formed to issue trust preferred securities. FIN 46R required the Company to deconsolidate its two subsidiary trusts (Independent Capital Trust III and Independent Capital Trust IV) on March 31, 2004. The result of deconsolidating these trusts was that trust preferred securities of the trusts, which were classified between liabilities and equity on the balance sheet (mezzanine section), no longer appear on the consolidated balance sheet of the Company. The related minority interest expense also no longer is included in the consolidated statement of income. Due to FIN 46R, the junior subordinated debentures of the parent company that were previously eliminated in consolidation are now included on the consolidated balance sheet within total borrowings. The interest expense on the junior subordinated debentures is included in the net interest margin of the consolidated company, negatively impacting the net interest margin by approximately 0.19% on an annualized basis. There is no impact on net income as the amount of interest previously recognized as minority interest is equal to the amount of interest expense that is recognized currently in the net interest margin offset by the dividend income on the subsidiary trusts common stock recognized in other non-interest income. Prior periods were not restated to reflect the changes made by FIN 46R.

     In July 2003, the Board of Governors of the Federal Reserve issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. In May 2004, the Federal Reserve Board requested public comment on a proposed rule that would retain trust preferred securities in the Tier 1 capital of bank holding companies, but with stricter quantitative limits and clearer qualitative standards. Under the proposal, after a three-year transition period, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25 percent of Tier 1 capital elements, net of goodwill. The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions. The Federal Reserve intends to review the regulatory implications of any accounting treatment changes and, if necessary or warranted, provide further appropriate guidance. There can be no assurance that the Federal Reserve will continue to allow institutions to include trust preferred securities in Tier 1 capital for regulatory capital purposes. As of June 30, 2004, assuming the Company was not allowed to include the $50.0 million in trust preferred securities issued by Capital Trust III and Capital Trust IV in Tier 1 capital, the Company would still exceed the regulatory required minimums for capital adequacy purposes. If the trust preferred securities were no longer allowed to be included in

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Tier 1 capital, the Company would also be permitted to redeem the capital securities, which bear interest at 8.625% and 8.375%, respectively, without penalty.

     For all other arrangements entered into subsequent to January 31, 2003, the Company adopted FIN 46R as of December 31, 2003. There was no material impact on the Company’s financial position or results of operations.

     Statement of Position 03-3 (“SOP 03-3”): “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” In December 2003, the American Institute of Certified Public Accountants (“AICPA”) issued SOP 03-3. SOP 03-3 requires loans acquired through a transfer, such as a business combination, where there are differences in expected cash flows and contractual cash flows due in part to credit quality be recognized at their fair value. The yield that may be accreted is limited to the excess of the investor’s estimate of undiscounted expected principal, interest, and other cash flows over the investor’s initial investment in the loan. The excess of contractual cash flows over expected cash flows is not to be recognized as an adjustment of yield, loss accrual, or valuation allowance. Valuation allowances can not be created nor “carried over” in the initial accounting for loans acquired in a transfer of loans. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004, with early adoption encouraged. The Company does not believe the adoption of SOP 03-3 will have a material impact on the Company’s financial position or results of operations.

     Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 105 - “Application of Accounting Principles to Loan Commitments” In March 2004, the SEC issued SAB No. 105. SAB No. 105 summarizes the views of the SEC regarding the application of Generally Accepted Accounting Principles (“GAAP”) to loan commitments for mortgage loans that will be held for sale accounted for as derivatives. The guidance requires the measurement at fair value of such loan commitments include only the differences between the guaranteed interest rate in the loan commitment and a market interest rate; future cash flows related to servicing the loan or the customer relationship should not be recorded as a part of the loan commitment derivative. SAB No. 105 is effective for said loan commitments accounted for as derivatives entered into beginning April 1, 2004. The Company adopted this SAB on April 1, 2004. The adoption of SAB No. 105 did not have an impact on the Company as the Company was valuing loan commitments to be accounted for as derivatives consistent with this guidance.

     Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) 106-2: “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” In May 2003, the FASB issued FSP 106-2. FSP 106-2 provides guidance on accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“the Act”) for employers that sponsor postretirement health care plans that provide prescription drug benefits. It also requires certain disclosures regarding the effect of the Federal subsidy provided by the Act. FSP 106-2 is effective for interim or annual periods beginning after June 15, 2004. The Company does not believe the adoption of FSP 106-2 will have a material impact on the Company’s financial position or results of operations.

     Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) Issue 03-1: “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” In June 2004, the FASB’s EITF issued EITF Issue 03-1. EITF 03-1 contains new guidance on other-than-temporary impairments of investment securities. The guidance dictates when impairment is deemed to exist, provides guidance on

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determining if impairment is other than temporary, and directs how to calculate impairment loss. Issue 03-1 also details expanded annual disclosure rules. EITF 03-1 is effective for periods beginning after June 15, 2004. The Company does not believe the adoption of EITF 03-1 will have a material impact on the Company’s financial position or results of operations.

NOTE 4 - SETTLEMENT OF REAL ESTATE INVESTMENT TRUST (“REIT”) RETROACTIVE TAXATION DISPUTE

     During the first six months of 2003, the Company took an initial charge for, and then settled, a tax dispute with the Massachusetts Department of Revenue (the “DOR”) relating to the Company’s former real estate investment trust subsidiary. The Company recognized a $2.1 million credit to its provision for income taxes in the quarter ended June 30, 2003 due to its settlement with the DOR. That settlement reduced the $4.1 million charge initially recorded to the Company’s provision for income taxes in the first quarter of 2003 to $2.0 million.

NOTE 5 - EARNINGS PER SHARE

     Basic earnings per share (“EPS”) excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if options or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that share in the earnings of the entity.

     Earnings per share consisted of the following components for the three months and six months ended June 30, 2004 and 2003:

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For the Three Months Ended June 30,

For the Three Months Ended June 30,

For the Six Months Ended June 30,

For the Six Months Ended June 30,

     Options to purchase common stock with an exercise price greater than the average market price of common shares for the period are excluded from the calculation of diluted earnings per share, as their effect on earnings per share would be antidilutive. For the three and six months ended June 30, 2004, there were 135,695 and 129,901, respectively, of shares excluded from the calculation of diluted earnings per share. For the three and six months ended June 30, 2003, there were 187,155 and 185,278 shares excluded from the calculation of diluted earnings per share.

NOTE 6 - EMPLOYEE BENEFITS

POST RETIREMENT BENEFITS AND SUPPLEMENTAL EXECUTIVE RETIREMENT PLANS

     The following table illustrates the status of the post-retirement benefit plan and supplemental executive retirement plans (“SERPs”) as of June 30 for the years presented:

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Components of Net Periodic Benefit Cost

Components of Net Periodic Benefit Cost

     The Company previously disclosed in its financial statements for the fiscal year ended December 31, 2003 that it expected to contribute $55,000 to its post retirement benefit plan and $124,000 to its SERPs in 2004 and presently anticipates making these contributions. As of June 30, 2004, $24,000 and $62,000 of contributions have been made to the post retirement benefit plan and the SERPs, respectively.

     Not included in the above summary are the components of net periodic benefit cost for the noncontributory defined benefit pension plan administered by Pentegra (“the Fund”). The Fund does not segregate the assets or liabilities of all participating employers and, accordingly, disclosure of accumulated vested and nonvested benefits is not possible. The pension plan year is July 1^st through June 30^th. The Company disclosed in its financial statements for the year ended 2003 that the expected contributions for the remainder of the 2003-2004 plan year was $859,000. As of June 30, 2004, $781,000 of contributions were paid as the final obligation for the 2003-2004 plan year. The Company anticipates that $1.0 million of contributions will be paid during the remainder of 2004 for the 2004-2005 plan year.

     The above measures of net periodic postretirement benefit costs do not reflect any amount associated with the Federal subsidy provided by the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“the Act”) because the Company has yet to conclude whether the benefits provided by the postretirement benefit plans are actuarially equivalent to Medicare Part D under the Act. The Company does not believe that the Act will materially impact accounting for postretirement benefit costs.

