FIRST ESSEX BANCORP INC - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended 3/31/03

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

For the transition period from to

Commission file number 0-16143

FIRST ESSEX BANCORP, INC.

(Exact name of registrant as specified in its charter)

Delaware		04-943217
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

71 Main Street, Andover, MA		01810
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (978) 681-7500

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 ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 126-2 of the Securities Exchange Act of 1934).

Yes ý No o

The number of shares outstanding of each of the registrant’s classes of common stock as of March 31, 2003:

Title of Class		Shares Outstanding
Common Stock, $.10 par value		7,718,224

CAUTIONARY STATEMENT FOR PURPOSES OF THE

PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

First Essex Bancorp, Inc. (the Company) desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. This Report contains certain “forward-looking statements” including statements concerning plans, objectives, future events or performance, assumptions, and other statements which are other than statements of historical fact. The Company wishes to caution readers that the following important factors, among others, may have affected, and could in the future affect, the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by, or on behalf of, the Company herein: (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company and its wholly owned banking subsidiary, First Essex Bank, must comply, and the associated costs of compliance with such laws and regulations, either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company’s organization, compensation and benefit plans; (iii) the effect on the Company’s competitive position within its market area of the increasing consolidation within the banking and financial services industries, including increased competition from larger regional and out-of-state banking organizations as well as nonbank providers of various financial services; (iv) the effect of unforeseen changes in interest rates; and (v) the effect of changes in the business cycle and downturns in the local, regional and national economies. The Company disclaims any intent or obligation to update forward-looking statements whether in response to new information, further events or otherwise.

FIRST ESSEX BANCORP, INC.

INDEX

PART I - FINANCIAL INFORMATION

ITEM 1.	Financial Statements (unaudited):

	Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002

	Consolidated Statements of Operations for the three months ended March 31, 2003 and 2002

	Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2003 and 2002

	Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002

	Notes to the Consolidated Financial Statements

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

ITEM 3.	Quantitative and Qualitative Disclosure About Market Risk

ITEM 4.	Controls and Procedures

PART II - OTHER INFORMATION

ITEM 6.	Exhibits and Reports on Form 8-K

	Signatures

	Certifications

ITEM 1. FINANCIAL STATEMENTS

FIRST ESSEX BANCORP, INC.

Consolidated Balance Sheets

(Unaudited)

	March 31, 2003			December 31, 2002
	(Dollars in thousands)
ASSETS
Cash and cash equivalents	$	88,097		$	217,158
Investment securities available-for-sale	402,057			332,421
Stock in Savings Bank Life Insurance Company	1,194			1,194
Stock in Federal Home Loan Bank of Boston	12,771			12,771
Mortgage loans held-for-sale	7,101			7,684
Loans receivable, less allowance for loan losses of $14,472 and $14,452	1,149,536			1,114,258
Foreclosed property	1,980			1,198
Bank premises and equipment	8,415			8,670
Accrued interest receivable	6,848			7,193
Goodwill	11,633			11,633
Core deposit intangible	3,322			3,661
Other assets	62,260			58,089

	$	1,755,214		$	1,775,930

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	1,369,567		$	1,380,637
Borrowed funds	195,045			207,408
Company-obligated mandatorily redeemable trust preferred securities of subsidiary trust holding solely junior subordinated debentures of the Company	24,441			24,409
Mortgagors’ escrow accounts	1,525			860
Other liabilities	20,111			18,690
Total liabilities	1,610,689			1,632,004

STOCKHOLDERS’ EQUITY:
Serial preferred stock: $.10 par value per share; 5,000,000 shares authorized, no shares issued or outstanding
Common stock, $.10 par value per share; 25,000,000 shares authorized, 10,147,524 and 10,090,176 shares issued	1,015			1,009
Additional paid-in capital	83,359			82,698
Retained earnings	80,523			77,365
Treasury stock, at cost, 2,429,300 shares	(23,535		)	(23,535		)
Accumulated other comprehensive income	3,163			6,389
Total stockholders’ equity	144,525			143,926

	$	1,755,214		$	1,775,930

See accompanying notes to the consolidated financial statements.

FIRST ESSEX BANCORP, INC.

