## MANAGEMENT’ S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

Past due loans for the 2001 period decreased $4.3 million compared to the corresponding period of 2000 and included decreases of $3.1 million for commercial loans secured by real estate and $1.7 million for commercial and industrial loans. Past due loans secured by residential real estate and loans to individuals increased $622 thousand and $110 thousand, respectively over the same time period. Nonperforming loans as a percentage of total loans was 1.62% at December 31, 2001 compared to 1.41% at December 31, 2000. 

The Corporation’ s loan portfolio continues to be monitored by senior management to identify potential portfolio risks and detect potential credit deterioration in the early stages. During 2001 the Corporation established a “ Watchlist Committee”  which includes credit workout officers of the bank and meets bi-weekly to review watchlist credits for workout progress or deterioration. Loan loss adequacy and the status of significant nonperforming credits are monitored on a quarterly basis by a committee made up of senior officers of the bank and parent company. These committees were established to provide additional internal monitoring and analysis in addition to that provided by the credit committees of the banks and parent company. Credit risk is mitigated during the loan origination process through the use of sound underwriting policies and collateral requirements. The Corporation has also initiated an additional level of approval for credit relationships between $500 thousand and $1.0 million. This procedure requires approval of those credits by a committee consisting of senior lenders of the Corporation. Management also attempts to minimize loan losses by analyzing and modifying collection techniques on a periodic basis. Management believes that the allowance for credit losses and nonperforming loans remained safely within acceptable levels. 

## Capital Resources 

Equity capital increased $35.9 million in 2001 to $370.1 million. Dividends declared decreased equity by $34.1 million during 2001, an increase over dividends for the 2000 period. The retained net income of $16.1 million remained in permanent capital to fund future growth and expansion. Long-term debt payments and fair value adjustments to unearned ESOP shares increased equity capital by $1.2 million. The market value adjustment to securities available for sale increased equity by $16.5 million during 2001. Amounts paid to fund the discount on reinvested dividends 

reduced equity by $612 thousand. Proceeds from the reissuance of treasury shares to provide for stock options exercised increased equity by $2.5 million during 2001, while the tax benefit related to the stock options, increased equity by $269 thousand. 

A capital base can be considered adequate when it enables the Corporation to intermediate funds responsibly and provide related services while protecting against future uncertainties. The evaluation of capital adequacy depends on a variety of factors, including asset quality, liquidity, earnings history and prospects, internal controls and management caliber. In consideration of these factors, management’ s primary emphasis with respect to the Corporation’ s capital position is to maintain an adequate and stable ratio of equity to assets. See NOTE 25 to the Consolidated Financial Statements for an analysis of regulatory capital guidelines and the Corporation’ s capital ratios relative to these measurement standards. 

## Inflation and Changing Prices 

Management is aware of the impact inflation has on interest rates and therefore the impact it can have on a bank’ s performance. The ability of a financial institution to cope with inflation can only be determined by analyzing and monitoring its asset and liability structure. The Corporation monitors its asset and liability position with particular emphasis on the mix of interest-sensitive assets and liabilities in order to reduce the effect of inflation upon its performance. However, it must be remembered that the asset and liability structure of a financial institution is substantially different from an industrial corporation in that virtually all assets and liabilities are monetary in nature, meaning that they have been or will be converted into a fixed number of dollars regardless of changes in general price levels. Examples of monetary items include cash, loans and deposits. Nonmonetary items are those assets and liabilities which do not gain or lose purchasing power solely as a result of general price level changes. Examples of nonmonetary items are premises and equipment. 

Inflation can have a more direct impact on categories of noninterest expenses such as salaries and wages, supplies and employee benefit costs. These expenses are very closely monitored by management for both the effects of inflation and increases relating to such items as staffing levels, usage of supplies and occupancy costs. 