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NOTE 7 - COMPREHENSIVE INCOME (LOSS)

     Information on the Company’s comprehensive income (loss), presented net of taxes, is set forth below for the quarter and six months ended June 30, 2004 and 2003.

NOTE 8 - ACQUISITION

     On July 16, 2004, the Company completed its previously-announced acquisition of Falmouth Bancorp, Inc., the parent of Falmouth Co-operative Bank. In accordance with SFAS No. 142, the acquisition will be accounted for under the purchase method of accounting and the Company expects to recognize approximately $20 million of goodwill due to the transaction.

NOTE 9 - NEW MARKETS TAX CREDIT PROGRAM

     During the second quarter of 2004, the Company announced that the Community Development Financial Institutions Fund of the United Stated Department of the Treasury has awarded $30 million in tax credit allocation authority to one of its wholly-owned subsidiaries, the Rockland Trust Community Development LLC, under the federal New Markets Tax Credit Program.

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     The $30 million award to the Rockland Trust Community Development LLC enables the Company to acquire federal tax credits by making an equity investment in the Rockland Trust Community Development LLC, for a period of at least seven years, up to the full amount of the award. The Rockland Trust Community Development LLC, in turn, must use that equity investment to make loans to qualified businesses and individuals in low-income communities in accordance with New Markets Tax Credit Program criteria. The Company’s overall tax credit will be equal to 39% of its total equity investment in the Rockland Trust Community Development LLC, credited at a rate of 5% in each of the first 3 years and 6% in each of the final 4 years. In order for tax credits to be obtained, the Rockland Trust Community Development LLC must enter into an Allocation Agreement with the Treasury Department, make loans in accordance with regulatory guidelines, and otherwise comply with New Markets Tax Credit Program requirements.

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

     The following discussion should be read in conjunction with the consolidated financial statements, notes and tables included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, filed with the Securities and Exchange Commission.

Cautionary Statement Regarding Forward-Looking Statements

     A number of the presentations and disclosures in this Form 10-Q, including, without limitation, statements regarding the level of allowance for loan losses, the rate of delinquencies and amounts of charge-offs, and the rates of loan growth, and any statements preceded by, followed by or which include the words “may,” “could,” “should,” “will,” “would,” “hope,” “might,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “assume” or similar expressions constitute forward-looking statements.

     These forward-looking statements, implicitly and explicitly, include the assumptions underlying the statements and other information with respect to the Company’s beliefs, plans, objectives, goals, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business, including the Company’s expectations and estimates with respect to the Company’s revenues, expenses, earnings, return on equity, return on assets, efficiency ratio, asset quality and other financial data and capital and performance ratios.

     Although the Company believes that the expectations reflected in the Company’s forward-looking statements are reasonable, these statements involve risks and uncertainties that are subject to change based on various important factors (some of which are beyond the Company’s control). The following factors, among others, could cause the Company’s financial performance to differ materially from the Company’s goals, plans, objectives, intentions, expectations and other forward-looking statements:

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•		A weakening in the strength of the United States economy in general and the strength of the regional and local economies within the New England region and Massachusetts which could result in a deterioration of credit quality, a change in the allowance for loan losses or a reduced demand for the Company’s credit or fee-based products and services;
•		adverse changes in the local real estate market, as most of the Company’s loans are concentrated in southeastern Massachusetts and Cape Cod and a substantial portion of these loans have real estate as collateral, could result in a deterioration of credit quality and an increase in the allowance for loan loss;
•		the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System could affect the Company’s business environment or affect the Company’s operations;
•		inflation, interest rate, market and monetary fluctuations could reduce net interest income and could increase credit losses;
•		adverse changes in asset quality could result in increasing credit risk-related losses and expenses;
•		competitive pressures could intensify and affect the Company’s profitability, including as a result of continued industry consolidation, the increased financial services from non-banks and banking reform;
•		a deterioration in the conditions of the securities markets could adversely affect the value or credit quality of the Company’s assets, the availability and terms of funding necessary to meet the Company’s liquidity needs and the Company’s ability to originate loans;
•		the potential to adapt to changes in information technology could adversely impact the Company’s operations and require increased capital spending;
•		changes in consumer spending and savings habits could negatively impact the Company’s financial results; and
•		future acquisitions may not produce results at levels or within time frames originally anticipated and may result in unforeseen integration issues.