Consolidated Statement of Operations

(Unaudited)

	Three Months Ended March 31,
	2003		2002
	(Dollars in thousands, except per share amounts)

Interest and dividend income:
Loans	$	19,665	$	19,987
Investment securities available-for-sale	4,299		6,081
Short-term investments	348		169
Other earning assets	268		267
Total interest and dividend income	24,580		26,504

Interest expense:
Deposits	6,372		8,363
Borrowed funds	2,770		2,875
Total interest expense	9,142		11,238

Net interest income	15,438		15,266
Provision for loan losses	1,938		1,812

Net interest income after provision for loan losses	13,500		13,454

Non-interest income:
Net gain on sales of loans	478		410
Loan fees	288		266
Other income	2,051		1,825
Total non-interest income	2,817		2,501

Non-interest expense:
Salaries and employee benefits	4,617		4,532
Buildings and equipment	1,293		1,229
Professional services	275		318
Information processing	748		744
Foreclosure expenses	157		87
Amortization of core deposit intangible	339		361
Other	1,103		1,245
Total non-interest expenses	8,532		8,516

Income before provision for income taxes	7,785		7,439

Provision for income taxes	2,775		2,705
Net income	$	5,010	$	4,734

Earnings per share - Basic	$	0.65	$	0.62
Earnings per share - Diluted	$	0.63	$	0.60
Dividends declared per share	$	0.24	$	0.22

Weighted average number of shares - basic	7,700,180		7,569,766
Weighted average number of shares - diluted	8,013,375		7,880,293

See accompanying notes to the consolidated financial statements.

FIRST ESSEX BANCORP, INC.

Consolidated Statements of Stockholders’ Equity

For the Three Months Ended March 31, 2003 and 2002

(Unaudited)

				Components of Stockholders’ Equity
	Comprehensive Income			Common Stock		Paid in Capital		Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income			Total
	(Dollars in thousands)

Balance at December 31, 2002				$	1,009	$	82,698	$	77,365		$	(23,535	)	$	6,389		$	143,926
Comprehensive income:
Net income	$	5,010						5,010									5,010
Other comprehensive income:
- Unrealized securities losses, net of tax benefit, arising during the period	(3,226		)
Total other comprehensive income	(3,226		)											(3,226		)	(3,226
																			)
Total Comprehensive income	$	1,784
Cash dividends declared								(1,852		)							(1,852		)
Stock options exercised				6		661											667
Balance at March 31, 2003				$	1,015	$	83,359	$	80,523		$	(23,535	)	$	3,163		$	144,525

Balance at December 31, 2001				$	996	$	81,035	$	63,782		$	(23,535	)	$	2,916		$	125,194
Comprehensive income:
Net income	$	4,734						4,734									4,734
Other comprehensive income:
- Unrealized securities losses, net of tax benefit, arising during the period	(1,007		)
Total other comprehensive income	(1,007		)											(1,007		)	(1,007
																			)
Total Comprehensive income	$	3,727
Cash dividends declared								(1,673		)							(1,673		)
Stock options exercised				7		629											636
Balance at March 31, 2002				$	1,003	$	81,664	$	66,843		$	(23,535	)	$	1,909		$	127,884

See accompanying notes to the consolidated financial statements.

FIRST ESSEX BANCORP, INC.

Consolidated Statements of Cash Flows

(Unaudited)

	Three Months Ended March 31,
	2003			2002
	(Dollars in thousands)
Cash flows from operating activities:
Net income	$	5,010		$	4,734
Adjustments to reconcile net income to net cash (used) provided by operating activities:
Provision for loan losses	1,938			1,812
Depreciation and amortization	478			497
Loss on sale of foreclosed property	(20		)	(47		)
Amortization of investment securities discounts and premiums, net	351			210
Amortization of core deposit intangible	339			361
Proceeds from sales of mortgage loans	31,768			26,194
Mortgage loans originated for sale	(30,707		)	(27,584		)
Realized gains on the sale of mortgage loans	(478		)	(410		)
Decrease in accrued interest receivable	345			370
Increase in other assets	(4,171		)	(10,531		)
Increase (decrease) in other liabilities	3,411			(768		)

Net cash provided by (used in) operating activities	8,264			(5,162		)

Cash flows from investing activities:
Proceeds from maturities and principal payments of available-for-sale securities	66,801			27,896
Purchases of available-for-sale securities	(142,017		)	(9,748		)
Loans originated and purchased, net of principal collected	(38,946		)	(17,904		)
Proceeds from sales of foreclosed property	968			768
Purchases of bank premises and equipment	(191		)	(369		)

