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The allowance for loan losses is available to offset credit losses in connection with any loan, but is internally allocated to various loan categories as part of the CompanyGLYPH<213>s process for 

## Allocation of the Allowance for Loan Losses—Five-Year Schedule 

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## LIQUIDITY 

Liquidity is defined as the ability to meet current and future financial obligations. The primary objective of liquidity management is to maintain a balance between sources and uses of funds to meet the cash flow needs of the Company in the most economical and expedient manner. The liquidity needs of the Company require the availability of cash to meet the withdrawal demands of depositors and credit commitments to borrowers. Due to the potential for unexpected fluctuations in both deposits and loans, active management of the CompanyGLYPH<213>s liquidity is necessary. The Company maintains various sources of funding and levels of liquid assets in excess of regulatory guidelines in order to satisfy its varied liquidity demands. The Company monitors its liquidity in accordance with its internal guidelines and all applicable regulatory requirements. As of December 31, 2002 and 2001, the CompanyGLYPH<213>s level of liquidity exceeded its target levels. Management believes that the Company currently has appropriate liquidity available to respond to liquidity demands. Sources of funds utilized by the Company consist of deposits, borrowings from the Federal Home Loan Bank of Boston (GLYPH<210>FHLBBGLYPH<211>) and other sources, cash flows from operations, prepayments and maturities of outstanding loans, investments and mortgage-backed securities, and the sales of mortgage loans. 

Deposits continue to represent the CompanyGLYPH<213>s primary source of funds. In 2002, total deposits increased by $86.6 million, or 11.3%, over 2001, ending the year at $850.1 million. The Company experienced growth in all deposit categories in 2002. Comparing year-end balances 2002 to 2001, money market accounts increased by $35.1 million, certificates of deposit by $20.8 million, transaction accounts (demand deposits and NOW) by $20.6 million, and savings accounts 

evaluating its adequacy. The following table sets forth information concerning the allocation of the CompanyGLYPH<213>s ALL by loan categories at the dates indicated. 

by $10.0 million. In 2001, total deposits increased by $19.2 million, or 2.6%, over 2000, ending the year at $763.6 million. Borrowings supplement deposits as a source of liquidity. In addition to borrowings from the FHLBB, the Company purchases federal funds, sells securities under agreements to repurchase, and utilizes treasury tax and loan accounts. Total borrowings were $238.8 million at December 31, 2002 compared to $210.8 million at December 31, 2001, an increase of $28.0 million, or 13.3%. The majority of the borrowings were from the FHLBB, whose advances remained the largest non-deposit-related, interest-bearing funding source for the Company. Qualified residential real estate loans, certain investment securities and certain other assets available to be pledged secure these borrowings. The carrying value of loans pledged as collateral at the FHLBB was $236.3 million and $194.6 million at December 31, 2002 and 2001, respectively. The Company also pledges securities as collateral at the FHLBB depending on its borrowing needs. The Company, through its bank subsidiaries, has an available line of credit with FHLBB of $13.0 million at December 31, 2002 and 2001. The Company had no outstanding balance on its line of credit with the FHLBB at December 31, 2002 or 2001. 

In addition to the liquidity sources discussed above, the Company believes the investment portfolio and residential loan portfolio provide a significant amount of contingent liquidity that could be accessed in a reasonable time period through sales. The Company also believes that it has significant untapped access to the national brokered deposit market. These sources are considered as liquidity alternatives in the CompanyGLYPH<213>s contingent liquidity plan. The Company believes that the level of liquidity is sufficient to meet current and future funding requirements. 

## OFF-BALANCE SHEET ITEMS 

In the normal course of business, the Company is a party to credit related financial instruments with off-balance sheet risk, which are not reflected in the Consolidated Statements of Condition. These financial instruments include lending commitments and letters of credit. Those instruments involve varying degrees of credit risk in excess of the amount recognized in the Consolidated Statements of Condition. 

The Company follows the same credit policies in making commitments to extend credit and conditional obligations as it does for on-balance sheet instruments, including requiring similar collateral or other security to support financial instruments with credit risk. The CompanyGLYPH<213>s exposure to credit loss in the event of nonperformance by the customer is represented by the contractual amount of those instruments. Since many of the commitments are expected to expire without being drawn upon, the total amount does not necessarily represent future cash requirements. At December 31, 2002, the Company had the following levels of commitments to extend credit. 

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The Company is a party to several off-balance sheet contractual obligations through lease agreements on a number of branch facilities. The Company has an obligation and commitment to make future payments under these contracts. These commitments and the related payments are made during the normal course of business. At December 31, 2002, the Company had the following levels of contractual obligations. 

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The Company uses derivative instruments as partial hedges against large fluctuations in interest rates. The Company uses interest rate swap and floor instruments to partially hedge against potentially lower yields on the variable prime rate loan category in a declining rate environment. If rates were to decline, resulting in reduced income on the adjustable rate loans, there would be an increased income flow from the interest rate swap and floor instruments. The Company also uses cap instruments to partially hedge against increases in short-term borrowing rates. If rates were to rise, resulting in an increased interest cost, there would be an increased income flow from the cap instruments. These financial instruments are factored into the CompanyGLYPH<213>s overall interest rate risk position. The Company regularly reviews the credit quality of the counterparty from which the instruments have been purchased. At December 31, 2002, the Company had swap agreements with a notional amount of $30 million with the following cash flows. 

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The net cash flow reflected on the table above is based on the current rate environment. The Company receives a fixed 6.9% on the notional amount during the contract period from the counterparty on the swap agreements and pays a variable rate based on the prime rate, which is currently at 4.25%. The cash flow will remain positive for the Company as long as the prime rate remains below 6.9%. This derivative instrument was put into place to partially hedge against potential lower yields on the variable prime rate loan category in a declining rate environment. If the prime rate increases, the Company will experience a reduction of cash flow from this derivative instrument that will be offset by an increase in cash flow for the variable prime rate loans. 