     If one or more of the factors affecting the Company’s forward-looking information and statements proves incorrect, then the Company’s actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Form 10-Q. Therefore, the Company cautions you not to place undue reliance on the Company’s forward-looking information and statements.

     The Company does not intend to update the Company’s forward-looking information and statements, whether written or oral, to reflect change. All forward-looking statements attributable to the Company are expressly qualified by these cautionary statements.

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EXECUTIVE LEVEL OVERVIEW

     The Company’s results of operations are largely dependent on net interest income, which is the difference between the interest earned on loans and securities and interest paid on deposits and borrowings. The results of operations are also affected by the level of income/fees from loans, deposits, mortgage banking, and investment management fees, as well as operating expenses, the provision for loan losses, the impact of federal and state income taxes, and the relative levels of interest rates and economic activity.

     As anticipated, the net interest margin continued to compress during the second quarter of 2004 to 3.84% from 4.47% for the same period in 2003. The Company’s adoption of a new accounting standard on March 31, 2004 caused certain expenses to be reclassified to interest expense prospectively and contributes, on an annualized basis, approximately 19 basis points to the compression of the net interest margin when compared to reported net interest margin calculations prior to the second quarter of 2004. (See Note 3 to the Condensed Notes to Unaudited Consolidated Financial Statements in Item 1 hereto.)

     The remainder of the net interest margin compression is a consequence of the prolonged low interest rate environment, coupled with what the Company believes to be the prudent management of its balance sheet in anticipation of rising interest rates. During this historically low interest rate environment, the Company has emphasized adjustable rate lending and extended the duration of its borrowings. While these measures, along with the use of promotional pricing for certain retail deposit products, have somewhat exacerbated the margin compression and decreased near-term earnings, Management believes that these measures will result in long-term franchise value. The Company’s continued ability to generate loan growth has somewhat offset the compression of the net interest margin.

     As previously announced, the Company remains focused on and continues to make deliberate investments in a number of initiatives. During the first half of 2004, the Company incurred business initiative expenses to implement a small business banking model, to expand residential lending, to develop a new set of consumer deposit products, to improve the commercial loan process, to fund retail sales training, and to fund a core information system selection process. The Company estimates that the total expenses associated with its business initiatives were approximately $606,000 and $1.1 million for the three and six months ended June 30, 2004, respectively, across all expense categories. In addition, advertising and business development increased incrementally by $314,000 and $515,000 for the three and six months ended June 30, 2004, respectively, as compared to the same periods in the prior year, to support the afore-mentioned business initiatives and capitalize on market changes due to merger disruption.

     Looking ahead, Management anticipates that the net interest margin has stabilized and will increase modestly by year-end. For the third and fourth quarter, Management anticipates a total for both quarters of $590,000, pre-tax, in incremental spending on the strategic initiatives. Advertising and business development expense will be consistent with the levels in the third and fourth quarter of last year. The Company believes that the investments made in its initiatives will lead to top-line growth in 2005-2006.

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FINANCIAL POSITION

     Loan Portfolio Total loans increased by $115.2 million, or 7.3%, during the six months ended June 30, 2004 as compared to December 31, 2003. The increases were mainly in consumer, residential real estate, and commercial construction, which increased $62.8 million, or 14.5%, $32.6 million, or 10.1%, and $24.2 million, or 32.1%, respectively. Consumer loans increased primarily due to an increase in indirect auto loans and home equity lines. Commercial real estate decreased by $4.4 million, or 0.8%, primarily due to prepayment activity in 2004. Residential loans held for sale increased $0.4 million.