Net cash (used in) provided by investing activities	(113,385		)	643

Cash flows from financing activities:
Net increase in demand deposits, NOW accounts and savings accounts	11,374			76,299
Net increase (decrease) in term deposits	(22,444		)	3,121
Net decrease in borrowed funds with maturities of three months or less	(5,344		)	(2,397		)
Repayments of borrowed funds with maturities in excess of three months	(7,019		)	(19		)
Increase in mortgagors’ escrow accounts	665			925
Dividends paid	(1,839		)	(1,657		)
Stock options exercised	667			636

Net cash (used in) provided by financing activities	(23,940		)	76,908

Net (decrease) increase in cash and cash equivalents	(129,061		)	72,389

Cash and cash equivalents at beginning of period	217,158			54,237

Cash and cash equivalents at end of period	$	88,097		$	126,626

Supplemental disclosure of cash flow information:
Interest paid during the year	$	9,217		$	10,699
Income taxes paid during the year	600			808
Supplemental schedule of noncash financing and investing activities:
Assets acquired through, or deeds in lieu of, foreclosure	1,730			656

See accompanying notes to the consolidated financial statements.

FIRST ESSEX BANCORP, INC.

Notes to Consolidated Financial Statements

March 31, 2003

1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements are unaudited and include the accounts of the Company and its subsidiaries, First Essex Bank (the “Bank”), First Essex Capital Trust I, and First Essex Capital Statutory Trust II. These financial statements reflect, in management’s opinion, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the Company’s financial position and the results of its operations and cash flows for the periods presented. The results of operations for the interim period ended March 31, 2003 are not necessarily indicative of results for the entire year. All significant intercompany accounts and transactions have been eliminated in consolidation. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s 2002 Form 10-K.

Earnings Per Share

Included in diluted EPS are 313,195 and 310,527 dilutive potential shares for the quarters ended March 31, 2003 and 2002, respectively. Excluded from diluted earnings per share were options to purchase 245,600 shares at March 31, 2003. These shares were excluded as the exercise price was greater than the average market price of the common shares during the period.

Stock Based Compensation

In December 2002, the Financial Accounting Standards Board issued (“FASB”) Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS 148) an amendment of FASB Statement No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition provisions of the statement are effective for financial statements for fiscal years ending after December 15, 2002 while the disclosure requirements are effective for interim periods beginning after December 15, 2002, with early application encouraged.

The Company accounts for stock options at intrinsic value with disclosure of the effects of fair value accounting on net income and earnings per share on a pro forma basis. Had compensation costs for the stock option plans been determined using the fair value method based upon the Modified Black-Scholes American option model, the Company’s net income and earnings per share from operations for the three months ended March 31, 2003 and 2002 would have been reduced to the following pro forma amounts:

	2003			2002
	(Dollars in thousands, except per share amounts)

Net income, as reported	$	5,010		$	4,734
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	(112		)	(50		)

Pro forma net income	$	4,898		$	4,684

Basic EPS:
As reported	$	0.65		$	0.62
Pro forma	0.64			0.62

Diluted EPS:
As reported	$	0.63		$	0.60
Pro forma	0.61			0.59

Pro forma compensation cost may not be representative of that in future years.

Goodwill and Intangible Assets

In the fourth quarter of 2002, the Company adopted and retroactively applied to January 1, 2002, SFAS No. 147, “Acquisitions of Certain Financial Institutions”. Upon adoption, the previously defined balance of unidentified intangibles was reclassified to goodwill effective January 1, 2002. All 2002 goodwill amortization expense recorded through September 30, 2002 was reversed and all future amortization was halted. As a result of this change, for the three months ended March 31, 2002, diluted earnings per share restated continues to be $0.60, and restated net income will be $4.734 million, as compared to $4.698 million as previously reported. The Company’s goodwill will be periodically reviewed for impairment, as required by the new standard.