     Asset Quality Rockland Trust Company actively manages all delinquent loans in accordance with formally drafted policies and established procedures. In addition, Rockland Trust Company’s Board of Directors reviews delinquency statistics, by loan type, on a monthly basis.

     Delinquency The Bank’s philosophy toward managing its loan portfolios is predicated upon careful monitoring which stresses early detection and response to delinquent and default situations. The Bank seeks to make arrangements to resolve any delinquent or default situation over the shortest possible time frame. Generally, the Bank requires that a delinquency notice be mailed to a borrower upon expiration of a grace period (typically no longer than 15 days beyond the due date). Reminder notices and telephone calls may be issued prior to the expiration of the grace period. If the delinquent status is not resolved within a reasonable time frame following the mailing of a delinquency notice, the Bank’s personnel charged with managing its loan portfolios, contacts the borrower to ascertain the reasons for delinquency and the prospects for payment. Any subsequent actions taken to resolve the delinquency will depend upon the nature of the loan and the length of time that the loan has been delinquent. The borrower’s needs are considered as much as reasonably possible without jeopardizing the Bank’s position. A late charge is usually assessed on loans upon expiration of the grace period.

     On loans secured by one-to-four family owner-occupied properties, the Bank attempts to work out an alternative payment schedule with the borrower in order to avoid foreclosure action. If such efforts do not result in a satisfactory arrangement, the loan is referred to legal counsel whereupon counsel initiates foreclosure proceedings. At any time prior to a sale of the property at foreclosure, the Bank may and will terminate foreclosure proceedings if the borrower is able to work out a satisfactory payment plan. On loans secured by commercial real estate or other business assets, the Bank similarly seeks to reach a satisfactory payment plan so as to avoid foreclosure or liquidation.

     The following table sets forth a summary of certain delinquency information as of the dates indicated:

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Table 1 - Summary of Delinquency Information

     Nonaccrual Loans As a general rule, a commercial or real estate loan more than 90 days past due with respect to principal or interest is classified as a nonaccrual loan. Income accruals are suspended on all nonaccrual loans and all previously accrued and uncollected interest is reversed against current income. A loan remains on nonaccrual status until it becomes current with respect to principal and interest, when the loan is liquidated, or when the loan is determined to be uncollectible and is charged-off against the allowance for loan losses. As permitted by banking regulations, consumer loans and home equity loans past due 90 days or more continue to accrue interest. In addition, certain commercial and real estate loans that are more than 90 days past due may be kept on an accruing status if the loan is well secured and in the process of collection.

     Nonperforming Assets Nonperforming assets are comprised of nonperforming loans, other real estate owned (“OREO”) and nonperforming investment securities. Nonperforming loans consist of nonaccrual loans and loans that are more than 90 days past due but still accruing interest. OREO includes properties held by the Bank as a result of foreclosure or by acceptance of a deed in lieu of foreclosure. Nonperforming investment securities consist of investments that have been identified as other than temporarily impaired and are no longer accruing interest. The Company’s strong underwriting guidelines, prudent investment practices, and the resilient local economy continue to result in strong asset quality. Nonperforming assets totaled $3.3 million at June 30, 2004 (0.12% of total assets), as compared to the $3.5 million (0.14% of total assets) reported at December 31, 2003. The Company’s allowance for loan losses to nonperforming loans is 715.21% as compared to 659.16% at December 31, 2003. The Bank held no OREO property on June 30, 2004 and all investment securities were performing.

     Repossessed automobile loan balances continue to be classified as nonperforming loans, and not as other assets, because the borrower has the potential capacity to satisfy the obligation within twenty days from the date of repossession (before the Bank can schedule disposal of the collateral). The borrower can redeem the property by payment in full at any time prior to the disposal of it by the Bank. Repossessed automobiles loan balances amounted to $462,000, $770,000, and $560,000 for the periods ending June 30, 2004, December 31, 2003, and June 30, 2003, respectively.

     The following table sets forth information regarding nonperforming assets held by the Company at the dates indicated.

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Table 2 - Nonperforming Assets / Loans
(Unaudited - Dollars in Thousands)

(1)

There were no restructured nonaccruing loans at June 30, 2004, December 31, 2003 and June 30, 2003.