2. Loans

The following table sets forth information concerning the Company’s loan portfolio at the dates indicated. The balances are net of unadvanced funds and unearned discounts and fees:

	March 31, 2003				December 31, 2002
	(Dollars in thousands)

Real Estate:
Residential	$	73,603	6.3	%	$	67,238	5.9	%
Commercial	200,731		17.1		195,468		17.2
Construction	62,811		5.4		63,272		5.6
Total Real Estate Loans	337,145		28.8		325,978		28.7

Owner occupied Commercial Real Estate	78,578		6.7		75,886		6.7

Commercial loans	116,515		9.9		117,549		10.3

Aircraft loans	226,227		19.3		217,167		19.1

Consumer loans
Home Equity, Home Improvement & Second Mortgage	40,725		3.5		42,674		3.8
Automobile	368,682		31.5		353,778		31.1
Other	3,237		0.3		3,362		0.3
Total consumer loans	412,644		35.3		399,814		35.2

Total loans	$	1,171,109	100.0	%	$	1,136,394	100.0	%

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

FIRST ESSEX BANCORP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS

March 31, 2003

General

First Essex Bancorp, Inc. (the “Company”) is a Delaware corporation whose primary activity is to act as the parent holding company for First Essex Bank (the “Bank”).

The Company’s net earnings depend to a large extent upon its net interest income, which is the difference between interest and dividend income earned on its loans and investments and interest expense paid on its deposits and borrowed funds. The Company’s net earnings also depend upon its provision for loan loss, noninterest income, noninterest expense and income tax expense. Interest and dividend income and interest expense are significantly affected by general economic conditions. These economic conditions, together with conditions in the local real estate markets, affect the levels of non-performing assets and provisions for loan losses.

Results of Operations

Net income for the three months ended March 31, 2003 was $5.0 million compared to $4.7 million for same period in 2002, or a 5.8% increase. Net interest income totaled $15.4 million for the quarter compared to $15.3 million for the same period in 2002. The increase in net interest income of $172 thousand, combined with an increase in noninterest income of $316 thousand partially offset by increases in the provision for loan losses of $126 thousand accounts for the $346 thousand increase in pretax income.

Analysis of Average Yields Earned and Rates Paid

The following table presents an analysis of average yields earned and rates paid for the periods indicated:

	For the Three Months Ended March 31,
	2003							2002
	Average Balance			Interest Earned/ Paid		Average Yield/ Rate		Average Balance			Interest Earned/ Paid		Average Yield/ Rate
	(Dollars in thousands)
Assets
Earning assets
Short-term investments	$	121,297		$	348	1.16	%	$	51,897		$	169	1.32	%
Investment securities	357,535			4,299		4.88		411,112			6,081		6.00
Total loans (1)	1,148,887			19,665		6.94		1,051,008			19,987		7.71
Other earning assets	17,851			268		6.09		17,728			267		6.11
Total earning assets	1,645,570			24,580		6.06		1,531,745			26,504		7.02
Allowance for loan losses	(14,986		)					(13,033		)
Total earning assets less allowance for loan losses	1,630,584							1,518,712
Other assets	131,837							91,880
Total assets	$	1,762,421						$	1,610,592

Liabilities and Stockholders’ Equity
Deposits
NOW accounts	$	90,480		$	142	0.64	%	$	77,531		$	179	0.94	%
Money market accounts	224,615			818		1.48		99,183			481		1.97
Savings accounts	320,449			793		1.00		346,439			1,632		1.91
Time deposits	581,825			4,619		3.22		586,806			6,071		4.20
Total interest bearing deposits	1,217,369			6,372		2.12		1,109,959			8,363		3.06
Borrowed funds	227,158			2,770		4.95		228,176			2,875		5.11
Total interest bearing deposits and borrowed funds	1,444,527			9,142		2.57		1,338,135			11,238		3.41
Demand deposits	142,165							126,336
Other liabilities	28,885							18,213
Total liabilities	1,615,577							1,482,684
Stockholders’ equity	146,844							127,908
Total liabilities, trust preferred securities and stockholders’ equity	$	1,762,421						$	1,610,592

Net interest income				$	15,438						$	15,266

Weighted average interest rate spread						3.49	%						3.61	%

Net yield on average earning assets (2)						3.75	%						3.99	%

Return on average assets						1.14	%						1.18	%
Return on average equity						13.65	%						14.80	%

(1) Loans on a non-accrual status are included in the average balance.

(2) Net interest income before provision for loan losses divided by average earning assets.

Net Interest Income

Net interest income increased by $172 thousand to $15.4 million for the three months ended March 31, 2003. This represents an increase of 1.1% from $15.3 million when compared to the same period in 2002.

Interest and Dividend Income

Interest and dividend income decreased by $1.9 million or 7.3% to $24.6 million for the three month period ended March 31, 2003, from $26.5 million in the same period in 2002. The change is primarily due to a decrease in the yield on average earning assets to 6.06% for the period ended March 31, 2003 as compared to 7.02% for the same period of 2002. Partially offsetting this decrease in yield on average earning assets was an increase of $113.8 thousand or 7.4% in the balance of average earning assets. The decline in the yield on earning assets resulted from lower interest rates in the economy, in general.

Interest Expense

Interest expense decreased by $2.1 million or 18.7% to $9.1 million for the three months ended March 31, 2003 when compared to the same period in 2002. This decrease is primarily the result of a decrease in the average rate paid on deposits and borrowings to 2.57% from 3.41% for the same period of 2002. Partially offsetting this decrease in average rate paid was an increase in the balance of average interest bearing liabilities of $106.4 million or 8.0%. The decline in the cost of funds resulted from continued growth in lower-rate core deposits while higher-rate term deposits declined, and from lower interest rates in the economy, in general.

Provision for Loan Losses

Losses on loans are provided for under the accrual method of accounting. Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon management’s evaluation of the amount required to meet estimated losses inherent in the loan portfolio after weighing various factors. Among the factors management may consider are the quality of specific loans, risk characteristics of the loan portfolio generally, the level of non-accruing loans, economic conditions and their effect on borrowers, trends in delinquencies and charge-offs and collateral values of the underlying security. Ultimate losses may vary significantly from current estimates. Losses on loans, including impaired loans, are charged against the allowance when management believes the collectability of principal is doubtful.

The provisions for loan losses totaled $1.9 million for the three month period ended March 31, 2003 compared to $1.8 million for the same period in 2002. Provisions result from management’s continuing internal review of the loan portfolio as well as its judgment as to the adequacy of the reserves in light of the condition of the regional real estate and other markets, and the economy in general. As a result of increased loans, there is an expectation that the Bank will continue to find it necessary to make provisions for loan losses in the future. See “Financial Condition - Non-Performing Assets.”

Noninterest Income

Noninterest income consists of net gains from the sales of mortgage loans together with fee and other noninterest income.

Noninterest income increased by $316 thousand or 12.6% to $2.8 million for the three months ended March 31, 2003 compared to $2.5 million for the same period in 2002. This increase is primarily attributable to increases in gains recognized on sales of mortgage loans, deposit fees and additional income recognized on bank owned life insurance purchased during the first quarter of 2002.

Noninterest Expense

Noninterest expenses increased $16 thousand or 0.19% to $8.5 million for the three months ended March 31, 2003 as compared to the same period of 2002.

Income Taxes

The effective income tax rate decreased to 35.7% for the three month period ended March 31, 2003 compared to 36.4% for the same period of 2002. This decrease is primarily the result of the purchase of $10 million of bank-owned life insurance during the first quarter of 2002.

Financial Condition

Total assets amounted to $1,755.2 million at March 31, 2003, a decrease of $20.7 million or 1.2% from $1,775.9 million at December 31, 2002.

Loans

At March 31, 2003, the loan portfolio, including mortgage loans held for sale, and before consideration of the allowance for loan losses, was $1.2 billion, representing 66.7% of total assets, compared to $1.1 billion or 64.1% of total assets at December 31, 2002. Refer to Note 2 for the composition of loans at March 31, 2003 and December 31, 2002.

Allowance for Loan Losses

The allowance for loan losses is maintained at a level determined by management to be adequate to provide for probable losses inherent in the loan portfolio. The allowance for loan losses is maintained through the provision for loan losses, which is a charge to operations. The potential for loss in the portfolio reflects the risks and uncertainties inherent in the extension of credit.

The determination of the adequacy of the allowance for loan losses is based upon management’s assessment of risk elements in the portfolio, factors affecting loan quality and assumptions about the economic environment in which the Company operates. The process includes identification and analysis of loss potential in various portfolio segments utilizing a credit risk grading process and specific reviews and evaluations of significant individual problem credits. In addition, management reviews overall portfolio quality through an analysis of current levels and trends in charge-off, delinquency and nonaccruing loan data, collateral values, economic conditions and their effect on borrowers, and the overall-banking environment. These reviews are of necessity dependent upon estimates, appraisals and judgements, which may change quickly because of changing economic conditions and the Company’s perception as to how these factors may affect the financial condition of debtors.