     In the course of resolving nonperforming loans, the Bank may choose to restructure the contractual terms of certain commercial and real estate loans. Terms may be modified to fit the capacity of the borrower to repay in line with the current financial status of the borrower. It is the Bank’s policy to maintain restructured loans on nonaccrual status for approximately six months before management considers a return to accrual status. At June 30, 2004, the Bank had $436,000 of restructured loans. At June 30, 2004, the Bank also had eight potential problem loans which were not included in nonperforming loans with an outstanding balance of $6.8 million. Potential problem loans are those loans deemed to have well-defined weakness in credit quality, but that are not yet impaired. Potential problem loans are identified through a formal, ongoing loan review process and through monitoring of past due payment status.

     Real estate acquired by the Bank through foreclosure proceedings or the acceptance of a deed in lieu of foreclosure is classified as OREO. When property is acquired, it is recorded at the lesser of the loan’s remaining principal balance or the estimated fair value of the property acquired, less estimated costs to sell. Any loan balance in excess of the estimated fair value (less estimated costs to sell on the date of transfer) is charged to the allowance for loan losses on that date. All costs incurred thereafter in maintaining the property, as well as subsequent declines in fair value, are charged to non-interest expense.

     Interest income that would have been recognized for the three months ended June 30, 2004 and June 30, 2003, if nonperforming loans at the respective dates had been performing in accordance with their original terms, approximated $68,000 and $59,000, respectively. Interest income that would have been recognized for the six months ended June 30, 2004 and

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June 30, 2003, if nonperforming loans at the respective dates had been performing in accordance with their original terms, approximated $158,000 and $116,000, respectively. The actual amount of interest that was collected on nonaccrual and restructured loans during the three months ended June 30, 2004 and June 30, 2003 and included in interest income was approximately $78,000 and $71,000, respectively. The actual amount of interest that was collected on nonaccrual and restructured loans during the six months ended June 30, 2004 and June 30, 2003 and included in interest income was approximately $119,000 and $183,000, respectively.

     A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

     Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual, consumer, or residential loans for impairment disclosures. At each of June 30, 2004 and December 31, 2003, impaired loans were $2.1 million, which includes all commercial real estate loans and commercial and industrial loans on nonaccrual status and restructured loans.

     Allowance For Loan Losses While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on increases in non-performing loans, changes in economic conditions or for other reasons. Various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. The Federal Deposit Insurance Corporation (“FDIC”) regulators examined the Company during the first quarter of 2004. No additional provision for loan losses was required as a result of this examination.

     The allowance for loan losses is maintained at a level that management considers adequate to provide for potential loan losses based upon evaluation of known and inherent risks in the loan portfolio. The allowance is increased by provisions for loan losses and by recoveries of loans previously charged-off and is reduced by loans charged-off. As of June 30, 2004, the allowance for loan losses totaled $23.9 million, or 1.41%, of total loans as compared to $23.2 million, or 1.46%, of total loans at December 31, 2003. Based on the analyses described herein, management believes that the level of the allowance for loan losses at June 30, 2004 is adequate.

     The following table summarizes changes in the allowance for possible loan losses and other selected loan data for the periods presented:

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Table 3 - Summary of Changes in the Allowance for Loan Losses

     The allowance for loan losses is allocated to various loan categories as part of the Bank’s process of evaluating its adequacy. The amount of allowance allocated to these loan categories was $21.2 million at June 30, 2004, compared to $20.2 million at December 31, 2003. The distribution of allowances allocated among the various loan categories as of June 30, 2004 was comparable to the distribution as of December 31, 2003. Increases in the amounts allocated were observed in all loan type categories except Commercial & Industrial, which exhibited a minor decrease. These changes are attributed to changes in portfolio balances outstanding and the results of ongoing assessments of the loan portfolio.

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     The following table summarizes the allocation of the allowance for loan losses for the dates indicated:

Table 4 - Summary of Allocation of the Allowance for Loan Losses
(Unaudited - Dollars In Thousands)