The methodology for assessing the appropriateness of the allowance consists of a review of the following key elements:

• a formula allowance for the various loan portfolio classifications,

• a valuation allowance for loans identified as impaired, and

• a nonspecific allowance.

The formula allowance is a percentage-based reflection of historical loss experience and assigns required allowance allocations by loan classification based on an estimated percentage of all outstanding loan balances. The formula allowance employs a risk-rating model that grades loans based on general characteristics of credit quality and relative risk. As credit quality becomes more suspect, so-called “watch list” loans, the risk rating and allocation percentage increase. The sum of these allocations comprise the Company’s “formula” or “general” allowance.

The Company also has “valuation” allowances for impaired loans. Loans are evaluated for impairment by measuring the net present value of the expected future cash flows using the loan’s original effective interest rate, or looking at the fair value of the collateral if the loan is collateral dependent. When the difference between the net present value of a loan (of fair value of the collateral if the loan is collateral dependent) is lower than the recorded investment of the loan, the difference is reflected with a resulting “valuation” allowance.

In addition to the formula and valuation components, there is a nonspecific allowance component that takes into consideration the imprecise nature of the loan loss estimation process and various other factors as discussed below. This component’s adequacy is also based upon management’s evaluation of various factors, the effects of which are not directly measured in determining the formula and valuation allowances. The evaluation of the inherent loss resulting from these factors involves a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The factors evaluated in connection with the nonspecific allowance include the following:

• then-existing general economic and business conditions affecting the Company’s key lending areas,

• credit quality trends, including trends in nonperforming loans expected to result from existing conditions,

• collateral values,

• loan volumes and concentrations,

• seasoning of the loan portfolio,

• specific industry conditions within portfolio segments,

• recent loss experience in particular segments of the portfolio,

• duration of the current business cycle,

When an evaluation of these conditions signifies a change in the level of risk, the Company adjusts the formula allowance. Periodic credit reviews enable further adjustment to the allowance through the risk rating of loans and identification of loans requiring a valuation allowance. In addition, the formula model is designed to be self-correcting by taking into account recent loss experience.

The following table summarizes the activity in the allowance for loan losses (including amounts established for impaired loans) for the periods indicated:

	Three Months Ended March 31, 2003			Three Months Ended March 31, 2002
	(Dollars in Thousands)

Balance at beginning of period	$	14,452		$	12,758

Provision for loan losses	1,938			1,812

Charge-offs	(2,010		)	(1,238		)
Recoveries	92			291

Net charge-offs	(1,918		)	(947		)

Balance at end of period	$	14,472		$	13,623

Total loans at end of period*	$	1,171,109		$	1,071,206
Average loans for the period*	1,148,887			1,051,008
Allowance to loans ratio	1.24		%	1.27		%
Net charge-offs to average loans ratio (annualized)	0.67		%	0.36		%

* Includes loans held for sale.

Nonperforming Assets

Nonperforming assets consist of nonaccruing loans (including loans impaired under SFAS No. 114), and foreclosed property. Nonperforming assets totaled $5.2 million at March 31, 2003 and $4.3 million at December 31, 2002.

The Bank’s policy is to discontinue the accrual of interest on all loans (including loans impaired under SFAS No. 114), for which payment of interest or principal is 90 days or more past due or for such other loans as considered necessary by management if collection of interest and principal is doubtful. When a loan is placed on nonaccrual status, all previously accrued but uncollected interest is reversed against the current period interest income.

The following table indicates the recorded investment of nonperforming assets and the related valuation allowance for impaired loans:

	March 31, 2003					December 31, 2002
	Recorded Investment			Impaired Loan Valuation Allowance		Recorded Investment			Impaired Loan Valuation Allowance
	(Dollars in Thousands )
Non-accruing loans
Impaired loans
Requiring a valuation allowance	$	104		$	104	$	105		$	105
Not requiring a valuation allowance	720			—		935			—
	824			104		1,040			105

Restructured loans	—			—		—			—

Total impaired	824			$	104	1,040			$	105

Residential mortgage	46					—
Other	2,309					2,065

Total non-accruing	3,179					3,105

Foreclosed property, net	1,980					1,198

Total non-performing assets	$	5,159				$	4,303


Percentage of non-performing assets to total assets	0.29		%			0.24		%

Percentage of allowance for loan losses to non-accruing loans	455.2		%			465.4		%

The valuation allowance for impaired loans is included in the allowance for loan losses on the balance sheet.

Investments

At March 31, 2003, the Company’s investment portfolio, consisting of short-term investments, investment securities, mortgage-backed securities, Federal Home Loan Bank (“FHLB”) stock and Savings Bank Life Insurance Company of Massachusetts stock, totaled $455.8 million or 26.0% of total assets, compared to $472.0 million or 26.6% of total assets at December 31, 2002. Interest and dividend income on the investment portfolio generated 18.9% of total interest and dividend income for the three months ended March 31, 2003 compared to 23.6% for the same period in 2002. This ratio declined as proceeds from investment repayments were placed into short-term investments as opposed to long-term investments at relatively low yields due to the low interest rate environment.

To identify and control market risks associated with the investment portfolio, the Company has established policies and procedures, which include stop loss limits and stress testing on a periodic basis.

Deposits

Deposits are the primary source of funds for lending and investment activities. Deposit flows vary significantly and are influenced by prevailing interest rates, market conditions, economic conditions and competition. At March 31, 2003 the Bank had total deposits of $1,369.6 million representing a net decrease of $11.1 million or .8% compared to total deposits of $1,380.6 million at December 31, 2002.

While deposit flows are by nature unpredictable, the Bank attempts to manage its deposits through selective pricing. Due to the uncertainty of market conditions, it is not possible for the Bank to predict how aggressively it will compete for deposits in future quarters or the likely effect of any such decision on deposit levels, interest expense and net interest income. Strategies are currently in place to aggressively market more stable deposit sources in products such accounts as savings accounts.

Borrowed Funds

The Bank is a member of the FHLB and is entitled to borrow from the FHLB by pledging certain assets. The Bank also utilizes short term repurchase agreements with maturities less than three months, as an additional source of funds. Repurchase agreements are secured by U.S. government and agency securities. Borrowings are an alternative source of funds compared to deposits and totaled $195.0 million at March 31, 2003 versus $207.4 million at December 31, 2002.

Regulatory Capital Requirements

The Bank is subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation (FDIC). Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the FDIC about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of March 31, 2003, that the Bank meets all capital adequacy requirements to which it is subject.

The most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios as set forth in the table.

The Bank may not declare or pay cash dividends on its shares of common stock if the effect thereof would cause stockholders’ equity to be reduced below applicable capital maintenance requirements or if such declaration and payment would otherwise violate regulatory requirements.

The following table displays the Bank’s capital calculations as defined under prompt corrective action for the periods indicated:

	First Essex Bank				For Capital				To Be Well Capitalized Under Prompt
	Actual		Actual		Adequacy Purposes				Corrective Action Provision:
	Amount		Ratio		Amount		Ratio		Amount			Ratio
	(Dollars in Thousands )
March 31, 2003

Tier 1 (Core) Capital (to Adjusted Assets)	$	142,962	8.23	%	69,523		4.00	%	$	86,904	³	5.00	%

Tier 1 (Core) (to Risk Weighted Assets)	142,962		10.51		54,401		4.00		81,601			6.00

Total Risk Based Capital (to Risk Weighted Assets)	157,434		11.58		108,802		8.00		136,002			10.00

December 31, 2002

Tier 1 (Core) Capital (to Adjusted Assets)	$	137,275	7.81	%	$	70,312	4.00	%	$	87,890	³	5.00	%

Tier 1 Capital (to Risk Weighted Assets)	137,275		9.79		56,094		4.00		84,141			6.00

Total Risk Based Capital (to Risk Weighted Assets)	151,727		10.82		112,188		8.00		140,235			10.00

Recent Accounting Developments

In 2003, the FASB is expected to issue a draft statement establishing standards for issuers’ classification of liabilities in the statement of financial position of financial instruments that have characteristics of both liabilities and equity. If this statement is adopted as currently proposed, the Company will be required to reclassify its Company-Obligated Mandatorily Redeemable Trust Preferred Securities of Subsidiary Trust Holding Solely Junior Subordinated Debentures of the Company to borrowings. In anticipation of this statement, the trust preferred securities, or junior subordinated debentures, have been reclassified to liabilities on the consolidated balance sheet. In addition, the interest cost on the trust preferred securities, has been reclassified as interest on borrowings. There will be no impact to the results of operations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. The Company’s primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process which is governed by policies established by the Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out the asset/liability management policies to the Asset/Liability Committee (ALCO). In this capacity, ALCO develops guidelines and strategies impacting the Company’s asset/liability related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels/trends.

Interest Rate Risk

Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change the interest income and expense streams associated with the Company’s financial instruments also change thereby impacting net interest income (NII), the primary component of the Company’s earnings. ALCO utilizes the results of a detailed and dynamic simulation model to quantify the estimated exposure of NII to sustained interest rate changes. While ALCO routinely monitors simulated NII sensitivity over a rolling two-year horizon, it also utilizes additional tools to monitor potential longer-term interest rate risk. There have been no material changes in the interest rate risk reported at the conclusion of the Company’s December 31, 2002 year end.

Liquidity and Capital Resources

The Bank’s principal sources of liquidity are customer deposits, borrowings from the FHLB, scheduled amortization and prepayments of loan principal, cash flow from operations, maturities of various investments and loan sales.

Management believes it is prudent to maintain an investment portfolio that not only provides a source of income, but also provides a potential source of liquidity to meet lending demand and deposit flows. The Bank adjusts the level of its liquid assets and the mix of its loans and investments based upon management’s judgment as to the quality of specific investment opportunities and the relative attractiveness of their maturities and yields.

Management believes the Company has adequate sources of liquidity to fund current and future operations.

Impact of Inflation

The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles which require measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.

An important concept in understanding the effect of inflation on financial institutions is the distinction between monetary and non-monetary items. In a stable environment, monetary items are those assets and liabilities that are or will be converted into a fixed amount of dollars regardless of changes in prices. Examples of monetary items include cash, investment securities, loans, deposits and borrowings. Non-monetary items are those assets and liabilities that gain or lose general purchasing power as a result of the relationships between specific prices for the items and price change levels. Examples of non-monetary items include equipment and real estate. Additionally, interest rates do not necessarily move in the same direction, or in the same magnitude, as the prices of goods and services as measured by the consumer price index.

Item 4. Controls and Procedures

As required by new rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934, within the 90-day period prior to the filing of this report and under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer of the Company, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures. Based upon such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that such disclosure controls and procedures are effective in ensuring that material information relating to the Company is made known to the certifying officers by others within the Company during the period covered by this report. There were no significant changes in the Company’s internal controls for financial reporting or in other factors that could significantly affect such internal controls subsequent to the date of such evaluation. In connection with the new rules, the Company currently is in the process of further reviewing and documenting its disclosure controls and procedures, and its internal accounting controls, and may from time to time make changes as deemed necessary.

PART II - OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(3) Articles of Incorporation and By-laws:

3.1. The Restated Certificate of Incorporation of the Company is incorporated herein by reference to Exhibit 3.1 to Amendment No. 1 to the Company’s Registration Statement on Form S-1, Registration No. 33-10966, filed with the Securities and Exchange Commission on April 17, 1987 (“Amendment No. 1 to the Form S-1”).

3.2. The Amended and Restated By-laws of the Company are incorporated herein by reference to Exhibit 4.1 of the

Company’s current report on Form 8-K filed on December 28, 1992.

(11) Computation of Earnings Per Share:

Statement regarding computation of per share earnings is included in Note 1 to the consolidated financial statements.

(99) Statement as to certification under 906 of the Sarbanes-Oxley Act of 2002 is attached hereto as Exhibit 99.

(b) Reports on Form 8-K.

No reports on Form 8-K were filed by the Registrant during the quarter ended March 31, 2003.

SIGNATURES

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

	FIRST ESSEX BANCORP, INC.
	(Registrant)



Date: May 6, 2003	By	/s/ William F. Burke
		William F. Burke
		Executive Vice President and Chief Financial Officer

CERTIFICATIONS

I, Leonard A. Wilson, certify that:

(1) I have reviewed this quarterly report on Form 10-Q of First Essex Bancorp, Inc.;

(2) Based upon my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period presented in the report;

(3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition and results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

(4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

(5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weakness in internal controls;

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

(6) The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

May 6, 2003

/s/ Leonard A. Wilson
Leonard A. Wilson
Chairman of the Board and
Chief Executive Officer

I, William F. Burke, certify that:

(1) I have reviewed this quarterly report on Form 10-Q of First Essex Bancorp, Inc.;

(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

May 6, 2003

/s/ William F. Burke
William F. Burke
Executive Vice President and
Chief Financial Officer